[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]





                          PERSPECTIVES ON THE
                            ECONOMIC OUTLOOK

=======================================================================

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                               __________

             HEARING HELD IN WASHINGTON, DC, MARCH 8, 2001

                               __________

                            Serial No. 107-6

                               __________

           Printed for the use of the Committee on the Budget


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                        COMMITTEE ON THE BUDGET

                       JIM NUSSLE, Iowa, Chairman
JOHN E. SUNUNU, New Hampshire        JOHN M. SPRATT, Jr., South 
  Vice Chairman                          Carolina,
PETER HOEKSTRA, Michigan               Ranking Minority Member
  Vice Chairman                      JIM McDERMOTT, Washington
CHARLES F. BASS, New Hampshire       BENNIE G. THOMPSON, Mississippi
GIL GUTKNECHT, Minnesota             KEN BENTSEN, Texas
VAN HILLEARY, Tennessee              JIM DAVIS, Florida
MAC THORNBERRY, Texas                EVA M. CLAYTON, North Carolina
JIM RYUN, Kansas                     DAVID E. PRICE, North Carolina
MAC COLLINS, Georgia                 GERALD D. KLECZKA, Wisconsin
ERNIE FLETCHER, Kentucky             BOB CLEMENT, Tennessee
GARY G. MILLER, California           JAMES P. MORAN, Virginia
PAT TOOMEY, Pennsylvania             DARLENE HOOLEY, Oregon
WES WATKINS, Oklahoma                TAMMY BALDWIN, Wisconsin
DOC HASTINGS, Washington             CAROLYN McCARTHY, New York
JOHN T. DOOLITTLE, California        DENNIS MOORE, Kansas
ROB PORTMAN, Ohio                    MICHAEL E. CAPUANO, Massachusetts
RAY LaHOOD, Illinois                 MICHAEL M. HONDA, California
KAY GRANGER, Texas                   JOSEPH M. HOEFFEL III, 
EDWARD SCHROCK, Virginia                 Pennsylvania
JOHN CULBERSON, Texas                RUSH D. HOLT, New Jersey
HENRY E. BROWN, Jr., South Carolina  JIM MATHESON, Utah
ANDER CRENSHAW, Florida
ADAM PUTNAM, Florida
MARK KIRK, Illinois

                           Professional Staff

                       Rich Meade, Chief of Staff
       Thomas S. Kahn, Minority Staff Director and Chief Counsel




                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, March 8, 2001....................     1
Statement of:
    Robert Greenstein, Executive Director, Center on Budget and 
      Policy Priorities..........................................     2
    William G. Gale, Joseph A. Pechman Fellow, the Brookings 
      Institution................................................    20
    Daniel J. Mitchell, McKenna Senior Fellow in Political 
      Economy, the Heritage Foundation...........................    44
    Bruce Bartlett, Senior Fellow, National Center for Policy 
      Analysis...................................................    49
Prepared statement of:
    Mr. Greenstein...............................................     7
    Mr. Gale.....................................................    24
    Mr. Mitchell.................................................    47
    Mr. Bartlett.................................................    51

 
                  PERSPECTIVES ON THE ECONOMIC OUTLOOK

                              ----------                              


                        THURSDAY, MARCH 8, 2001

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 9 a.m. in room 
210, Cannon House Office Building, Hon. Jim Nussle (chairman of 
the committee) presiding.
    Present: Representatives Nussle, Spratt, Sununu, Bentsen, 
Hoekstra, Clayton, Gutknecht, Price, Collins, Moran, Hooley, 
Brown, Watkins, Culberson, Brown, Moore, and Holt.
    Chairman Nussle. Good morning. We have a number of 
outstanding witnesses that we have asked to come before us 
today to testify before the committee on their perspectives on 
the future of our economy and the impact that that will have on 
the budget and vice versa. Before I begin, I would like to take 
a certain prerogative in that I would also invite Mr. Spratt as 
well, we have with us here today someone who at least from a 
committee standpoint needs absolutely no introduction. But I 
just want to highlight the fact that returning to our committee 
room today is Richard Cogan, who worked for this committee for 
127 years. [Laughter.]
    Actually I don't think it's quite that long. I believe you 
started with the Library of Congress and CRS back in about 
1973, is that right?
    Mr. Cogan. Right.
    Chairman Nussle. And after CRS is one of the longest-
serving staff members, majority or minority staff members, and 
you are now with the Center on Budget and Policy. While there 
have been times in the past when there has been good-natured, 
in a bipartisan manner, disagreements over particular policy, I 
have come to know Mr. Cogan during the discussion on budget 
process reform. He is an outstanding advocate for the budget 
and for the process for the 1974 act. I don't know if there's 
anyone in town or anywhere who has better knowledge about the 
budget policy and process.
    Even though you were on the other side many times, we 
welcome you back. We congratulate you on your retirement. We're 
kind of glad you're gone. [Laughter.]
    But I understand you keep coming back and that on a regular 
basis you're still providing some assistance. So we'll look 
forward to working with you in the future.
    But welcome back, and I'd invite Mr. Spratt, if he'd like 
to say anything.
    Mr. Spratt. Richard Cogan is sort of like Bill Clinton when 
he was at Andrews Air Force Base, and he said, everybody's 
wishing me goodbye, I'm not going anywhere. [Laughter.]
    We're glad you're here, Richard, and glad you're still 
available.
    And to our entire panel, let me say, Mr. Greenstein, Mr. 
Gale, Mr. Mitchell, Mr. Bartlett, I think we have a good 
segment of the spectrum represented here today. We're glad to 
have all of you. We appreciate your input, not just today, but 
from time to time, and we look forward to your testimony today.
    Chairman Nussle. We have four witnesses. First is Robert 
Greenstein, who's the Executive Director for the Center on 
Budget and Policy Priorities. Next is Bill Gale, Senior Fellow, 
in the Economic Studies Program at the Brookings Institution. 
Next we have Dan Mitchell, who is with the Heritage Foundation, 
a Senior Fellow in political economy. And last, certainly not 
least, is Bruce Bartlett, a Senior Fellow with the National 
Center on Policy Analysis.
    We welcome all four of you today. We appreciate your 
willingness to come and share your perspectives. And we would 
invite you, I'd ask unanimous consent that all members be 
allowed to put a statement in the record if they care to, and 
that all our witnesses be allowed to enter their full statement 
in the record, and that they take their time, if you can, to 
summarize your testimony in about 5, 6, 7 minutes if you could, 
so that we can get into some questions and some comments.
    So I'll invite Mr. Greenstein to begin. Welcome, and we'll 
receive your testimony.

 STATEMENT OF ROBERT GREENSTEIN, EXECUTIVE DIRECTOR, CENTER ON 
   BUDGET AND POLICY PRIORITIES; WILLIAM G. GALE, JOSEPH A. 
PECHMAN FELLOW, THE BROOKINGS INSTITUTION; DANIEL J. MITCHELL, 
   MC KENNA SENIOR FELLOW IN POLITICAL ECONOMY, THE HERITAGE 
FOUNDATION; AND BRUCE BARTLETT, SENIOR FELLOW, NATIONAL CENTER 
                      FOR POLICY ANALYSIS

                 STATEMENT OF ROBERT GREENSTEIN

    Mr. Greenstein. Thank you very much, Mr. Chairman. It's a 
pleasure to be here.
    If I could say just before starting, in your packets is my 
testimony. The testimony in this case is a series of charts and 
tables. I actually would like to walk through some of them, so 
I think it would work better, if it's possible, for members to 
have that out. Mr. Chairman, these are mostly tables with 
numbers in them, so it won't surprise you that the person who 
helped put together a lot of these numbers is the 
aforementioned Mr. Richard Cogan.
    If I were to start right at the beginning on these tables, 
you'll find first a table labeled Uncertainty of CBO Surplus 
Projections. The point I simply wanted to make here is the 
importance of the Congress exercising real caution with these 
projected budget surpluses. If you look at the bottom of the 
page, it tells you that based on CBO's estimates, CBO as you 
know has a chapter on uncertainty in its new report, that the 
chance, according to the CBO figures that the non-Social 
Security, non-Medicare HI surplus will only be half as large as 
projected is about one in three, the chance that we'll slip 
back into deficits with no change in policy is about one in 
five.
    To me this indicates the importance of taking a significant 
share of what is only a projected budget surplus and setting it 
to the side and using it for neither tax cuts nor spending 
increases at this point.
    The second table looks at the best information at this time 
of the cost of the tax cut in the President's budget. The first 
two figures are from the President's budget itself. The 
President's estimate of the budget's estimate of the tax cuts, 
which is a little over $1.6 billion, and of the interest costs 
associated with that, which are printed in the budget. Then we 
go to the Joint Committee on Taxation re-estimates of several 
provisions in H.R. 3 that are listed there, including but not 
limited to the acceleration. The joint committee believes the 
rate reductions in the plan will cost a bit more than the 
President's budget estimates. When we add those in we're up to 
$2.2 trillion.
    The final item on that list, if you flip back one page, you 
see a table that the Joint Tax Committee gave to the Ways and 
Means Committee last Thursday. It shows that under current law, 
the number of filers subject to the alternative minimum tax 
will explode from 1.5 million to 21 million by 2011 and that 
under H.R. 3 that will jump to 36 million. The joint committee 
also estimated the cost at nearly $300 billion simply of 
keeping the number of filers subject to the AMT at 21 million 
in 2011, rather than 36 million.
    Now, I recognize that fixing the AMT problem is not part of 
H.R. 3 or the President's budget as submitted. But I think, Mr. 
Chairman, we all know that we're going to have to address this, 
it will be addressed sometime in the next few years. Therefore, 
we need to leave room in the budget for it. The $300 billion 
figure I've shown here, it's really the $292 billion figure off 
the next page, really could be considered an unfunded liability 
of the President's tax proposal, because his proposal, 
according to the Joint Tax Committee, increases by $292 billion 
the cost of fixing the AMT.
    So we have a projection, we have figures here that suggest 
that about $2.5 trillion of the surpluses outside Social 
Security would be consumed by the tax cut. I would note that 
while there are some estimates and other witnesses here today 
will testify the economy could grow faster and that could 
reduce the number, there's an upside risk as well.
    And the upside risk is that these estimates do not include 
further revenue loss from substantial tax avoidance that could 
result from complete elimination of the estate tax. There are 
now a growing number of tax experts, tax attorneys, tax 
accountants, there have been two articles in Tax Notes, one in 
the New York Times, all outlining the kinds of tax avoidance 
strategies with regard to income and capital gains taxes that 
would likely develop from elimination of estate tax as 
currently proposed.
    Now, the question this next leads to is, does the budget 
reserve take care of this problem? The budget lists an $842 
billion reserve. First off, because the tax cut is now being 
adjusted upwards by the Joint Tax Committee, that $842 billion 
would be a smaller starting number. But let's use the $842 
billion that's in the budget. Over half of that, $526 billion, 
is really the surplus building up in the Medicare Hospital 
Insurance trust fund. The administration's budget takes the 
unprecedented step of adding together the total costs of 
Medicare Parts A and B, and comparing them to Medicare revenues 
from payroll taxes and premiums.
    But as you know, under the Social Security Act, Medicare 
Part A is supposed to be self-financing, Medicare Part B is 
supposed to have three-quarters of its financing coming from 
general revenues. To add the cost together in this fashion and 
leave out the general revenues and then argue that there's no 
surplus in the Medicare Hospital Insurance trust fund doesn't 
make a whole lot of sense. If you followed that logic, it would 
mean that every program in the Federal budget that is financed 
by general revenues is running a deficit. The Pentagon is 
running a deficit, the Military Pension Program is in deficit, 
it needs reform, we should cut back on pension benefits. The 
education and health research programs the President proposes 
to expand are in deficit.
    By this logic, everything in the budget that doesn't have 
an earmarked tax is in deficit. The Congress has purposely set 
up Medicare Parts A and B with different funding structures, 
and the situation in Part A is like that in Social Security. We 
have temporary surpluses now while the boomers are in their 
peak earning years. They all get drawn down when the boomers 
retire and all those funds are eventually needed.
    Ironically, if one does the kind of presentation the 
administration has to add, to artificially make the Medicare HI 
surplus disappear in order to add $500 billion to the surplus 
and the general fund, it makes it appear as though the Medicare 
surplus funds are available for other purposes, and that 
there's more room in the budget for the tax cut. But it really 
leaves less room for other things.
    Ironically, one of the tradeoffs is that if the tax cut is 
enacted, there will be less money available for an adequate 
Medicare drug benefit and for the infusion of resources into 
Medicare to restore long term solvency. No plan, Breaux-Frist, 
Breaux-Thomas or any other reform plan that has been proposed 
to date closes even half of the long term financing gap in 
Medicare. If we're not going to raise Medicare payroll taxes, 
then we're going to have to use general revenues to close the 
rest of the gap. But if the money's all gone on a tax cut, we 
don't have the general revenues left.
    Now, if we account for the Medicare surplus properly, that 
leaves only a little over $300 billion in the reserve. But 
there are several inevitable costs that are left out of the 
budget, and they consume more than $300 billion. Table S11 in 
the budget, Mr. Chairman, shows funding for agriculture 
programs cut nearly in half, because the budget does not 
include the continuation of the roughly $10 billion a year in 
payments to farmers Congress has provided on a bipartisan basis 
each of the last 3 years. I think we all know that something 
like that will be continued, and therefore $100 billion is 
needed in the budget for that.
    There is the alternative minimum tax problem I've 
mentioned. We now have Joint Tax Committee estimates keeping 
this from exploding into the middle class in a way neither 
party would want to see happen or will accept, entails a cost 
of $300 billion to $400 billion over the next 10 years if the 
Bush tax cut is passed. The budget takes some of the extenders, 
the tax credits that expire every 2 years and are always 
extended, it extends some of them for 1 year only.
    We know they're going to ultimately be extended for all 10 
years; $25 billion is left out for the cost of extending them 
through the 2d through the 10th year. When you simply add these 
three costs and the associated interest payments, it adds about 
$550 billion, which exceeds the $300 billion or so left in the 
reserve.
    In other words, to get out of all the technical detail, the 
bottom line is that when you add the numbers up, there really 
is no reserve left. The only way the numbers in the budget add 
up is if we go into the Medicare Hospital Insurance or Social 
Security reserves and use some of those funds for the rest of 
the Government, something that the House voted 407 to 2 or 
something like that a few weeks ago not to do. You either would 
have to do that, or do significant cuts in programs that are 
not specified in the budget.
    With that, let me turn to the table called Discretionary 
Spending in the Budget. Table S2 in the budget says that over 
the next 10 years, total discretionary spending will go up $30 
billion. But it also lists initiatives in discretionary 
spending for education, defense, health research and a few 
other areas, at plus $260 billion over the next 10 years. 
Although there's a little question of what baseline that $260 
billion is off of.
    If these numbers are right, it means the administration and 
the Congress would have to find $230 billion in unspecified 
discretionary cuts over the next 10 years, possibly more than 
that after the missile defense request comes up.
    Going to the next page, this raises questions such as, 
while the President said in the address to the Congress that 
education is the highest priority, do the numbers in the budget 
really support that? What we see here, maybe the easiest way to 
look at this is to take the 2011 column, everything is in full 
effect here. In the 2011 column, we see the budget has $4.5 
billion for education increases. The budget says that the tax 
cut that year is $254 billion. That is more than 50 times the 
amount for education in that year.
    Estate tax repeal alone is $60 billion, according to the 
President's budget. That's 14 times the education increase. Or 
if you go to the final figure here, half of the estate tax is 
paid by a tiny fraction of the estates, the biggest ones. About 
4,000, the estates of about 4,500 people in 2011, 7 percent, 
the largest 7 percent of the taxable estates, the taxable 
estates of the wealthiest one of every 1,000 people who die, 
would pay half of the estate tax. To repeal the estate tax, 
there is a $30 billion tax cut in 2011 for the estates of the 
wealthiest 4,500 people who die. Those 4,500 estates would get 
seven times the entire increase for the entire Nation in the 
education budget.
    The next page also shows you that if you look in the 
President's budget and the President's baseline over the next 
years, Function 500, which includes education, has no increase. 
It's an increase of $100 million over the whole next 5 years. 
How do we explain this?
    The only explanation can be that each dollar of increase in 
education is offset by a dollar of cuts in job training, child 
care or other programs in Function 500. There's no other way to 
interpret the numbers here.
    Let me conclude with two larger observations. A table I 
passed over, it's about the third or fourth table, it's called 
Policy Changes from the Budget in 2011. It tells you that in 
2011, the policy proposals in this budget would add $25 million 
on the spending side, about half of that in a modest Medicare 
drug benefit. And there's a $253 billion tax cut, about 10 
times as much.
    This helps explain the figures that are on the table called 
Tax Cuts for Top One Percent versus Tax Cuts for Initiatives. 
If one looks at not the Joint Tax Committee figures, not 
counting the AMT, bending over backwards to benefit the 
President, just looking at the cost of the tax cut as listed in 
his budget, without the higher Joint Tax Committee figures, and 
if we use figures for the proportion of the tax cut going to 
the top 1 percent that use the Treasury methodology for estate 
and corporate taxes, what we find is that about $555 billion 
over 10 years would go in tax reductions to the top 1 percent.
    If we then look at all of the initiatives in the budget, 
Medicare, education, health research, defense, a health 
insurance tax credit, everything in the budget combined here, 
it adds up to about $485 to $495 billion. That's before you 
lower the number to reflect the unspecified and other spending 
reductions that are in the budget. The point is that the top 1 
percent would indeed get more in tax reductions under the 
budget than every initiative area in the budget combined, 
including defense.
    So the bottom line, in my view, Mr. Chairman, is that a tax 
cut is appropriate but the budget lacks balance. The tax cut is 
much too large, the risk is high that at the end of the day, 
either Congress would have to go into the Social Security and 
Medicare Hospital Insurance trust funds to fund the rest of 
Government, or the Congress in future years would have to come 
up with several hundred billion dollars in cuts that are not 
specified today, and at the same time this is done, some of the 
biggest problems facing the country are largely unaddressed. 
There is no new money for long term Medicare solvency, the 
attention to the uninsured is small, and the drug benefit 
appears to be of a magnitude that wouldn't allow us to cover 
more than about 50 percent of drug costs until the senior 
incurred about $11,000 or $12,000 a year in out-of-pocket drug 
expenditures.
    So I think there is a problem with the balance here. 
There's really only one priority in the budget, and it is the 
tax cut.
    [The prepared statement of Robert Greenstein follows:]

Prepared Statement of Robert Greenstein, Executive Director, Center on 
                      Budget and Policy Priorities








                  THE ADMINISTRATION'S BUDGET RESERVE
    The budget lists a $842 billion reserve. Closer examination, 
however, indicates that no such reserve is likely to be available.
    1. Medicare: The budget does not set to the side the surpluses in 
the Medicare Hospital Insurance trust fund, claiming that Medicare has 
no surpluses and is in deficit. Tables in the budget show that OMB 
projects the Medicare Hospital Insurance trust fund will run a $526 
billion surplus over the next 10 years. The Medicare HI surplus, which 
policymakers of both parties have voted to set to the side and not to 
use to finance tax cuts or other programs, amounts to more than half of 
the so-called ``reserve.''
    Medicare Hospital Insurance (Part A) is financed by payroll taxes 
and, to a small degree, by a portion of the income taxes that are 
collected from the taxation of a portion of the Social Security 
benefits of higher-income beneficiaries. Medicare Hospital Insurance 
has its own trust fund. The physician's services part of Medicare (Part 
B) is funded separately and, unlike Part A, was never intended to be 
self-financing. One-fourth of its financing of Medicare Part B comes 
from monthly premiums that beneficiaries pay, but the other three-
fourths comes from general revenues. This is how Medicare was designed.
    The administration takes the unprecedented step of adding the total 
costs of Medicare Parts A and B and then comparing them to Medicare 
revenues from payroll taxes and premiums. Since three-quarters of 
Medicare Part B is intended to be funded by general revenue, the effect 
is to make it look like Medicare's costs exceed Medicare's income. The 
administration then pronounces the Medicare HI surplus as meaningless 
and claims that Medicare is in deficit so it has no surpluses to save. 
By this logic, all programs funded by general revenues--including the 
Pentagon, the military pension program, and the education and health 
research programs that the administration proposes to expand--are in 
deficit and thus in need of reform, as is everything in the budget not 
specifically financed by an earmarked tax.
    By artificially making the Medicare HI surplus disappear, the 
budget is able to add the $526 billion Medicare HI surplus to the 
surplus in the general fund. This makes it appear as though these 
Medicare HI funds are available for other purposes. This also makes it 
look as though there is more room in the budget for the tax cut and 
masks the trade-offs the large tax cut creates for the rest of the 
budget. Ironically, one of those trade-offs is that if the tax cut is 
enacted, there will be less money available for an adequate Medicare 
drug benefit and for an infusion of more general revenue into Medicare 
as part of a Medicare reform package that restores long-term solvency 
to the program.
    Once the Medicare HI surpluses are set to the side, only a few 
hundred billion dollars of the Administration's $842 billion reserve 
remains.
    2. Inevitable Costs that are Left Out. The budget leaves out a 
number of inevitable costs. These include:
     Continuing current payments to farmers, at a cost of about 
$100 billion over 10 years (Table S-11 shows spending for agricultural 
programs plummeting from $26.1 billion in 2001 to $14.9 billion in 2003 
and smaller amounts in subsequent years, because of the 
administration's failure to include the virtually inevitable costs of 
continuing these farm payments);
     Fixing a well-known problem in the Alternative Minimum Tax 
so it does not subject millions of middle-class families to the AMT, 
which entails a cost of $300 billion to $400 billion over 10 years if 
the Bush tax cut is passed; and
     Extending the expiring tax credits for 10 years (the 
budget shows the cost of extending most of these credits for only one 
year), which adds about another $25 billion.
     The more-than-$400 billion in costs just mentioned would 
also generate additional costs for interest payments on the debt. This 
would bring these costs to more than $550 billion, which exceeds the 
amount left in the reserve when the Medicare HI trust fund surplus is 
set to the side.
    3. Additional Costs the Administration has not specified. The 
budget does not include funds for a national missile defense or other 
defense spending increases that are likely to emerge from the 
Administration's defense review.

                               CONCLUSION
    Rather than creating a reserve for unforeseen contingencies, the 
budget lacks sufficient funds to avoid a return to deficits outside the 
Social Security and Medicare HI trust funds, unless sizable reductions 
in domestic programs are enacted.




















    Chairman Nussle. Thank you, Mr. Greenstein. Mr. Gale.

                  STATEMENT OF WILLIAM G. GALE

    Mr. Gale. Thank you very much, Mr. Chairman, Mr. Spratt and 
members of the committee. It's my pleasure to speak here.
    I think it's particularly important to be discussing tax 
cut issues in the Budget Committee, because what we're really 
having is a budget debate, or what we really should be having 
is a budget debate, not just a tax debate. It seems very 
difficult to assess the appropriateness of any tax or spending 
policy in the absence of an overall budget framework.
    So in my comments, I'd like to focus on three items. The 
first is the budget outlook, the second is the President's 
budget and tax proposals, and the third is a brief discussion 
of some of the arguments put forth for and against the 
President's tax cut.
    Let's start with the budget outlook. The most recent CBO 
forecast projects a surplus of $5.6 trillion over the next 
decade. But there's really only about $1.7 trillion there or 
less even that should be thought of as available for new tax 
cuts or new spending initiatives, if Congress is willing to 
adopt responsible budgeting practices and realistic forecasts 
of tax and spending policy.
    How do I get from $5.6 trillion to $1.7 trillion? It's 
basically in two steps. The first step, and the biggest step, 
is to note that almost 60 percent of that $5.6 trillion is due 
to accumulations in retirement trust funds, including Social 
Security, Medicare Part A and Government pensions for military 
and civilian workers. Congress has shown overwhelming support 
for protecting the Social Security and Medicare trust funds 
with the compelling logic that these funds represent current 
tax accumulations that are committed to future payments.
    As you all know, the House voted both last year and this 
year to protect Social Security and Medicare from invasions for 
other uses, and the Senate voted on two separate bills last 
year, passing both of them, and 98 out of 100 Senators voted in 
favor of at least one of those bills. So at least up until now, 
there's been overwhelming support in the Congress for the 
responsible fiscal policy of not spending the Social Security 
and Medicare surplus.
    If you remove Social Security and Medicare, the $5.6 
trillion falls to $2.7 trillion. But there's a third Government 
pension fund that doesn't get discussed much, and that's 
pension reserves that are set aside for military workers and 
civilian workers. Those pension funds are projected to run a 
surplus of $400 billion over the next 10 years. I would submit 
to you that the economic case for not allocating those funds to 
new spending or new taxes is identical to the economic case for 
not invading the Social Security and Medicare trust funds.
    Certainly no responsible firm would consider its pension 
fund as a source of expenditure for current operating expenses. 
No household, if it had a budget like the Government's, would 
think of itself as anything but drastically under-saving for 
retirement. So the Government and the Congress should not be 
fooled into thinking that $5.6 trillion is the right starting 
point. At the very least, we want to remove pension funds from 
the budget, and that reduces the total surplus to $2.3 
trillion.
    Let me put it differently. The budget contains the assets 
in these pension funds, but it does not record the liabilities 
in the pension funds. If we included the liabilities, we all 
know the Government would show a deficit right now, because 
it's severely underfunded in Social Security and Medicare in 
the long term. If you're not going to include the liabilities, 
at the very least, don't include the assets as funds that can 
be spent.
    So the best solution would be to include the liabilities 
and therefore show a deficit. If that were the case, we 
wouldn't be talking about $2 trillion tax cuts. But at the very 
least, if you don't include the liabilities, don't include the 
assets either. Just set it aside and focus on the rest.
    So that brings us down to $2.3 trillion. You get from $2.3 
trillion to $1.7 trillion by adjusting for problems for sort of 
rosy scenario assumptions about spending and tax policy. In 
particular, under current law, the number of people that are 
projected to be under the AMT is going to rise dramatically, as 
Mr. Greenstein mentioned. Also, current law assumes that the 
expiring tax provisions will actually expire. The budget 
prediction also assumes that real discretionary spending will 
fall by 10 percent on a per capita basis.
    So if you just hold discretionary spending constant per 
person and fix the AMT and expiring tax provisions, that's 
another $600 billion that's used up. That leaves you with $1.7 
trillion.
    I want to emphasize, though, that the $1.7 trillion is just 
the surplus over the next 10 years. If we did Government 
budgeting correctly, if we budgeted the way a firm did, right 
now we would show a long term deficit, not a surplus.
    Having said that, let's turn to the President's budget 
proposal. The President's budget essentially threatens to undo 
most of all of the hard-won fiscal gains of recent years. There 
are two items I'd like to emphasize. The first is the President 
proposes to divert about $1 trillion of Social Security and 
Medicare funds from the surpluses to other programs. He would 
take $600 billion of surplus in the Social Security fund and 
divert it from debt repayment. He would not use those funds to 
buy private assets to hold in revenue for future Social 
Security benefits either.
    But if the money is used for any purpose other than Social 
Security, other than for paying down debt or Government 
purchase of assets, then in fact the money is being taken away 
from the Social Security fund and would violate longstanding 
policy to keep Government's hands off that money.
    As Mr. Greenstein mentioned, the President would also spend 
the $400 million surplus in the Medicare Part A trust fund on 
supplemental medical insurance for the elderly, rather than 
having general revenue finance SMI. But the point is that the 
Medicare Part A surplus is legislatively committed to paying 
future Part A benefits. The Part A fund is in a cash flow 
surplus right now, but it's in long term deficit.
    So taking money away from the Medicare Part A current 
surplus makes the long term deficit there worse, and taking the 
money away from there and using it to finance the tax cut is at 
best ironic and at worst much worse than that.
    The second part of the President's proposal, besides 
allocating $1 trillion to Social Security and Medicare trust 
funds to other uses, is a very large tax cut. Mr. Greenstein 
went through the calculations. I could go through a different 
set of calculations that gets to the same $2.5 trillion figure. 
I won't go through those calculations.
    I will mention, however, that the President's budget has a 
non-Medicare, non-Social Security surplus of $2.5 trillion. If 
you take what I view as the realistic estimates that the JCT 
has made of H.R. 3, of Bush's previous proposal, of the 
proposals in the President's budget, and if you add in the AMT 
adjustment and interest costs, the total cost of the tax cut is 
$2.5 trillion. That is according to the administration's own 
budget forecast, and realistic assessments of the cost of the 
tax cut. There is nothing left to do anything over the next 10 
years unless Congress is willing to invade the Medicare and 
Social Security surplus.
    Well, how does the President get this $842 trillion reserve 
fund? Basically, he invades the Medicare and Social Security 
surplus, as I stated earlier. So the invasion of Social 
Security and Medicare is directly linked to the magnitude of 
the President's tax cut. And the magnitude of the President's 
tax cut means that from a budget perspective, there's no money 
left to do anything else the entire next 10 years unless one is 
willing to invade the Medicare-Social Security trust fund.
    Let's talk about some other aspects of the President's tax 
plan. The administration's rhetoric on the distributional 
effects of its plan has been exceedingly misleading and 
disingenuous. There is no doubt that this is a tax cut that is 
tilted toward high income households. Any reasonable measure of 
the distribution of the tax cut shows it's tilted toward high 
income households. They get a higher percentage increase in 
after-tax income, they get a larger percentage reduction in 
their total taxes, not their income taxes, but their total 
taxes. And of course, they get a hugely larger dollar tax cut. 
The administration has presented some very deceptive numbers on 
this, which are discussed in my testimony that I would be happy 
to discuss further in questioning.
    One of the most puzzling and misleading aspects of the 
President's defense of his tax cut, and of the defense put 
forth of H.R. 3 is that it's going to stimulate the economy. I 
don't think anyone takes this view seriously any more. Even 
H.R. 3, which accelerates the cut, only had $6 billion of 
stimulus in the first year, in a $10 trillion economy. On top 
of that, if you did want to stimulate the economy, you would 
want to put the money in hands of people who would be more 
likely to spend it, which are low and middle income households. 
These are also the households that are more likely to lose 
their jobs if there really is a recession.
    On top of that, because of how large the President's tax 
proposal is, and the implied need to fix the AMT, the magnitude 
of the tax cut could well force interest rates up, which of 
course would have a negative short term effect on the economy. 
So if ever there were a plan that were not designed to fight an 
immediate recession, it's the President's tax cut. And that 
shouldn't be surprising, because the President's tax cut was 
designed 15 months ago when there was no sign of recession on 
the horizon.
    Some people will argue that tax cuts are needed to prevent 
Government from going on a spending spree. I think we can all 
see there's some validity to that concern. But in the fact, in 
the past year, vast portions of existing surpluses have been 
allowed to accumulate, and discretionary spending right now is 
a smaller share of the economy than at any time since 1962, and 
it's projected to fall even more.
    So it's hard to argue that Government is vastly 
overspending relative to the size of the economy. In addition, 
if the Congress wants to impose spending discipline, the best 
way to do that is not to spend the Social Security and Medicare 
surpluses, rather than taking $1 trillion out of those 
surpluses for other uses.
    Chairman Nussle. Mr. Gale, if I could ask you to--don't 
rush, but if you could summarize the remainder of your 
testimony so we can hear from the other witnesses and get to 
questions from the members. Then if there are any points that 
you haven't had a chance to get to, by all means, in the 
question and answer period, you'll have full liberty to expand 
a little bit.
    Mr. Gale. May I take 15 more seconds?
    Chairman Nussle. No, don't rush, just if you could 
summarize the rest of your testimony briefly, we could move to 
the other two witnesses.
    Mr. Gale. Finally, if the argument is that we need a tax 
cut to restrain Government, even if that's the argument, we 
don't need a tax cut that is disproportionately tilted to high 
income households. So even if you think we need a tax cut to 
restrain Government, you don't have to cut taxes by tens of 
thousands of dollars for the highest 1 percent, and by tiny 
amounts for households in the bottom 40 percent of the income 
distribution.
    Finally, let me just briefly address the economic effects, 
and I'll be happy to talk about this more in questioning. We 
had a rise in the top tax rate from 31 percent to 39.6 percent 
in the early 1990's. At the time it was predicted that that 
would cause a recession, that that would cause a drastic 
cutback in the taxable income and the economic activity of high 
income households. In fact, we've seen exactly the opposite 
over the ensuing decade. We've had a huge spurt in reported 
income and in after-tax income among high income households 
after the 1993 tax increase.
    So if anyone tells you that cutting the tax rates by less 
than we increased it in 1993 is going to cause a huge positive 
spurt in economic activity, realize that that implies that the 
huge ``increase'' in 1993 should have caused a gigantic 
recession, and that we saw nothing like that.
    Thank you.
    [The prepared statement of William Gale follows:]

 Prepared Statement of William G. Gale, Joseph A. Pechman Fellow, the 
                         Brookings Institution

    Part of the analysis discussed in this testimony is the result of 
collaborative work with Professor Alan Auerbach, Department of 
Economics, University of California, Berkeley. All opinions should be 
ascribed to the author, however, rather than to Professor Auerbach or 
the trustees, officers, or staff of the Brookings Institution.

    Mr. Chairman and Members of the Committee: Thank you for giving me 
the opportunity to discuss the budget outlook and the options for tax 
policy. My testimony is divided into two sections. The first provides a 
summary; the second provides the background analysis that supports 
these views.

                                SUMMARY

                         1. THE BUDGET OUTLOOK
    The most recent Congressional Budget Office baseline forecast 
projects cumulative surpluses of $5.6 trillion between 2002 and 2011. 
But there is really only $1.7 trillion or less that can be thought of 
as ``available'' for new tax cuts or new spending, under responsible 
budgeting practices and realistic forecasts of tax and spending 
policies.
    Almost 60 percent of the projected surplus is due to accumulations 
in retirement trust funds. No financially responsible firm would 
consider its pension reserves as a source of financing for current 
operating expenses, and neither should the federal government. Both 
Houses of Congress have shown overwhelming support for protecting the 
social security and medicare trust funds, because they represent 
current tax collections that are committed to future uses. Cordoning 
off social security reduces the available surplus to $3.1 trillion. 
Protecting the Medicare trust fund reduces the amount to $2.7 trillion. 
Protecting the pension reserves of government military and civilian 
workers--which makes sense for same reasons as protecting social 
security and medicare--would reduce the available surplus to $2.3 
trillion.
    Extending the temporary tax provisions, and fixing problems that 
already exist under current law with the alternative minimum tax 
reduces the available funds to $2.1 trillion. Allowing real 
discretionary spending per person to remain constant reduces the amount 
of available funds to $1.7 trillion over the next 10 years. If 
discretionary spending were to grow at the rate of GDP, the available 
surplus would fall to $1.0 trillion.
    There is nothing sacrosanct about a 10-year planning horizon. For 
public policies such as social security and medicare, the official 
planning horizon is 75 years. Looking beyond the 10-year horizon is 
particularly important for assessing the budget outlook because the 
rapid growth in entitlement programs driven by an aging population and 
rapidly rising medical care expenditures is not projected to begin 
until later dates. Despite current surpluses, estimates in this 
testimony show that the government continues to face a long-term 
financial shortfall. This fundamental fact counters claims that 
Americans are being ``overcharged'' for government currently.

              2. PRESIDENT BUSH'S BUDGET AND TAX PROPOSALS
    The President's budget threatens to undo most or all of the hard-
won fiscal gains of recent years. The budget is hugely fiscally 
irresponsible in two main ways.
    First, the President proposes to divert about $1 trillion of social 
security and medicare surpluses from the trust funds for those 
programs. He would take $600 billion of surplus in the social security 
trust fund and place it in a general ``reserve'' fund that could be 
used for any future (and currently unspecified) purpose. He would spend 
the $400 billion surplus in the medicare part A trust fund on 
supplemental medical insurance for the elderly (Medicare part B), even 
though Medicare part A is in long-term deficit, and even though part B 
is funded by general revenues and insurance premia by statute.
    Second, the President has proposed a massive tax cut. The tax cut 
in his budget differs from the tax cut he sent up to Congress just a 
month earlier. The tax cut would cost in excess of $2 trillion, 
inculding interest costs. As implemented in HR 3, the tax cut would 
leave 36 million on the AMT by 2011. Fixing that problem would raise 
the cost to over $2.5 trillion.
    Thus, the President's budget:
     violates the otherwise consensus view that social security 
and medicare funds should be protected and effectively diverts $1 
trillion from those funds to other purposes;
     proposes a tax cut that would use up the entire non-social 
security, non-medicare budget, according to the President's own 
proposals;
     would leave no funding left for anything else, without 
either tapping into retirement trust funds or running a deficit, for 
the next decade.

              3. EVALUATING THE PRESIDENT'S TAX PROPOSALS
    The Administration has had a very difficult time providing a 
coherent justification for its tax package. Notably, the President's 
justifications for his tax proposal keep changing, but the proposal 
does not.
    Over the next 10 years, HR3, the other components of the tax plan 
that the President sent to Congress on February 8, and the new 
proposals in the budget would cut taxes by about $1.8 trillion. The AMT 
adjustments would total $292 billion, and the added interest payments 
on the federal debt caused by the reduction in federal revenues would 
cost another $418 billion. Thus, although the proposal is often 
referred to as a $1.6 trillion tax cut, the real cost would exceed $2.5 
trillion over the next 10 years. This is much larger than the 
``available surplus'' noted above, and implies that no other policy 
priorities could not be met unless Congress were willing to finance new 
programs with balances in the retirement trust funds or with deficit 
spending.
    The proposed tax cut would roughly triple the severity of the long-
term fiscal problem. Properly adjusted, Bush's tax cut is about as 
large as the net tax cut created by the 1981 and 1982 tax acts. But 
taxes on most families were much higher then than they are now, and tax 
rates had been rising steadily in years before that. In recent years, 
the tax burdens on most families have fallen.
    Besides being too large, the Administration's tax cut would be 
disproportionately tilted toward high-income taxpayers, who would 
receive a bigger percentage decline in tax payments, a bigger 
percentage increase in after-tax income, a bigger share of the total 
tax cut than their current tax share, and a gigantic cut in dollar 
amounts. The Administration's rhetoric on distributional effects has 
been particularly misleading and disingenuous.
    The President's efforts to ``take down the tollbooth to the middle 
class'' and to address the marriage penalty leave out households with 
earnings below $20,000, who often face the highest effective tax rates 
and the largest marriage penalties.
    One of the most puzzling and misleading aspects of the President's 
defense of the tax cut is his claim that it would be an effective way 
to fight a brewing recession. It is not clear that a recession will 
emerge, and most economists (myself included) feel that tax policy is a 
poor way to counter a recession. Even if tax policy were a good way to 
counter a recession, the President's tax proposal is incredibly poorly 
designed for that purpose. It is so big it would raise interest rates, 
which would hurt the economy. It is delayed (no tax cuts in 2001 and 
only $20 billion in 2002), and so cannot help fight a recession now. 
And it is geared toward high-income households, when it is low- and 
middle-income households that would be most likely to lose their jobs 
and most likely to spend the tax cut.
    Another argument the president uses to justify tax cuts is that tax 
revenues are at historic highs and therefore that Americans are being 
crushed by overburdensome taxes. But if a high aggregate federal tax 
burden justifies tax cuts, it should justify cuts in a variety of 
taxes, not just the income and estate taxes. About 74 percent of 
families pay more in payroll taxes, for example, than in income taxes. 
Focusing tax cuts only on income taxes and estate taxes thus ignores 
the major tax burden facing almost three-quarters of American families. 
In fact, for most families, taxes are as low or lower than they have 
been in the past 20-30 years. Overall tax payments have risen because 
the rich have gotten richer at an impressive rate.
    Some argue that tax cuts are needed to prevent government from 
going on a spending spree. There is clearly some validity to this 
concern, but the vast portions of existing surpluses have been allowed 
to accumulate, and discretionary spending is a smaller share of GDP 
today than it has been in any year since at least 1962, so the argument 
is weakened considerably. And it is Congress that has been willing to 
cordon off Medicare, not the Administration. Finally, even if this 
argument justifies a tax cut, it does not provide a rationale for why 
the tax cut should be focused on the highest-income households.
    An argument put forth recently by Alan Greenspan, and quickly 
repeated by tax cut advocates, is that under current surplus 
projections, the government will pay off all available government debt 
by around 2006 or shortly thereafter. Greenspan and others argue that 
having the federal government hold such assets would raise a number of 
difficult issues. These issues are real, but the concerns are seriously 
overstated. Currently, for example, state and local government pension 
funds hold private assets equal to 28 percent of GDP.

                           4. POLICY OPTIONS
    The current fiscal surpluses are a significant accomplishment, and 
should not be taken lightly or for granted. There is clearly room for a 
tax cut, for spending priorities, and for debt reduction. But I believe 
that the most important budgeting decision for the Congress is to 
establish a new set of budget rules, and that these rules should be 
established before making a significant set of tax and spending 
changes.

                            A. BUDGET RULES
    The fiscal accomplishments of the last decade should be preserved 
and enhanced, not squandered. The old rules are expiring. And the 
current budget situation has dangers associated with it, since there 
are short-run surpluses but long-term deficits. Consideration of policy 
rules should take several factors into account. First, there is a 
certain asymmetry in policy options. It is always easier to reduce 
taxes later than to raise them. Second, new and unforeseen policy 
priorities frequently arise, so prudent fiscal management would suggest 
the equivalent of a ``reserve fund'' of some sort. Third, both budget 
projections and economic forecasts are subject to considerable 
uncertainty, which suggests another reason not to commit all available 
resources immediately.
     Reaffirm the commitment to protect social security and 
medicare and extend the same treatment to government pension reserves.
     Adopt a proposal put forth recently by Robert Reischauer 
to cordon off increasing amounts of future surpluses from current 
commitments.

                            B. TAX POLICY
    Tax policy should be made inside of a budgetary framework that 
recognizes the importance of other public policy goals-such as 
education, health, defense, the refurbishing of social security and 
medicare and so on. In addition, fairness, efficiency, and simplicity 
remain the core principles of tax policy regardless of the size of the 
surplus.
     Create a new, lower tax bracket of 10-12 percent, covering 
a range of income broader than the 10 percent bracket proposed by 
President Bush.
     Combine or integrate interactions between the child 
credit, earned income credit, and personal exemption. This would 
simplify taxes, improve incentives to work and marry, and provide added 
resources to low-income households. A crucial element would be to 
increase the refundability of the child credit.
     Simplify the tax code by raising the standard deduction, 
providing a uniform exclusion for capital gains income rather than the 
complicated patchwork of capital gains tax rates we currently have.
     Provide tax cuts to high-income taxpayers and simplify the 
tax system further by removing the phaseout of personal exemptions and 
the limitations on itemized deductions. Either reform or abolish the 
alternative minimum tax.
     Reform the estate tax by raising the effective exemption, 
modestly reducing rates, indexing the tax for inflation, and closing 
down a number of egregious sheltering practices.

          EVALUATING THE BUDGET SURPLUS AND TAX POLICY OPTIONS

                         1. THE BUDGET OUTLOOK
    After decades of deficits, the federal budget has recently yielded 
increasing annual surpluses. The most recent Congressional Budget 
Office baseline forecast, released in January projects cumulative 
surpluses of $5.6 trillion between 2002 and 2011, including $2.5 
trillion in the social security trust fund (the ``off budget'' surplus) 
and $3.1 trillion in the rest of the budget (the ``on-budget'' 
surplus).
    Just as perennial budget deficits dominated policy discussions in 
the 1980s and early 1990s, choices regarding how to use these surpluses 
will shape fiscal debates for years to come. Debates regarding these 
choices are almost always carried out in the context of CBO's baseline 
forecast. However, while it provides a common and visible benchmark, 
CBO's baseline is limited in several crucial ways and does not provide 
sufficient information to assess various policy options.
    To assess policy options accurately requires a measure of the 
surplus that would be available for tax cuts or new spending under 
responsible budgeting procedures, plausible assumptions about the 
maintenance of current policy, and appropriate time horizons. To obtain 
these measures, it is necessary to adjust the baseline forecast for the 
treatment of retirement funds, the definition of ``current policy;'' 
and the time horizon employed. These adjustments provide different 
perspectives on the size of the available surplus and generally imply 
that the funding likely to be available for new tax cuts or spending 
programs is substantially less than the baseline forecast-and the 
current policy debate-would suggest.

               A. THE TREATMENT OF RETIREMENT TRUST FUNDS
    No financially responsible firm would consider its pension reserves 
as a source of financing for current operating expenses. Neither should 
the federal government. This simple but fiscally prudent observation 
has a significant impact on estimates of the available surplus.
    As noted above, a substantial portion of currently projected budget 
surpluses over the next 10 years occurs because the Social Security 
trust fund will take in about $2.5 trillion more in payroll tax 
revenues and interest received on its assets than it will pay out in 
benefits and administrative costs. Leaders of both political parties 
agree that accruing Social Security trust fund balances should 
contribute to improving that program's long-term financial viability, 
and should not be used to finance tax cuts or other spending programs.
    Medicare pays for health care for the elderly, and is divided into 
two parts. Part A, hospital insurance, covers hospital costs and is 
financed by payroll taxes. Part A is very similar in structure to 
social security. Workers contribute payroll taxes to a trust fund while 
working and receive promised benefits when they are elderly. Part B, 
supplementary medical insurance, is financed by a combination of user 
fees and general revenues. Over the next 10 years, the Medicare (Part 
A) trust fund is projected to run surpluses totaling $392 billion (CBO 
2001, p. 19). Although Medicare is officially part of the on-budget 
surplus, both Houses of Congress voted last year to support measures 
that protected the Medicare trust fund from being used to finance other 
programs or tax cuts. The House of Representatives approved the measure 
by a vote of 420-2. The Senate passed two separate measures; 98 
Senators voted in favor of one or both. The strong votes demonstrated 
overwhelming Congressional support for preserving the Medicare trust 
fund. In 2001, the House again has voted overwhelmingly to protect 
Medicare surpluses.
    While the social security and Medicare trust funds have received 
significant attention in the budget debate, a third set of retirement 
funds has not. Trust funds holding pension reserves for federal 
military and civilian employees will accrue surpluses of $419 billion 
over the next 10 years (CBO 2001, p. 19). Under current budget 
procedures, these surpluses are a component of the on-budget surplus. 
Like Social Security and Medicare, however, these trust funds represent 
current accumulations intended to provide retirement benefits to future 
workers. Thus, the same economic logic that has led fiscally 
responsible leaders to protect Social Security and Medicare balances, 
implies that government pension reserves should be protected as well. 
Many states, in fact, already separate their pension reserves from 
funds available for tax cuts and other spending. A recent proposal (H. 
RES. 23) by Representatives Baron Hill (D-Indiana) and Gene Taylor (D-
Mississippi) would protect the pension reserves owed to military 
workers. Fiscal responsibility requires that the same protections be 
accorded to civilian pensions as well.

                  B. THE DEFINITION OF CURRENT POLICY
    In order to project future spending and tax revenues, assumptions 
must be made about how tax and spending programs will evolve. The CBO's 
baseline forecast is intended only to measure the implications of 
maintaining ``current policy.'' But how one should project current 
policy into the future is not always obvious. The baseline forecasts 
project current policy subject to a variety of statutory requirements, 
which limit the scope of the forecast's underlying assumptions and time 
horizons and can be at variance with reasonable expectations.
    Mandatory spending-e.g., entitlements, such as Social Security-is 
generally assumed to continue as it is currently structured in the law. 
Discretionary spending, however, poses problems with regard to defining 
``current policy.'' Unlike mandatory spending, discretionary programs-
e.g., defense, education, the environment, or infrastructure-are not 
automatically included in the annual budget and thus require annual 
appropriations from Congress. As a result, no consensus exists about 
how to project current policy for discretionary programs. In light of 
this quandary, CBO simply assumes that real discretionary spending 
authority will remain constant at fiscal year 2001 levels (CBO 2001, p. 
76).
    This assumption is clear, but may not be very reasonable. 
Discretionary spending totaled 6.3 percent of GDP in 1999 and 2000, the 
lowest share since at least 1962. Under CBO's baseline forecast, 
discretionary spending would fall to 5.1 percent of GDP. That is, it 
would fall by 20 percent relative to the size of the economy. It would 
also fall by over 10 percent in per capita terms. In a growing economy 
with large surpluses, growing defense needs, and other concerns, this 
seems to be a particularly draconian baseline.
    At the very least, it would be more reasonable to have real 
discretionary spending grow at the same rate as the population (about 1 
percent per year). This would hold real discretionary spending per 
person constant, but would still allow spending to fall to 5.6 percent 
of GDP by 2011. Incorporating this baseline would raise discretionary 
spending by $359 billion (CBO 2001, table 4-4) and, counting the added 
interest payments on federal debt that would be required, would reduce 
available surpluses by about $418 billion.\1\
---------------------------------------------------------------------------
    \1\ Interest payments are estimated by assuming the federal 
government pays an average of the 3-month rate and the 10-year rate on 
outstanding debt (CBO 2001, table E-2), that half of the increased 
expenditures in a given year accrue interest costs during that year, 
and all of the increased expenditures in a given year accrue interest 
costs in future years.
---------------------------------------------------------------------------
    A more ambitious alternative baseline would have discretionary 
spending grow at the same rate as nominal GDP, thus keeping the ratio 
of discretionary spending to GDP constant. This would raise spending by 
$905 billion (CBO 2001, table 4-4) and reduce the available surplus by 
$1,055 billion between 2002 and 2011.
    To put these figures in perspective, note that in the campaign 
President Bush proposed new spending programs totaling $475 billion, 
along with cuts in government spending of $196 billion, for a net 
spending increase of $279 billion between 2001 and 2010 (table 1). This 
is virtually identical to the cost of having real discretionary 
spending grow by 1 percent over the same period (rather than over 2002-
2011, see CBO table 4-4). Thus, this suggests that having real 
discretionary spending grow by 1 percent is a lower bound for the 
likely path of discretionary spending, both because Congressional 
Democrats and Republicans may have proposals of their own sometime over 
the next 10 years, and because President Bush may have more proposals 
for spending-especially on defense-after his initial round of 
proposals.
    At least two aspects of current policy toward taxation merit 
consideration. The first regards the alternative minimum tax (AMT), one 
of the most complex areas of individual tax law. The AMT was 
implemented as a sort of backstop confronting the small number of 
taxpayers who are considered to be too aggressive in creating shelters 
and claiming deductions to avoid paying taxes.
    In practice, the AMT has affected few taxpayers. In 2000, for 
example, about 2 million taxpayers faced the levy. Under current law, 
however, the Treasury projects that by 2011, 21 million taxpayers will 
be affected by the AMT. The main reason why is that the AMT exemption 
is not indexed for inflation. CBO's surplus forecasts assume that the 
dramatic rise in AMT taxpayers will occur. However, the increase would 
be fought fiercely by the affected groups. Indeed, the problem has 
already received significant attention, even though only a small 
portion of taxpayers currently face the tax.
    ``Current policy'' would be better represented by indexing the AMT 
for inflation. This would keep the number of taxpayers on the AMT 
limited to about 1.9 percent by 2010. The lost tax revenue from this 
policy would total $113 billion over the next 10 years. Counting the 
added interest, the net cost would be $130 billion.\2\
---------------------------------------------------------------------------
    \2\ Estimates of the revenue loss from indexing the AMT from 2002 
to 2010 are taken from Rebelein and Tempalski (2000). The estimates 
rise steadily and reach $18 billion by 2009, and $24 billion by 2010. I 
extrapolate the 2011 revenue loss to be $30 billion.
---------------------------------------------------------------------------
    A second tax issue relates to temporary tax provisions, a number of 
which are scheduled to expire over the next decade. For all taxes other 
than excise taxes dedicated to trust funds, CBO assumes that legislated 
expirations occur as scheduled. In the past, however, the temporary 
provisions have typically been extended another few years each time the 
expiration dates approached. In light of this practice, current policy 
is more aptly viewed as assuming that these so-called ``extenders'' 
will be granted a continuance. Extending the provisions-except the one 
relating to AMT, which is addressed above-through the 10-year horizon 
would cost a net of $69 billion in lost revenues (CBO 2001, table 3-
12), plus an estimated additional $13 billion in interest costs.

    C. IMPLICATIONS FOR THE AVAILABLE SURPLUS OVER THE NEXT 10 YEARS
    Table 2 shows that these adjustments have a profound effect on the 
amount of funds that should be considered to be available for tax cuts 
or new spending. (Appendix table 1 provides year-by-year estimates of 
the alternative surplus measures.) The total 10-year projected surplus 
of $5.6 trillion is shown in the first line. Removing the social 
security trust fund surplus generates an ``on-budget'' surplus of $3.1 
trillion. Removing Medicare trust funds reduces the surplus to $2.7 
trillion. Protecting government pension funds from invasion for other 
purposes reduces the available surpluses to $2.3 trillion. That is, 
almost 60 percent of the projected 10-year surpluses are due to the 
retirement trust funds.
    Adjusting for the issues regarding the AMT and expiring tax 
provisions reduces the available surplus to $2.1 trillion. If real 
discretionary spending were held constant on a per capita basis-or if 
President Bush's spending plans were implemented-the net available 
surplus for other programs would be just under $1.7 trillion. In 
contrast, if discretionary spending were held constant as a share of 
GDP, the remaining available surplus would be about $1 trillion (table 
3).
    Thus, depending on what is considered the most reasonable 
assumption regarding current policy toward discretionary spending, the 
available surplus is between $1.0 trillion and $1.7 trillion. This 
represents between 18 and 30 percent of the total surplus, and roughly 
one-third to one-half of the on-budget surplus over the 10-year period. 
The Center on Budget and Policy Priorities (CBPP) has made a similar 
set of adjustments and estimated an available surplus of about $2 
trillion over the next 10 years (Greenstein and Kogan 2001).\3\
---------------------------------------------------------------------------
    \3\ The CBPP estimates differ from the estimates presented here in 
a number of ways. CBPP focuses on holding discretionary spending per 
capita constant, does not adjust for government pension reserves, and 
includes adjustments for some other programs, such as farm spending. 
The differences between the CBPP estimates and the ones presented 
above, however, are small relative to their similarities: both studies 
make the case that the surplus available for new spending programs or 
tax cuts is much less than it appears to be, based on the baseline 
forecast.
---------------------------------------------------------------------------

                 D. LOOKING BEYOND THE 10-YEAR HORIZON
    There is nothing sacrosanct about a 10-year planning horizon. For 
public policies such as social security and medicare, the official 
planning horizon is 75 years. Indeed, an analysis of social security's 
finances that focused only on the next 10 years would not pass a laugh 
test. Likewise, many important private economic decisions, such as how 
an investor values a firm's stock, or how a family sets the parameters 
of a financial plan, also typically depend on perceptions of events 
that will occur more than 10 years into the future. Looking beyond the 
10-year horizon is particularly important for assessing the budget 
outlook because the rapid growth in entitlement programs driven by an 
aging population and rapidly rising medical care expenditures is not 
projected to begin until later dates.\4\
---------------------------------------------------------------------------
    \4\ Although CBO is the source of the 10-year baseline forecast, 
CBO itself warns several times of the dangers of ignoring the longer-
term situation (see CBO 2001, p. xiv and pp. 4-5) and in fact regularly 
publishes estimates of the federal government's long-term fiscal status 
(see CBO 2000). David Walker, head of the General Accounting Office, 
also testified recently on the importance of taking the long-term 
budget picture into account.
---------------------------------------------------------------------------
    To take these and other factors into account, previous research 
(Auerbach 1994 and 1997, Auerbach and Gale 1999, 2000) estimates the 
long-term ``fiscal gap'' under different policies. The fiscal gap is 
the size of the permanent increase in taxes or reductions in non-
interest expenditures (as a constant share of GDP) that would be 
required now to keep the long-run ratio of government debt to GDP at 
its current level. The fiscal gap gives a sense of the current 
budgetary status of the government, taking into account long-term 
influences.
    These estimates use the current CBO 10-year forecast through 2011 
and CBO long-term budget forecasts through 2070. In subsequent time 
periods, all revenues and non-interest expenditures are assumed to 
remain a constant share of GDP. Social Security and Medicare outlays 
follow the intermediate projections in the reports released by the 
trustees of the funds. Discretionary spending, federal consumption of 
goods and services, and all other government programs, with the 
exception of net interest, are assumed to grow with GDP after 2010. Tax 
revenues are a constant share of GDP, except for supplementary medical 
insurance premiums collected for Medicare, which grow relative to GDP.
    Table 4 shows that different measures of current policy can have a 
significant impact on the long-term fiscal status of the federal 
government, if these policies establish levels of spending or taxes 
that are preserved (relative to GDP) after 2011.\5\ Under the CBO 
baseline assumptions about discretionary spending, the fiscal gap 
through 2070 is projected to be 0.67 percent. That implies that a 
permanent tax increase of 0.67 percent of GDP, which would currently be 
about $67 billion, would be required to restore fiscal balance through 
2070. The fiscal balance on a permanent basis is currently 3.33 percent 
of GDP. Allowing discretionary spending outlays to remain constant as a 
share of GDP raises the fiscal gap further, to 1.45 percent of GDP over 
the next 70 years and 4.14 percent on a permanent basis.
---------------------------------------------------------------------------
    \5\ I thank Alan Auerbach for providing the estimates in table 4.
---------------------------------------------------------------------------
    In light of the recent political pressure to raise spending and/or 
cut taxes, it seems highly unlikely that there will be any immediate 
action to reduce the fiscal gap. But delaying the implementation of 
necessary tax increases or spending cuts will raise the required fiscal 
correction at the time of implementation.
    All of the calculations above show that systematically 
incorporating longer horizons implies that the government faces 
significant financial shortfalls. This, of course, significantly 
damages the case for large-scale tax cuts today. Remarkably, however, 
some tax cut advocates try to use horizons (slightly) longer than 10 
years to justify large tax cuts. They argue that when the 10-year 
projection period changes next year to 2003 to 2012 (from the current 
2002 to 2011), the 10-year projected surplus will rise dramatically 
because adding the surplus projected for 2012 will far outweigh the 
loss of the surplus projected for 2002. Their claim is correct as far 
as it goes, but is misleading. It is essentially arguing for an 11-year 
perspective, which completely ignores the long-term fiscal shortfall.

                             E. UNCERTAINTY
    It is difficult to predict the course of the economy over a period 
as short as 6 to 9 months. Thus, it should not be surprising that all 
of the estimates above are subject to a considerable amount of 
uncertainty. A few comments on the uncertainty of the forecasts are 
warranted.
    First, CBO's underlying economic assumptions do not appear to be 
unreasonable. Their forecast for GDP growth over the next two years-2.4 
percent in 2001 and 3.4 percent in 2002-is in the middle of the Blue 
Chip forecasters. Notably, CBO does not foresee a recession in 2001, 
just a slowdown. Just as notably, CBO projects that the economy will 
turn around and growth will accelerate in 2002, even without any 
changes in tax or spending policy. CBO predicts a growth rate of about 
3.1 percent for the rest of the decade, which does not seem out of line 
with reasonable expectations. CBO (2001, p. 60) points out that its 
forecast does not depend on a continuation of high capital gains 
revenues or high stock market values and in fact projects a decline in 
the share of revenues from capital gains.
    Second, there is simply a huge amount of uncertainty regarding the 
evolution of the economy and the surplus. CBO (2001, p. 99) reports 
optimistic and pessimistic scenarios for the economy, where the 10-year 
surpluses range from $8.8 trillion to $1.6 trillion. In the latter 
case, there is an on-budget deficit of about $525 billion over the 10 
years. CBO (2001, p. 96) also notes that on average their revenue 
forecast has been off by 11 percent of revenues after 4 years. If 
revenues were 11 percent higher or lower than forecast over the next 10 
years, the surplus would differ from baseline by about $3.9 trillion. 
Interestingly, CBO (2001, p. 102) estimates that a mild recession 
followed by higher-than-trend growth would have little effect on the 
10-year surplus, but that does not preclude a deeper, longer recession 
or a change in the long-term growth rate from having a significant 
impact.
    Third, an important source of uncertainty stems from the fact that 
the surpluses are expected to rise over time. Only 12 percent of the 
projected total surplus and 10 percent of the projected on-budget 
surplus occurs in the first two years. Likewise, only 36 percent of the 
projected total surplus and 32 percent of the projected on-budget 
surplus occur in the first five years.
    Fourth, other things equal, long-term estimates are inherently more 
uncertain than short-term estimates. But the added uncertainty should 
not lead us to ignore long-term issues, for at least two reasons. 
First, the serious consequences of a relatively bad long-term outcome 
should spur a precautionary response from policymakers now (Auerbach 
and Hassett 2000). Second, over the next 10 years, the primary factor 
affecting surpluses will be the course of the economy, which as noted 
above, is uncertain. In contrast, in the longer-term, the demographic 
pressures that are due to an aging population are far more certain to 
occur.

               F. IMPLICATIONS FOR THE TAX POLICY DEBATE
    These findings suggest some useful lessons for the current debate 
about how to allocate the surplus. The virtually exclusive emphasis 
given to baseline 10-year budget projections in current fiscal policy 
debates is inappropriate. The baseline forecast suggests the 
availability of trillions of dollars for tax cuts or new spending, but 
is based on a particular set of views of what constitutes current 
policy. Fiscal responsibility and plausible notions of current policy 
reduce the available 10-year surplus to between $1.0 and $1.7 trillion.
    Despite the recent strong improvement in the government's fiscal 
position, there is still a long-term imbalance. This imbalance is a 
``future'' problem only insofar as our budget accounting rules ignore 
the existence of liabilities already accrued.
    Given this long-term imbalance, the fiscal climate may be more 
troubling now than in previous years. The short-term surplus and the 
decline in the long-term fiscal gap are no doubt improvements, but 
fiscal discipline may be especially difficult to impose under current 
conditions. In the 1980s and early 1990s, when the country faced both 
short-term and long-term deficits, the short-term deficits helped focus 
attention in a way that also helped reduce long-term gaps. Today, the 
United States faces the same trade-off between current and future 
generations as in earlier decades, and it is still confronting a long-
term shortfall. But the current policy discussion focuses on ways to 
use the surplus that would likely exacerbate the long-term situation.

              2. PRESIDENT BUSH'S BUDGET AND TAX PROPOSALS
    President Bush's budget predicts a baseline surplus of about $5.6 
trillion, a non-social security surplus of $3.0 trillion, and a non-
medicare, non-social security surplus of $2.5 trillion. While these 
numbers are reassuringly similar to the CBO figures, the budget departs 
from fiscally responsible actions in three main ways.
    The first concerns the social security trust fund. Normally, trust 
fund surpluses are used to add to government saving, by paying down the 
debt. The President, however, would divert $600 billion of social 
security trust fund surpluses from debt repayment into a ``reserve 
fund.'' The Administration argues that it cannot use those surpluses to 
finance debt repayment because there will not be enough purchasable 
government debt outstanding. An alternative (discussed below) would be 
to purchase private assets with the funds, but the Administration 
claims to be philosophically opposed to such a view (even though the 
state of Texas holds $21 billion in private assets as part of pension 
fund for government workers). The ``reserve fund'' is the only 
alternative left, according to the Administration. However, the amount 
of available debt to be repurchased is controversial and CBO and Fed 
Chairman Alan Greenspan both suggest that the relevant amount that can 
be repurchased is hundreds of billions of dollars larger than the 
Administration claims. Moreover, if those funds are placed in the 
``reserve fund'' they are not being used to protect the social security 
surplus and thus represent a violation of the virtually unanimous 
agreement in both Houses of Congress to protect those funds.
    The second fiscally irresponsible act involves siphoning off the 
Medicare trust fund surplus to pay for the rest of Medicare. Medicare 
part A is financed by payroll taxes and is currently running a cash 
flow surplus. That surplus, however, is nowhere near sufficient to 
finance future Medicare part A payments-the part A system as a whole is 
in long-term deficit. That is why it is important not only to save the 
part A surplus, but to supplement that surplus with additional funds 
over the years. The Administration goes in exactly the opposite 
direction. Not only does it make no effort to fund the long-term 
deficit in Medicare part A, it also takes away the surplus in part A by 
spending the funds on current supplemental medical insurance for the 
elderly. This is a gross violation of the use of the Medicare surplus, 
and flies in the face of efforts of responsible members of Congress 
from both parties who have tried to protect the fund.
    The third fiscally irresponsible act is the President's tax 
proposal. The proposal contains several major elements, and is phased 
in gradually over time (Bush-Cheney 2000, JCT 2000a). The most 
important elements, listed in order of their revenue cost when fully 
phased in, are:
     Reduce the highest income tax rates.
    By 2006, tax rates in the 39.6 and 36 percent brackets would fall 
to 33 percent, and rates in the 31 and 28 percent brackets would fall 
to 25 percent.
     Abolish the estate tax.
    The estate tax would be reduced gradually and then abolished in 
2009. It is unclear whether any changes in the taxation of capital 
gains at death would occur.
     Create a new 10 percent tax bracket.
    The first $6,000 of taxable income for singles and $12,000 for 
married couples would be taxed at 10 percent rather than 15 percent.
     Expand the child credit to high-income households, reduce 
the phase-out rate, and double the credit amount.
    Eligibility for the full credit would be extended to all taxpayers 
with income below $200,000 (up from $110,000 for married couples and 
$75,000 for singles, currently), the phaseout rate would fall from 5 
percent to 2 percent, and credit would double to $1,000. The credit 
would remain non-refundable.
     Allow a two-earner deduction.
    Allow a 10 percent deduction for the earnings of the lower-earning 
spouse in a two-earner family. The maximum deduction would start at 
$12,000 in 2002 and rise to $30,000 in 2005.
    Other components include allowing a charitable contributions 
deduction for households that do not itemize, allowing individuals aged 
55 and over to make penalty-free withdrawals from their IRAs to make 
charitable contributions, raising the cap on corporate charitable 
contributions from 10 percent to 15 percent of taxable income, 
expanding the limits and uses of educational IRAs, and permanently 
extending the credit for research and development.
    Recently, HR 3 included the creation of a new bracket and the 
reduction in the marginal tax rates, with the latter accelerated one 
year. The Joint Committee on Taxation has estimated that if HR 3 were 
enacted, approximately 36 million taxpayers would face, or be affected 
by, the AMT by 2011. This is 15 million more than the 21 million that 
would be placed under the AMT under current law. The Bush 
administration has acknowledged that the AMT creates a problem for the 
proposed tax cut . Indeed, the tax program on the Bush campaign web 
site (where voters could calculate how much of a tax cut they would 
receive under Bush's plan) did not allow for the AMT to reduce anyone's 
tax cut, and thus implicitly assumed that an AMT fix was a de facto 
part of the Bush plan. For all of these reasons, I include the 
necessary AMT adjustments as part of the Bush plan. To be clear, these 
adjustments would merely undo the increase in AMT taxpayers due to the 
Bush plan. They would not address the increase in AMT taxpayers that is 
expected to occur under current law even in the absence of tax changes.

              3. EVALUATING THE PRESIDENT'S TAX PROPOSALS
    The justifications for a tax cut are a crucial part of the 
proposal, for at least two reasons. First, the goals themselves might 
be criticized. For example, trying to use a tax cut to prevent the 
economy from falling into a recession may not be an achievable goal, 
and thus may not be worth pursuing. Second, the goals may be laudable, 
but proposed tax cuts might not achieve the goals very effectively. For 
example, fighting a current recession with a tax cut that is 
substantially delayed would not be very effective.
    More generally, different justifications naturally lead to 
consideration of different policies, and the appropriate size, timing, 
and distribution of tax cuts depends on the justifications put forth. 
The justification given must pass two tests: it must justify a tax cut 
in general, and it must justify the particular cut that is being 
proposed.
    In practice, the Administration has had a very difficult time 
providing a coherent justification for its tax package. The President's 
justifications for his tax proposal have changed markedly over time, 
though the proposal itself has not. Most recently, the goals appear to 
include: to provide a fairer distribution of tax burdens, to improve 
access to the middle class, to reduce the marriage penalty, to 
stimulate the economy, and to reduce the high tax burdens on families 
(White House Press Office 2001). In this section, I evaluate the 
President's plan along these and other criteria.

                         A. SIZE OF THE TAX CUT
    Interestingly, ``maintaining fiscal discipline'' is not usually 
stated as a goal of the President's tax plan, and it is easy to see 
why. Table 5 breaks down the costs into three components. (Year-by-year 
and provision-by-provision estimates are provided in Appendix Table 2). 
The provisions of HR 3 would reduce taxes by $958 billion over the next 
10 years. Other components of the plan the President submitted to the 
Congress on February 8 would cost $717 billion. Additions to the plan 
that were in the President's budget, but not in the earlier submission 
to Congress cost another $127 billion. The adjustments required to 
avoid having taxpayers bear the burden of the AMT because of Bush's tax 
cuts would total $292 billion. The added interest payments on the 
federal debt caused by the reduction in federal revenues would cost 
another $418 billion. Thus, although the proposal is often referred to 
as a $1.6 trillion tax cut, the real cost of the proposal now comes to 
an astonishing $2.5 trillion over the next 10 years.
    Note also that these figures underestimate the cost because some of 
the estimates are based on JCT estimates from May 2000. Projected 
revenues in the January 2001 CBO baseline are about 9 percent, or $2 
trillion, higher than in the January, 2000 baseline. If the revenue 
effects were estimated from the current revenue base, they would be 
larger.
    Ultimately, assessments of whether the Bush's proposed tax cut is 
too large are in ``the eyes of the beholder.'' Several analytic 
perspectives, however, suggest the tax cut is excessive. First, the 
magnitude of the tax cut exceeds the ``available surplus'' listed in 
tables 2 and 3 by between $800 billion and $1.5 trillion. Thus, 
enacting Bush's tax cut would imply that no other important policy 
priorities could not be met unless Congress is willing to finance the 
programs with balances in the retirement trust funds. The Bush tax cut 
is exactly equal in size to the Bush administration's non-medicare, 
non-social security surplus.
    Some have claimed that economic responses to the tax cut would 
reduce the costs by one-quarter. However, these economic responses 
leave out the reduction in national saving that would occur along with 
the cut in tax rates. The reduction in national saving would reduce 
productivity growth and place a drag on economic growth. Analysis by 
Peter Orszag for the Center for Budget and Policy Priorities suggests 
that the decline in national saving would reduce revenue by about as 
much as the improved incentives have been claimed to raise revenue. 
Hence, the net effect would be roughly a wash.
    Third, the proposed tax cut would substantially increase the long-
term fiscal gap listed in table 3. Even if discretionary spending were 
held constant in real terms, so that it fell continuously as a share of 
GDP, Bush's tax cut would triple the long-term fiscal gap through 2070 
and raise it by 150 percent on a permanent basis. This would 
significantly worsen the long-term fiscal problem the government faces. 
This should not be surprising. By 2011, the Bush tax cut, including the 
AMT adjustment, would reduce income tax revenues by over 16 percent on 
a permanent basis.
    Some tax cut advocates have asserted recently that Bush's proposals 
are smaller than the 1981 tax cut signed by President Reagan. This 
claim is misleading. When evaluated on an equivalent basis, the two 
plans are about the same size. Several adjustments are needed to 
evaluate the plans on an equivalent basis, though. Reagan's tax cut has 
been estimated by the CBO (1983) and the Treasury (Tempalski 1998) to 
have reduced revenues by between 4.2 percent and 5.6 percent of GDP. 
However, recall that the tax system was not indexed for inflation in 
1981. CBO (1983) estimates that at least 40 percent of the Reagan tax 
cut was simply an elimination of tax increases that would have occurred 
because of inflation. In addition, as soon as the 1981 act was passed, 
politicians on both sides of the aisle recognized that the tax cut was 
too large and moved to raise taxes in 1982 by about 1.2 percent of GDP. 
Adjusting for these two factors places the Reagan cut at between 1.3 
percent and 2.1 percent of GDP (Orszag 2001).
    Bush's proposed tax cut, of course, would occur above and beyond 
the inflation indexing that will automatically occur over the next 
decade. Bush's tax cut is phased in slowly over time and the costs are 
heavily backloaded. Table 5 shows that about three-quarters of the 
costs occur in the second five years of the forecast period. Thus, 
estimates of the cost of the plan relative to GDP over the 10-year 
period are misleading. In 2009, when the plan is fully phased in, the 
cost of the tax cut and the accompanying AMT adjustments is estimated 
at 1.7 percent of GDP. Note that this places the costs exactly in the 
middle of the range of the costs of the Reagan plan.
    Moreover, the case for tax cuts is much weaker currently than it 
was in 1981. The 1981 tax act reduced the top rate from 70 percent to 
50 percent, which is higher than the top rate is today. Also, Treasury 
data show that in 1981, income tax burdens for families of four with 
half-median, median and double-median income were the highest they have 
been in any year since 1955 (Lerman 1998). Income tax burdens had risen 
for five years in a row for the low-income family, the previous 7 years 
for the median income family, and the previous 10 years in a row for 
the high-income family. As of 1999, the low-income family's tax burden 
is 7 percentage points lower than it was in 1981, the median income 
family's burden is 4 percentage points lower than it was in 1981, and 
the high-income family's tax burden had fallen by 5 percentage points 
as well. Congressional Budget Office (1999) data show that for families 
in all five income quintiles, income tax burdens in 1981 were higher 
than they are today and in almost all other years.

                       B. DISTRIBUTIONAL EFFECTS
    The allocation across income groups of the tax cuts proposed by 
President Bush has proven controversial. The main reason why is that 
during the campaign and since the Inauguration, the Administration has 
launched a non-stop campaign of tortured logic, misleading examples, 
and outright false characterizations of the plan. The main results are 
clear: by any reasonable standard, the plan provides disproportionate 
benefits to high-income households. But the Adminstration's efforts to 
obfuscate this point have confused a significant number of commentators 
and are worth exploring carefully.
    The administration (White House 2001, p. 1) characterizes the tax 
plan as follows:
    (i) ``The highest percentage cuts go to the lowest income 
Americans''
    (ii) ``Lower income taxes for all''
    (iii) ``Everyone who pays income taxes benefits''
    (iv) ``The greatest help for those most in need''
    (v) ``The typical American family of four will be able to keep 
$1,600 more of their own
    money.''
    The Administration likes to focus on two aspects of their tax cut, 
each of which is extremely misleading in understanding the 
progressivity of the cut. First, they claim the plan benefits the 
lowest income Americans most because it gives them the highest 
percentage cut in income taxes. Second, the Administration notes that 
under its plan, high-income households would pay a larger share of 
income taxes than they currently do.
    First, the Administration apparently defines ``the lowest income 
Americans'' as those with income of $22,000 or higher. In fact, more 
than 40 million tax units have income below that figure. Second, the 
income tax for the family of four with $26,000 in 2001 is only $20 per 
year, so their 100 percent reduction in income taxes raises their 
after-tax income by trivial amounts (Greenstein 2001, Greenstein and 
Shapiro 2001).
    More generally, there are many ways to report the size of tax cuts, 
but the percentage reduction in one particular tax or the percentage 
share a particular tax-which the Administration has chosen to 
emphasize--is very misleading. To see why, examine table 6, which works 
through these issues in a hypothetical example. In the current system, 
a waitress earns $22,000 pays $72 in income taxes (after the child 
credit and before the EITC) and $3,366 in payroll taxes. The payroll 
tax includes both the employer and employee share since most economists 
believe that payroll taxes are passed on to workers in the form of 
lower wages. A lawyer earns $200,000 and pays $48,612 in income taxes 
and $15,250 in payroll taxes.
    The Bush tax cut would reduce the waitress' income tax by $72 and 
the lawyer's by $8,413. Who gets the bigger tax cut? The administration 
would say the waitress did. Her tax cut is a larger share of her income 
tax, and she pays a smaller share of income taxes after the tax than 
before.
    However, most reasonable observers would likely conclude that the 
lawyer got the larger cut. After all, the lawyer had a bigger 
percentage decline in the sum of payroll and income taxes, a bigger 
percentage increase in after-payroll-and-income-tax wages, and, most 
importantly, a larger percentage increase in after-tax income. Needless 
to say, the lawyer also received a tax cut that in absolute terms is 
gigantic compared to the waitress's tax cut. Indeed, the lawyer's tax 
cut is equal to 4.5 months of earnings for the waitress, yet the 
Administration claims that the attorney gets the worse part of the 
deal!
    It is important in these comparisons to emphasize total taxes, 
rather than just income taxes, because policy makers could choose to 
cut any of a variety of taxes and it is the overall impact of the tax 
cut that matters, not just how one tax is affected.
    Table 7 shows the estimated distributional impact of Bush tax cut 
proposal. As in the hypothetical example, taxpayers in higher income 
brackets receive a larger percentage reduction in total federal taxes, 
a larger percentage increase in after-tax income, and a much larger tax 
cut in absolute terms. These figures demonstrate that the largest 
benefits under the Bush proposal go to high income households.
    The administration notes that everyone who pays income taxes will 
benefit. However, there are many households that pay substantial 
amounts of payroll taxes, but not income taxes, who would not benefit. 
If the goal is to provide help for those most in need, it is unclear 
why the beneficiaries should be limited to income tax payers. For 
example, table 7 shows that 75 percent of tax filing units in the 
bottom 20 percent of the income distribution and 37 percent in the next 
quintile receive no benefit from the tax cut proposal. This shows that 
it is simply false to claim that ``the greatest help goes to those who 
are most in need.''
    Table 7 also shows that 89 percent of all tax filing units, 
including 95 percent of those in the bottom 80 percent of the income 
distribution, would receive less than $1,600 in tax cuts when the cuts 
were fully phased in. Thus, it may be that some typical family defined 
by some metric receives $1,600, but the overwhelming majority of 
households will receive less, and 27 percent will receive no tax cut at 
all (CTJ 2001).
    A common, and reasonable, response to complaints that high-income 
taxpayers receive a large share of proposed tax cuts is that high 
income taxpayers pay a large share of existing taxes. However, under 
the Bush plan, households in the top 1 percent would receive tax cuts 
that are far in excess of the proportion of taxes they pay. Table 8 
shows that the top 1 percent paid about 21 percent of total federal 
taxes in 1999, but under the Bush plan, they would receive at least 35 
percent of the tax cut. Under other estimates, not shown in the table, 
they would receive as much as 43 percent of the cut.
    Finally, the administration trumpets its expanded child credit as 
helping families with children. But one study found that 82 percent of 
the benefit of the expanded child credit would go to households in the 
top 40 percent of the income distribution. Moreover, about one-third of 
all children live in families with incomes too low to receive any 
benefit from the credit. (Shapiro, Dupree and Sly 2001).

                    C. TOLLBOOTH TO THE MIDDLE CLASS
    The President's proposal attempts to reduce what he calls the 
``tollbooth'' to the middle class, that is, the high effective marginal 
tax rates that working families face. The effective marginal tax rate 
varies as a function of income level and is a combination of federal 
and state income taxes, payroll taxes, and the phase-outs of various 
programs. However, it is well known that the highest effective marginal 
tax rates are faced by those earning less than $20,000. The President's 
proposal does not address these problems at all. As Shapiro et al 
(2001) note, expanding the EITC would help both this group and the 
higher-income group (in the mid $20,000s) that Bush's proposal is aimed 
to assist. In addition, there is little econometric evidence that the 
high effective marginal tax rates created, for example, by the EITC, 
actually reduce labor supply.

                          D. MARRIAGE PENALTY
    Bush's proposal to address the marriage penalty is to restore a 
second-earner deduction that was in place between 1981 and 1986. When 
fully phased in, the two-earner deduction would allow up to $30,000 of 
the earnings of the lower-earning spouse to be deducted from income. 
This would reduce the marriage penalty for two-earner families, who are 
the ones most likely to face such penalties. However, the proposal is 
poorly targeted in two ways. First, it would enlarge the marriage 
subsidies that already exist for many couples. Second, it would provide 
no benefits for lower income households. This is important both on 
distributional grounds and because the EITC imposes some hefty marriage 
penalties.

                      E. TAX CUTS AND A RECESSION
    One of the most puzzling and misleading aspects of the President's 
defense of the tax cut is his claim that it would be an effective way 
to fight a brewing recession. First, whether there is a recession or 
simply a slowdown in the growth rate is unclear. Second, almost all 
economists, including top Bush economic advisers Larry Lindsey and John 
Taylor, have argued that tax policy is a difficult way to fine tune the 
economy (See Lindsey 1999, pp 28-9 and Taylor 2000, p. 27). Tax laws 
have to be drafted, debated, passed, reconciled, signed and 
implemented. Counter-cyclical tax cuts could also make the Federal 
Reserve Board's job more difficult by adding a new element of 
uncertainty. In contrast, the Federal Reserve Board can cut interest 
rates quickly and decisively to stimulate the economy.
    But even if there is a recession, and even if tax cuts could in 
general fight recessions effectively, the President's tax proposal is 
incredibly poorly designed to fight a recession that is happening 
currently. For starters, there is simply no tax cut proposed for fiscal 
2001 (which ends on September 30, 2001). It is hard to see how a tax 
cut could boost the economy now if it is not providing any tax cuts 
now. In addition, the President's plan would only provide tax cuts of 
$21 billion (about $75 per person or 0.2 percent of GDP) in fiscal 
2002. Thus, in the next 18 months, the plan would provide virtually no 
stimulus at all.
    In addition, an anti-recession plan should put money in the hands 
of low- and middle-income households. These are the people who are most 
likely to lose their jobs in a recession, and the ones for whom tax 
cuts would give the biggest bang for the buck in stimulating the 
economy. In contrast, the President's plan gives the vast bulk of funds 
to high-income households, as shown above.
    Finally, an anti-recession tax package should be small enough not 
to raise interest rates. However, tax cuts that would use up more than 
$2 trillion of surpluses during the next 10 years could well lead to 
higher interest rates. Note that this would actually be 
counterproductive to fighting a recession, so that the plan could make 
matters worse. Nor does a plan that grows in costs over time make sense 
as an anti-recessionary device. Recessions are temporary. We do not 
need to cut taxes by $1.1 trillion between 2007 and 2011, as Bush's 
plan would, to stave off a recession in 2001.
    Bush supports the idea of making the tax cuts immediate, but his 
proposal does not contain such a feature. Moreover, accelerating his 
package would provide few benefits but would create significant 
problems. It would only give the economy a tiny stimulus ($21 billion) 
in fiscal 2001, and so would do little to help fight a recession 
directly. And it might indirectly hurt the economy. My own estimates, 
based on JCT data, and a similar analysis by Greenstein (2001) show 
that accelerating the plan would raise the 10-year cost by $400 
billion. This would further crowd out other spending priorities and 
would likely put increased pressure on interest rates. The net effect 
could be to make the economy less productive in the short run. And, of 
course, accelerating the package would not change the distributional 
effects.

                      F. ARE AMERICANS OVERTAXED?
    Another argument the president uses to justify tax cuts is that tax 
revenues are at historic highs and therefore that Americans are being 
crushed by overburdensome taxes. The first claim is right. Federal tax 
revenues were 20.6 percent of GDP in 2000, the highest peacetime level 
ever. Note, however, that this total includes all federal taxes, not 
just income taxes. Thus, if a high aggregate federal tax burden 
justifies tax cuts, it should justify cuts in a variety of taxes, not 
just the income and estate taxes.
    However, even granted that total revenues are high, it is not true 
that most households are bearing higher tax burdens than they would 
have with the same income in the past. In fact, for most families, 
taxes are as low or lower than they have been in the past 20-30 years. 
Overall tax payments have risen because the rich have gotten richer at 
an impressive rate and because they have faced higher tax rates due to 
policy changes in 1990 and 1993. This distinction between what is 
happening to most households and what is happening at the aggregate 
level is crucial to the debate. Tax cut advocates typically prefer to 
focus on the aggregate numbers. But even the Wall Street Journal 
editorial board, a staunch supporter of tax cuts, has acknowledged 
recently that ``taxes on a typical middle income family have fallen to 
their lowest level in more than 20 years'' (Wall Street Journal 2001).
    A Department of Treasury study (Lerman 1998), using a methodology 
that has not changed over the course of several Administrations, shows 
that across a wide range of income levels, federal income taxes as a 
share of earnings are down. A four-person family with earnings of about 
$55,000 paid 7.5 percent of that amount in federal income taxes in 
1999, the lowest rate since 1966. For families with earnings half as 
large, the 1999 income tax rate was the lowest since 1955, when the 
estimates begin. Families with earnings of almost $110,000, who are 
squarely in the top 10 percent of the income distribution, the 1999 
income tax burden of 14.1 percent was the lowest rate since 1972 (see 
figure 1). Adding social security and medicare taxes to the Treasury 
income tax estimates raises the estimated tax burden, but does not 
change the conclusion that taxes are low relative to previous years 
(see figure 2).
    Congressional Budget Office (1999) estimates show that, for 
households in the bottom 40 percent of the income distribution, the 
burden of all federal taxes is at a twenty-year low (see figure 3). For 
households in the 40th to 80th percentile, federal taxes are at 
approximately the average share that they have been in the past. Only 
among the top 20 percent of households did total federal taxes rise in 
the last 15 years. Notably, those households received the largest cuts 
in 1981, as shown in figure 3, and despite the increase in their 
average tax burden, their after-tax income has increased faster than 
income in any other quintile (see figure 4). The after-tax income of 
high-income households rose particularly fast between 1995 and 2000. 
Thus, their tax burden rose primarily because their incomes rose so 
much and the U.S. has a progressive tax system.
    American tax burdens are also low compared with those in other 
industrialized countries. Among the 20 largest OECD countries in 1996, 
the U.S. had the lowest ratio of taxes to gross domestic product.
    Ultimately, whether Americans are overtaxed is a judgment call. The 
measure of appropriate tax levels depends on many factors, including an 
analysis of how the money is used. But the evidence speaks clearly: the 
vast majority of American families forfeit the same or smaller share of 
their income to taxes today than they would have in the past with the 
same income, and those that forfeit more have generally experienced 
huge income gains in the past decade.

   G. ARE TAX CUTS NEEDED BECAUSE GOVERNMENT WOULD WASTE ANY SURPLUS 
                                 FUNDS?
    Another set of arguments claims that we need tax cuts because 
surpluses lead to bloated government spending. There is certainly an 
element of truth to this characterization of the problem. For example, 
Congress exceeded the spending caps by increasing amounts in each of 
the past three years. However, the vast portions of existing surpluses 
have been allowed to accumulate, so the argument is weakened 
considerably.
    Moreover, it is especially inappropriate for defenders of the Bush 
administration's tax cut to make this argument, for several reasons. 
First, President Bush himself has proposed about $500 billion in new 
spending programs over the next decade (see table 1). The President 
clearly believes that not all government spending is wasteful. Second, 
reforming social security and medicare and increasing defense spending, 
as the President has indicated he would like to do, will cost 
additional funds. Third, while both Houses of Congress have voted to 
protect Medicare surpluses from being used for other purposes, it is 
the White House that is currently resisting this effort.
    Finally, even if this argument justifies a tax cut, it does not 
provide a rationale for why the tax cut should be focused on the 
highest-income households.

H. PAYING OFF THE DEBT WOULD FORCE THE GOVERNMENT TO INVEST IN PRIVATE 
                                 ASSETS
    An argument put forth recently by Alan Greenspan, and quickly 
repeated by tax cut advocates, is that under current surplus 
projections, the government will pay off all available government debt 
by around 2006 or shortly thereafter. At that point, with more 
surpluses pouring in every year, the government would have to start 
accumulating private assets, either bonds or stocks. Greenspan and 
others argue that having the federal government hold such assets would 
raise a number of difficult issues, concerning government interference 
in the operation of private companies, the selection of assets to go 
into the government portfolio, etc. Greenspan and others claim that it 
would be preferable to avoid that situation by cutting taxes now, 
rather than being forced either to cut taxes or raise spending 
massively at some point in the future or have the government invest in 
private assets.
    Many supporters of fiscal discipline, however, recognize that these 
issues are important, but believe that Greenspan has overstated the 
problem. For example, government agencies could invest passively in 
index funds, in the manner of the Federal Thrift Savings Plan. Orszag 
(2001b) notes that state and local government pension funds have 
invested in private assets for a long period of time. In 2000, state 
and local pensions held the equivalent of 28 percent of GDP in bonds 
and other assets, including almost $2 trillion (equivalent in size to 
about 19 percent of GDP) in corporate equities. Research suggests that 
such funds perform relatively well (Munnell and Sunden 1999). Foreign 
governments also have extensive experience in private investments. 
Canada, Norway, and Denmark have all had favorable experiences with 
investment of government funds in private assets. In addition, note 
that giving tax cuts in order to avoid paying off the national debt 
will likely reduce national saving, and thereby impose a cost on future 
generations.
    A related concern is that paying off the debt will make the market 
for Treasury bills and bonds evaporate. Treasuries play several 
important roles in financial markets-as a safe asset, a source of 
liquidity, an index against which other loans are priced, as a 
mechanism for Federal Reserve Board open market operations, etc. 
However, paying off government debt does not preclude the government 
from continuing to issue bonds. It would merely collect the funds and 
then reinvest them. Moreover, if the government did not issue any new 
bonds, fierce competition among private suppliers of debt could be 
expected.
    In any case, how government would handle investment in private 
assets and how the Treasury market would respond to paying off the 
government debt are important questions that should be addressed. But 
they do not provide a justification for large tax cuts, nor do they 
provide a justification for tax cuts aimed at the highest-income 
households.

     I. ARE TAX CUTS NEEDED BECAUSE THE AMERICAN PEOPLE ARE BEING 
                              OVERCHARGED?
    President Bush and others have claimed that tax cuts are needed 
because Americans are being overcharged for government currently. 
Apparently, ``overcharged'' refers to the idea that current revenues 
exceed current outlays, under budget procedures that are in place now. 
Unfortunately, it is not that simple. As noted above, the government 
faces a long-term shortfall, not a surplus. That is, Americans have 
collectively promised themselves more in benefits than they have been 
willing to commit to in taxes. That hardly qualifies as overcharging 
themselves.
    A related argument claims that ``It is the American people's money. 
Give it back to them.'' Again, that argument is correct as far as it 
goes-it is the American people's money. But the long-term financial 
shortfall is also the American people's financial obligation.
    A slightly more sophisticated version of the same argument says 
that if the deficits in the 1980s and early 1990s justified tax 
increases, then the surpluses that are currently in existence should 
justify tax cuts. However, in the 1980s and early 1990s, the nation 
faced long-term deficits and short-term deficits. The short-term 
deficits helped focus attention on improving the fiscal status of the 
government, but the real problem was the longer-term situation. Now, 
short-term cash-flow surpluses are obscuring the real problem, which is 
that we still have a long-term financial shortfall.

                           4. POLICY OPTIONS
    The current fiscal surpluses are a significant accomplishment, and 
should not be taken lightly or for granted. There is clearly room for a 
tax cut, for spending priorities, and for debt reduction. But I believe 
that the most important budgeting decision for the Congress is to 
establish a new set of budget rules, and that these rules should be 
established before making a significant set of tax and spending 
changes.

                            A. BUDGET RULES
    There are several reasons to develop a new set of rules. The fiscal 
accomplishments of the last decade should be preserved and enhanced, 
not squandered. The old rules are expiring. It will be more difficult 
to make wise choices in the absence of an overall budgetary framework. 
And the current budget situation has dangers associated with it. The 
emergence of significant cash-flow surpluses over the medium term will 
create understandable pressures to use the funds for tax or spending 
initiatives. However, most of the surpluses stem from the retirement 
trust funds (tables 2 and 3), which prudent budgeting suggests should 
not be used to finance other programs, and the long-term fiscal stance 
is still negative (table 4).
    Consideration of policy rules should take several factors into 
account. First, there is a certain asymmetry in policy options. It is 
always easier to reduce taxes later than to raise them. Second, new and 
unforeseen policy priorities frequently arise, so prudent fiscal 
management would suggest the equivalent of a ``reserve fund'' of some 
sort. Third, both budget projections and economic forecasts are subject 
to considerable uncertainty, which suggests another reason not to 
commit all available resources immediately. A set of budget rules that 
is consistent with these views would include the following:
     Reaffirm the commitment not to spend social security trust 
funds on other programs.
     Reaffirm the votes taken last year that protect Medicare 
Part A trust funds from being spent on anything other than hospital 
insurance. This is especially important because the Bush administration 
has not committed to this view.
     Accord similar protections to the balances in trust funds 
for military and civilian pensions.
     Elevate the importance of budget outcomes over longer time 
horizons by having CBO report its long-term forecast at the same time, 
and in the same document, as the 10-year Outlook that is produced every 
winter and the Update that is produced every summer.
     Adopt a proposal put forth recently by Robert Reischauer, 
President of the Urban Institute (Reischauer 2001). Under the 
Reischauer rule, Congress and the President would establish a benchmark 
surplus measure and would only allow themselves to commit a certain 
percentage of projected benchmark surpluses to new spending or tax 
cuts, with the percentage declining over the 10-year horizon. 
Reischauer suggests the benchmark surplus should be the non-social 
security, non-medicare surplus, and that 80 percent of the benchmark 
surplus projected in years 1 and 2 would be available, 70 percent in 
years 3 and 4, and so on concluding with 40 percent of the benchmark 
surplus in years 9 and 10. Making this adjustment would result in a 10-
year ``usable'' surplus of about $1.4 trillion (determined by applying 
the Reischauer percentages to the appropriate figures in appendix table 
1). The non-retirement trust fund surplus (thus removing government 
pensions as well as social security and medicare) is an alternative 
possible benchmark. In practice, this alternative definition does not 
make a huge difference; the available surplus would be $1.2 trillion. 
These proposals may not be as radical as they first appear. Last year, 
for example, the House passed a resolution to devote 90 percent of the 
coming year's surplus to debt reduction. This is merely an extreme 
version of the Reischauer rule.
    There has also been discussion of making tax cuts or new spending 
programs contingent on actual budget surpluses in the previous year. 
The ``trigger mechanism'' has an admirable goal-to ensure that Congress 
does not promise more than it can afford. But I believe the Reischauer 
rule would work better, for two reasons. First, a trigger mechanism 
introduces uncertainty about future taxes. Second, if the goal is to 
ensure that tax cuts can be paid for, the trigger mechanism may fall 
short. A trigger mechanism would allow a tax cut in a given year, if 
the surplus in the previous year surpassed a target level. The problem 
is that the tax cut would typically be permanent (for example, if rates 
were cut), but the surplus may only be temporary. The fact that the 
surplus the previous year surpassed a target does not guarantee that 
surpluses in future years will be sufficient to cover the permanent 
costs of the tax cut. One way around this problem is to use the trigger 
each year to generate a one-time tax rebate. The rebate would not be 
repeated the following year, unless the surplus was sufficiently large. 
This removes the question of whether the tax cut could be funded but 
limits the scope of policy that could be undertaken.

                             B. TAX POLICY
    Tax policy should be made inside of a budgetary framework that 
recognizes the importance of other public policy goals-such as 
education, health, defense, the refurbishing of social security and 
medicare and so on. In addition, fairness, efficiency, and simplicity 
remain the core principles of tax policy regardless of the size of the 
surplus. A number of important tax policies are consistent with these 
objectives and a prudent budget framework:
     Create a new, lower tax bracket of 10-12 percent, covering 
a range of income broader than the 10 percent bracket proposed by 
President Bush.
     Combine or integrate interactions between the child 
credit, earned income credit, and personal exemption, along the lines 
proposed by Sawhill and Thomas (2001), Ellwood and Liebman (2000) or 
the Economic Policy Institute (2000). This would simplify taxes, 
improve incentives to work and marry, and provide added resources to 
low-income households. A crucial element would be to increase the 
refundability of the child credit.
     Examine the potential for an income tax credit that is 
based on payroll tax liabilities.
     Simplify the tax code by raising the standard deduction, 
providing a uniform exclusion for capital gains income rather than the 
complicated patchwork of capital gains tax rates we currently have, and 
consolidating the various education programs and the various retirement 
saving programs.
     Provide tax cuts to high-income taxpayers, and simplify 
the tax system further, by removing hidden taxes and ``take back'' 
provisions. These taxes are imposed even when a taxpayer is complying 
perfectly with the law, but ends up with what the law has deemed ``too 
many'' deductions or ``too little'' income. These items adversely 
affect incentives, raise little revenue and create unnecessary 
complexity.
    Personal exemptions are phased out for high-income taxpayers. Two 
percent of the exemption is eliminated for each $2,500 or fraction 
thereof that AGI exceeds certain thresholds. The total amount of 
itemized deductions a taxpayer may claim is reduced by 3 percent of 
households' income above certain (different) thresholds. These two 
items can raise effective tax rates by more than 3 percentage points 
above statutory tax rates, and should simply be repealed.
    The major reason individuals get placed on the AMT is that they 
have high deductions for state and local taxes or large families 
(Rebelein and Tempalski 2000). This is hardly the egregious tax 
sheltering behavior that the AMT was intended to capture. Either the 
AMT exemption should be increased substantially (by $100,000) and 
indexed for inflation, or the AMT should be abolished. However, before 
abolishing it, Congress should study what sort of sheltering 
opportunities would be created and act preemptively to close them off.
     Another way to assist high-income taxpayers is by 
reforming the estate tax. The effective exemption could usefully be 
raised and the rates brought down modestly. In addition, the exemptions 
and rate brackets should be indexed for inflation. Making these changes 
would provide room to eliminate the most egregious and abusive 
sheltering practices, of which there are many. (See Gale and Slemrod 
2001, or Schmalbeck 2000, for further discussion.)
    It would also make sense to decide whether the expiring tax 
provisions should be made permanent or should be abolished. Finally, 
there has been substantial discussion of tax rebates. Rebates have the 
advantage that they can be administered immediately, and they make the 
most sense either if Congress desires to put money in citizens' hands 
quickly, or if a tax cut is made contingent upon the size of a surplus. 
However, as discussed above, tax policy is generally not a useful 
counter-cyclical policy tool, and making a tax cut contingent on the 
size of the surplus introduces unnecessary uncertainty.

                               REFERENCES
    Auerbach, Alan. 1994. ``The U.S. Fiscal Problem: Where We Are, How 
We Got Here, and Where We're Going,'' in Stanley Fischer and Julio 
Rotemberg, eds. NBER Macroeconomics Journal. Cambridge, MA.
    Auerbach, Alan. 1997. ``Quantifying the Current U.S. Fiscal 
Imbalance.'' National Tax Journal, 50(3):387-98.
    Auerbach, Alan, and William Gale. 1999. ``Does the Budget Surplus 
Justify Big Tax Cuts?: Updates and Extensions.'' Tax Notes, October 
18:369-376.
    Auerbach, Alan, and William Gale. 2000. ``Perspectives on the 
Budget Surplus.'' National Tax Journal, 53(3):459-72.
    Auerbach, Alan, and Kevin A. Hassett. 2000. ``Uncertainty and 
Design of Long-Run Fiscal Policy,'' in Alan J. Auerbach and Ronald D. 
Lee, eds. Demographic Change and Fiscal Policy. Cambridge, UK: 
Cambridge University Press.
    Bush-Cheney 2000 Campaign. 2000. ``A Tax Cut with a Purpose.'' 
http://www.georgewbush.com/Media/PDFs/tax.pdf
    Cherry, Robert and Max B. Sawicky. 2000. ``Giving Tax Credit Where 
Credit is Due. A `Universal Unified Child Credit' that expands the EITC 
and cuts taxes for working families.'' Economic Policy Institute 
Briefing Papers.
    Citizens for Tax Justice. 2001. ``Bush Tax Plan Benefits are 
Similar to Campaign Proposal: Skewed Toward Wealthy.'' http://
www.ctj.org/pdf/bush0201.pdf, February.
    Congressional Budget Office. 1983. ``Baseline Budget Projections 
for Fiscal Years 1984-1988.'' Washington, D.C.: U.S. Government 
Printing Office, February.
    Congressional Budget Office. 1999. ``Preliminary Estimates of 
Effective Tax Rates.'' Washington, D.C., September.
    Congressional Budget Office. 2001. The Budget and Economic Outlook: 
Fiscal Years 2002-2011. Washington, D.C.: U.S. Government Printing 
Office, January.
    Ellwood, David T. and Jeffrey B. Liebman. 2000. ``The Middle Class 
Parent Penalty: Child Benefits in the U.S. Tax Code.'' NBER Working 
Paper 8031. December.
    Gale, William G. and Joel B. Slemrod. 2001. ``Rethinking the Estate 
and Gift Tax: Overview.'' Brookings Institution. http://www.brook.edu/
views/papers/gale/20010126.pdf, January.
    Greenstein, Robert. 2001. ``How Would Families at Different Income 
Levels Benefit From the Bush Tax Cut?''. Center on Budget and Policy 
Priorities. http://www.cbpp.org/2-6-01tax3.pdf, February.
    Greenstein, Robert, and Richard Kogan. 2001. ``What the New CBO 
Projections Mean: Can the New Surplus Projections Accommodate a Large 
Tax Cut?''. Center on Budget and Policy Priorities. http://
www.cbpp.org/1-31-01bud.pdf, January.
    Greenstein, Robert, and Isaac Shapiro. 2001. ``Taking Down the Toll 
Booth to the Middle Class?: Myth and Reality Governing the Bush Tax 
Plan and Lower-income Working Families.'' Center on Budget and Policy 
Priorities. http://www.cbpp.org/2-5-01tax.pdf, February.
    Joint Committee on Taxation. 2000a. ``Estimated Revenue Effects of 
Various Provisions Described as the `George W. Bush Tax Reduction 
Proposal.' '' May.
    Joint Committee on Taxation. 2000b. Memorandum from Paull to Mays, 
Buckley, and Davis on Revenue Request, September.
    Lerman, Allen H. 1998. ``Average and Marginal Federal Income, 
Social Security and Medicare, and Combined Tax Rates for Four-Person 
Families at the Same Relative Positions in the Income Distribution, 
1955-1999.'' Office of Tax Analysis Report. January.
    Lindsey, Lawrence B. 1999. Economic Puppetmasters: Lessons from the 
Halls of Power. Washington, D.C.: The AEI Press.
    Munnell, Alicia and Annika Sunden. 1999. ``Investment Practices of 
State and Local Pension Funds: Implications for Social Security 
Reform.'' Center for Retirement Research, Boston College, WP 1999-01. 
April.
    Orszag, Peter R. 2001a. ``How the Bush Tax Cut Compares in Size To 
the Reagan Tax Cuts.'' Center on Budget and Policy Priorities. http://
www.cbpp.org/2-6-01tax2.pdf, January.
    Orszag, Peter R. 2001b. ``The Budget and Long-Term Fiscal Policy'': 
Testimony Before the Senate Budget Committee. February 7.
    Rebelein, Robert and Jerry Tempalski. 2000. ``Who Pays the 
Individual AMT?'' Office of Tax Analysis Paper 87, June.
    Reischauer, Robert D. 2001. ``Stop Them Before They Overspend 
Again.'' New York Times, February 8, A31.
    Sawhill, Isabel, and Adam Thomas. 2001. ``A Tax Proposal for 
Working Families with Children.'' Brookings Institution: Welfare Reform 
and Beyond Policy Brief No.3. January.
    Schmalbeck, Richard. 2000. ``Avoiding Federal and Wealth Transfer 
Taxes.'' in William G. Gale and Joel B. Slemord, eds. Rethinking the 
Estate and Gift Tax. Washington, DC: Brookings Institution Press. 
forthcoming
    Shapiro, Isaac, Allen Dupree, and James Sly. 2001. ``An Estimated 
12 Million Low- and Moderate-Income Families--with 24 Million 
Children--Would Not Benefit from Bush Tax Plan.'' Center on Budget and 
Policy Priorities. http://www.cbpp.org/2-7-01tax.pdf, February.
    Taylor, John B. 2000. ``Reassessing Discretionary Fiscal Policy''. 
Journal of Economic Perspectives 14(3):21-36.
    Tempalski, Jerry. 1998. ``Revenue Effects of Major Tax Bills.'' 
Office of Tax Analysis Paper 81, December.
    Wall Street Journal. 2001. ``Progressive Plunder.'' Wall Street 
Journal, February 6, A18.
    White House Press Office. 2001. The President's Agenda for Tax 
Relief. http://www.whitehouse.gov/news/reports/taxplan.pdf, February.

  TABLE 1.--PRESIDENT BUSH'S CAMPAIGN PROPOSALS FOR NEW SPENDING: 2001-
                                  2010
------------------------------------------------------------------------
                                                            $ Billions
------------------------------------------------------------------------
Medicare Prescription Drugs and Reform..................           158.0
Additional Medicare.....................................            40.3
Health..................................................           131.9
Defense.................................................            45.0
Education...............................................            47.6
Compassion/Charity......................................            23.9
Agriculture.............................................             7.6
Housing/IDAs............................................             6.6
Environment.............................................             5.3
Crime...................................................             0.7
Other Domestic..........................................             7.8
      Subtotal..........................................           474.6
Less Savings from Government Reform.....................          -196.4
      Total Spending....................................           278.2
------------------------------------------------------------------------
Source: Bush Campaign. September 5, 2000. ``Bush Budget 2001-2010,''
  http://www.georgewbush.com/Media/PDFs/SummaryBudgetSept052000.pdf.

  
  
  
  
  
  
  
  
    Chairman Nussle. Mr. Mitchell.

                STATEMENT OF DANIEL J. MITCHELL

    Mr. Mitchell. Thank you. If I could submit my full 
testimony for the record and just focus on the highlights.
    I'd like to address four questions. One, is the economic 
forecast being used to guide policy accurate? Two, are there 
policies that can affect the economy's performance? Three, what 
is the best use of surplus? And four, is Government debt a 
serious problem?
    The first question I think is easy to answer. Neither CBO 
nor OMB are going to get it right. But it doesn't matter, so 
long as we assume that the errors are random and that the 
average long term growth rate is somewhere close to what 
they're projecting. If you look at the CBO and OMB forecast 
compared to the consensus blue chip forecast and other 
estimates that are out there, I don't think there's any reason 
to believe that there's a rosy scenario, so to speak. If 
anything, they're probably understating growth rate and 
understating the amount of revenue that's going to come flowing 
in in the next 10 years, in large part because they make an 
assumption that taxes as a percent of GDP, assuming no changes 
in policy, are going to decline, when of course normally you 
would expect taxes as a share of GDP to rise slightly because 
our tax system imposes higher rates on people as their income 
climbs.
    The second question is whether certain policies affect the 
economy's performance. I think this is much more important. And 
I think it's important because some people are incorrectly 
assuming that the economy's growth path and therefore the 
revenues that are going to come in are somehow independent of 
the fiscal policy decisions that will be made in the near 
future. I think this is a big mistake. Substantial reductions 
in tax rates will of course improve the economy's performance.
    As economists, we all may disagree on the amount of 
additional growth that will be generated when tax rates are 
reduced. But one will be hard pressed to find a credible 
economist who would argue that there is no impact whatsoever. 
Likewise, if we reduced the tax code's bias against savings and 
investment, we are going to see positive economic results from 
that. This is why the elimination of the death tax is going to 
cause an increase in economic output. This doesn't even 
consider the dramatic reduction in compliance costs and the 
substantial improvement in the efficiency of investment if the 
death tax disappears.
    Tax policy is important, but it's not the only thing that 
can have an effect on the economy's long term performance and 
therefore the tax revenues that will be generated by the 
economy. Social security reform is something that lawmakers are 
very likely going to address in the next 2 years. That could 
have a profound impact. If we make a transfer from a pay-as-
you-go system that reduces employment and lowers national 
savings to a system based on personal accounts, as so many 
other countries have done, we would very likely see substantial 
long term benefits.
    Then of course, no discussion of the economy's performance 
and the budget would be complete without addressing the size of 
Government. Regardless of whether Government is financed by 
taxes or by borrowing, you're shifting resources from the 
productive sector of the economy to the Government. Unless 
you're willing to believe that Government spending is more 
efficient than private spending, you're very likely causing 
some substantial drag on the economy. And as a result, if there 
can be even a modest level of fiscal discipline, such as 
holding the aggregate growth of spending to 4 percent a year, 
that should create benefits compared to allowing spending to 
grow faster.
    This of course plays into the whole issue of dynamic 
scoring. The President in effect in his budget has taken a 
worst case scenario, assuming that his tax cuts and other 
proposals to reform the economy are going to have zero economic 
impact, zero benefit and of course, our economic history in the 
U.S., world economic history shows that countries that move to 
lower tax rates and more fiscal discipline will grow faster and 
perform better. Therefore, it's very, very likely that the 
President's tax cut will actually have a revenue loss of much, 
much less than $1.6 trillion, whether it's 33 percent less, 50 
percent less, no one's going to know the exact answer. But we 
know from history that it will be substantially less.
    The third question is how best to use the surplus. I 
actually think in some sense this is the wrong issue. Whether 
or not we have a surplus or deficit is not nearly as important 
as whether we have a tax code that rewards productive behavior 
or at least doesn't punish it as heavily. It's not as important 
as whether or not we can modernize the Social Security system 
to address the huge long term problems that Mr. Gale pointed 
out. And it's not as important as whether or not we can reduce 
the size of Government and the burden it imposes upon the 
American economy.
    In short, deficits and surpluses do not have much impact on 
the economy's performance. Self-proclaimed debt hawks assert 
that fiscal balance is important, because interest rates will 
remain low, yet there is virtually no empirical evidence for 
that proposition. Indeed, the evidence actually suggests that 
both fiscal balance and interest rates are dependent on the 
economy, not vice versa. In other words, a healthy economy will 
generate the tax revenues that balance the budget, but a 
healthy economy will also probably create attractive investment 
opportunities and this will tend to bid up interest rates.
    If we like low interest rates, we should go back to the 
Great Depression. Real interest rates were very, very low at 
the time, because no one wanted to borrow any money, because 
there was nothing to invest in. Moreover, the idea that changes 
in our fiscal balance are going to have a dramatic impact on 
interest rates is rather questionable, given the sheer 
magnitude of international capital markets. Can anyone 
seriously believe that a $50 billion to $100 billion shift in 
the U.S. annual fiscal balance will have a noticeable impact in 
interest rates, when more than $2 trillion changes hands every 
day in world financial markets?
    But having issued all these caveats that the surplus or the 
deficit isn't the appropriate measure, let me now talk about 
what I think is the best use of the surplus. Tax cuts, 
specifically lower tax rates and reduction in the double 
taxation of income that is saved and invested, will improve the 
economy's performance and thereby create more opportunities for 
American families. Indeed, because certain tax cuts will have 
significant supply side effects, the amount of tax relief can 
actually be much larger than the package proposed by the 
administration. The $1.6 trillion figure, as I mentioned, is 
based on static estimates and therefore greatly overstates the 
actual revenue left to the Treasury.
    Social Security is another very desirable use of the 
surplus. But frankly, it should happen even if we didn't have a 
surplus. Simply stated, the current system faces two big 
crises. The first crisis is the long term deficit, the second 
crisis is that it's a bad deal for workers. They have to pay 
record levels of taxes into the system, and they get very 
meager benefits in exchange.
    I think America should learn from countries like Australia, 
Sweden, Chile, England, countries all over Latin America, all 
around the world, that are shifting to personal retirement 
accounts. These professionally managed personal retirement 
accounts are allowing workers to build up nest eggs that will 
give them comfort and security in retirement.
    Now, of course, an important component of any Social 
Security reform plan is to hold all current retirees and older 
workers completely harmless. In other words, the Government 
should fulfill its part of the contract and give them all the 
benefits they've been promised. This guarantee could be 
fulfilled, as other countries have shown, even if there wasn't 
a surplus. But certainly, having all this extra tax revenue 
coming into Washington will make this commitment very easy to 
discharge.
    This brings us to my final question, which is, what about 
the national debt? Shouldn't we use all the surplus to pay down 
the national debt? I would argue that the national debt is only 
a minor irritant. At just over $3 trillion, it is a small 
fraction of our annual income. Compared to other nations, our 
national debt is trivial. And the burden of debt will continue 
to keep falling, even if we don't redeem a single bond, so long 
as the economy continues to grow.
    The national debt today, for example, is much bigger than 
the debt we had at the end of World War II. But because our 
economy has expanded so much in the last 50 years, the burden 
of debt measured as a share of GDP is less than one-third of 
its World War II high. The real debt problem, for those 
concerned about debt, is of course Social Security. The long 
term deficit in Social Security, even after adjusting for 
inflation, is more than $20 trillion. That's seven times 
bigger, roughly, than our national debt.
    This of course is a debt that does threaten future 
generations, assuming we don't want massive payroll tax 
increases or massive benefit cuts, this is the debt, this is 
the issue that our surplus should be at least in part dedicated 
to solving.
    Now, some critics complained that shifting to personal 
accounts will use up the surplus, make it harder to pay off 
debt. But this is akin to not removing a tumor for fear of 
leaving a scar. Social Security reform may use up some of 
today's surpluses, but the long term reduction in the program's 
unfunded liability makes this one of the most effective 
investments that lawmakers can make.
    In effect, Social Security reform is like refinancing a 
mortgage when interest rates drop. Yes, there may be some 
upfront costs, the transition expense of fulfilling the 
contract with older workers and current retires. But the long-
term savings will more than make up for that short-term cost. 
This is why it is so misleading to talk about the cost of the 
transition to Social Security reform. If lawmakers consider the 
total impact on Government finances, Social Security is a big 
money saver. But more importantly, it's good for the American 
people.
    Thank you for the opportunity to discuss these questions.
    [The prepared statement of Daniel Mitchell follows:]

  Prepared Statement of Daniel J. Mitchell, McKenna Senior Fellow in 
               Political Economy, the Heritage Foundation

    Mr. Chairman, members of the committee, thank you for the 
opportunity to testify on the economic and budget outlook. I must 
stress, however, that the views I express are entirely my own and 
should not be construed as representing any official position of The 
Heritage Foundation. I would like to focus on four key questions:
    1. Is the economic forecast being used to guide policy accurate?
    2. Are there policies that can affect the economy's performance?
    3. What is the best use of the surplus?
    4. Is government debt a serious problem?
    The first question is easy to answer. Neither the CBO forecast nor 
the OMB forecast is accurate. But the fact that economists have never 
been able to predict the economy's short-term performance is not a 
cause for concern-as long as there is reason to believe that the errors 
are random and balance out over time.
    In other words, a forecast is a good guide for policymakers if the 
average annual growth rate over the 10-year period is reasonably close-
perhaps within 0.5 percentage points-to what actually happens. Using 
this more sensible performance standard, both CBO and OMB are basing 
their economic estimates on very reasonable predictions of the two key 
components of real GDP-population growth and productivity gains.
    As such, there is no reason to believe that either forecast is 
systematically optimistic. Indeed, it is more likely that they are 
understating revenue growth over the next ten years-and thereby low-
balling the surplus. This is not because the growth estimate is 
necessarily too pessimistic, but rather because the forecasts assume 
that tax revenues as a percent of GDP will decline slightly from 
today's record levels.
    This is somewhat puzzling. As long as real income is increasing, 
and as long as we have a tax code that imposes harsher penalties on 
people for earning more income, tax collections should slowly climb as 
a share of economic output. The fact that the forecasts show just the 
opposite indicates that CBO and OMB are making some rather interesting 
assumptions. These assumptions may be reasonable, but this is an issue 
the committee may want to investigate.
    The second question is whether certain policies can affect the 
economy's performance. This is a much more important topic to address. 
Many policymakers incorrectly are assuming that the economy's growth 
path is somehow independent of the fiscal policy decisions that will be 
made in the near future.
    This is a mistake. Substantial reductions in tax rates will improve 
the economy's performance. Economists may disagree over the amount of 
additional growth that will be generated when tax rates are reduced, 
but one would be hard-pressed to find a credible economist who would 
say there is no effect. Likewise, one would find even stronger 
agreement that the economy will grow faster if lawmakers reduce the tax 
code's bias against savings and investment. This is why elimination of 
the death tax will result in additional economic output, particularly 
if the dramatic reduction in compliance costs and substantial 
improvement in the efficiency of investment are included in the 
estimate.
    Tax policy is important, but it is not the only economic policy 
variable that deserves attention. Social Security reform could have 
profound consequences on future economic performance. The current 
system, a pay-as-you-go, tax-and-transfer scheme, reduces employment 
and lowers national saving. If America does what so many other 
countries have done and shifts to a system of personal retirement 
accounts, the impact on the economy's long-term performance would be 
quite significant.
    Finally, no discussion of economic growth would be complete without 
addressing the size of government. Regardless of whether it is financed 
through taxes or borrowing, government spending represents a transfer 
of resources from the private sector to the public sector. If 
government spends that money in a way that generates a sufficiently 
high rate of return, the economy will benefit. If the rate of return is 
below that of investments in the private sector, however, then the rate 
of growth will be slower than it otherwise would have been. 
Unfortunately, most analyses indicate that the vast majority of 
government programs have low rates of return. Thus, if lawmakers can 
reduce the size of government-or at least limit its growth to 4% 
annually-this could free up resources that could be more efficiently 
used by the productive sector of the economy.
    What does all this mean? If tax rates are lowered and the death tax 
is repealed, the economy will grow faster. This will enable more 
families to climb the ladder of opportunity. More important, for 
purposes of this committee, it will mean that tax cuts will not result 
in nearly as much foregone revenue as static forecasts suggest. My 
colleagues at The Heritage Foundation estimate that roughly half of the 
lost revenue will be recaptured as a result of improved economic 
performance. In simple terms, if a tax cut results in more income to 
tax, then there will be some level of revenue feedback. Similar 
``supply-side'' estimates have been produced by economists at Harvard 
University and the American Enterprise Institute.
    The third question is how best to use the surplus. This is the 
dominant debate on Capitol Hill, but it actually is a greatly overblown 
issue. Whether or not we have a surplus or a deficit is not nearly as 
important as whether we have a tax code that rewards productive 
behavior. It is likewise not as important as whether we can modernize 
the Social Security system. And it is not as important as whether we 
can impose some greatly needed discipline on the spending side of the 
budget.
    In short, deficits and surpluses do not have much impact on the 
economy's performance. Self-proclaimed debt hawks asset that fiscal 
balance is important because interest rates will remain low, yet there 
is virtually no empirical evidence for this proposition. Indeed, the 
evidence actually suggests both fiscal balance and interest rates are 
dependent on the economy, not vice versa. In other words, a healthy 
economy will generate the tax revenues that balance a budget, but a 
healthy economy also will create attractive investment opportunities, 
and this will tend to bid up interest rates.
    Moreover, changes in our fiscal balance are dwarfed by the sheer 
magnitude of international capital markets. Can anyone seriously 
believe that a $50 billion-$100 billion annual shift in the U.S. fiscal 
balance will have a noticeable impact on interest rates when more than 
$2 trillion changes hands every day in world financial markets?
    Having issued caveats as to why this is not the right question, let 
me now suggest the best way to use the surplus. Lawmakers should focus 
on policies that will produce the greatest benefits for the people. 
This suggests both tax cuts and Social Security reform.
    Tax cuts, more specifically lower tax rates and a reduction in 
double taxation of income that is saved and invested, will improve the 
economy's performance and therefore create more opportunities for 
families to prosper. Indeed, because certain tax cuts have significant 
supply-side effects, the amount of tax relief can be much larger than 
the package proposed by the Administration. Remember, the $1.6 trillion 
figure is based on a static revenue estimate and the actual revenue 
loss will be far less than that amount.
    Social Security reform is another desirable use of the surplus, 
though it should happen even if there were no surplus. Simply stated, 
the current system faces two crises. The first crisis is the gigantic 
long-term deficit. According to Social Security Administration figures, 
the inflation-adjusted deficit between 2015 and 2075 is a staggering 
$21.6 trillion. The other crisis is the fact that Social Security is an 
increasingly bad deal for workers. They are required to pay a record 
level of taxes into the system, but the benefits they are promised upon 
retirement are very meager.
    America should learn from countries like Australia, Sweden, Chile, 
and England. Workers should be allowed to shift some portion of their 
payroll tax burden into a professionally managed personal retirement 
account. These private accounts would enable today's workers to build a 
substantial nest egg that will provide a secure and comfortable income 
upon retirement.
    An important component of any reform plan, however, is that current 
retirees and older workers should be given every penny of benefits that 
currently are promised. This guarantee could be fulfilled even if we 
did not have a surplus, but the extra money certainly will make this 
commitment easy to discharge.
    Some would argue that the surplus should be used to reduce the 
national debt, which leads us to the final question. More specifically, 
is government debt a problem? The answer is yes, but not for the reason 
most people usually cite.
    America's national debt is a minor irritant. At just over $3 
trillion, it is a small fraction of our annual income. Indeed, compared 
to other industrialized nations, our national debt is inconsequential. 
And the burden of debt will keep falling even if we don't redeem a 
single bond-so long as the economy continues to grow. The national debt 
today, for example, is much bigger than the debt that was built up 
during World War II. But because our economy has expanded so much in 
the last 50+ years, the burden of the debt-measured as a share of GDP-
is only one-third of its post-World War II high.
    The real debt problem facing America is Social Security's unfunded 
liability. The program's long-term deficit is more than $21 trillion, 
roughly seven times bigger than the official national debt. This is the 
debt that threatens the well-being of future generations. And this is 
why Social Security reform is the issue that debt hawks should 
champion.
    Critics complain that shifting to personal accounts will use up 
some of the surplus and therefore make it harder to pay off the debt. 
This is akin to not removing a tumor for fear of leaving a scar. Social 
Security reform may use up some of today's surplus, but the long-term 
reduction in the program's unfunded liability makes this one of the 
most effective investments that lawmakers can make.
    Social Security reform is like refinancing a mortgage when interest 
rates drop. Yes, there may be some up-front costs, but the long-term 
savings will dwarf the short-term expense. This is why it is so 
misleading to talk about the ``cost'' of transitioning to a system of 
personal accounts. If lawmakers considered the total impact on 
government finances, Social Security reform is a big money-saver.
    Thank you for the opportunity to discuss these important issues, 
and I look forward to answering any questions.

    Chairman Nussle. Thank you, Mr. Mitchell. Mr. Bartlett.

                  STATEMENT OF BRUCE BARTLETT

    Mr. Bartlett. Thank you, Mr. Chairman.
    I would just like to make three brief points. First, I 
believe that the estimated revenue loss that we keep hearing 
about, and which keeps getting inflated every time I hear it, 
is way, way too high. Because all these estimates are so-called 
static estimates, they assume that the tax cut that is being 
considered will have no macroeconomic effect on the economy--no 
effect on GDP growth, no effect on productivity, no effect on 
anything.
    I think this is a very unreasonable assumption. The House 
of Representatives also believes this. Six years ago, the House 
voted to allow the Joint Committee on Taxation to take into 
account macroeconomic effects in its revenue forecast, upon 
request. For reasons I don't know, no one has ever asked them. 
They've hired new economists, they've done research on this 
matter precisely for this purpose. And I believe now is a very 
good time to do this.
    I do not know what figures they will come up with. I don't 
know what the figures would be. I do know that there are some 
published estimates. The Heritage Foundation, which Dan 
represents, believes that the faster economic growth resulting 
from this tax cut will recoup almost half of the static revenue 
loss, with the loss being less than $1 trillion over 10 years.
    Recently, Martin Feldstein, using the National Bureau of 
Economic Research model, estimated that about 35 percent of the 
revenue would be recouped. This is a very standard estimate. 
You can get it out of any textbook. Basically any textbook will 
tell you you'll get back about 35 percent from faster 
consumption and therefore faster economic growth. That doesn't 
even take into account any supply side effects.
    Therefore, I think the static revenue figures we've heard 
here are absolutely a minimum of 35 percent too high. If the 
committee wanted to make an assumption of 25 percent, I think 
that would be extremely conservative and well within the bounds 
of what is acceptable in academic theory. I append to my 
testimony a long list of articles in prominent academic 
journals that point out almost universally that dynamic 
scoring, that does take into account macroeconomic effects, is 
feasible. There are of course questions about it. But I think 
that this is a very good time to institute this for budgetary 
purposes.
    Second, I'd like to make the point that I believe that the 
baseline revenues which we are all discussing are way, way too 
low. For reasons I don't understand, both the CBO and OMB are 
estimating that over the next 10 years, Federal revenues will 
grow at a rate slower than GDP. This is simply contrary to all 
evidence and all logic. Since 1963, Federal revenues have risen 
about 4 percent faster than GDP. Since 1986, they've risen 18 
percent faster than GDP. And since 1993, they've risen, I 
believe, 37 percent faster than GDP.
    I think a very reasonable assumption would be that some of 
the post-1993 bulge in revenues was due to one-time factors. So 
if you simply stick with the post-1986 trend, we're looking at 
18 percent more revenues--revenues growing 18 percent faster 
than GDP--over the foreseeable future. If you calculate it out, 
this gives you about $2.1 trillion of additional revenue in the 
baseline than is currently being projected.
    Now, that's more than enough to pay for this tax cut. And 
you'd still have exactly the same amount of revenue that is 
currently being forecast without a tax cut.
    Lastly, I would point out to people who worry, I think 
excessively, about the potential risks of enacting a large tax 
cut such as this, much of this discussion in effect implies 
that we only do a budget once every 10 years. So we worry, I 
think, very, very excessively about things that are going to 
happen so far into the future they are absolutely not worth 
thinking about. The history of this Congress is that when 
there's a need for additional revenues, it has not shown any 
resistance to enacting tax increases.
    Over the last 20 years, there have been 15 major tax bills 
that have been passed into law. And of those, only four were 
tax cuts, and two of them were trivial, and one was very small. 
Only the 1981 tax cut was substantial.
    So I would say that this means there really is no need for 
a trigger mechanism. If there is some reason why additional 
revenues are needed in the future, Congress should simply pass 
a tax increase at that time. Thank you.
    [The prepared statement of Bruce Bartlett follows:]

 Prepared Statement of Bruce Bartlett, Senior Fellow, National Center 
                          for Policy Analysis

    Mr. Chairman, there are three major points I would like to make 
this morning regarding the budgetary implications of President George 
W. Bush's proposed tax cut.
    First, the estimated revenue loss from it is too high, because the 
published estimates do not take into account the macroeconomic impact 
of the tax cut.
    Second, I believe that the baseline revenue forecast is too low, 
meaning that the impact of the tax cut on the surplus is too high.
    Third, the tax cut is being treated as if it will be a permanent 
feature of our tax system for all time. In the event that budgetary or 
economic circumstances change, it can be changed in the future.

                            SCORING TAX CUTS
    As this Committee well knows, the impact of tax changes on 
aggregate revenues is highly uncertain. I believe that a key reason for 
this is that the revenue estimators use static scoring methods that 
ignore the macroeconomic effect of tax changes. Use of dynamic scoring, 
which is permitted under House rules, would give a more accurate 
estimate of proposed tax changes.
    The basic issue is this. Large tax cuts, of the sort currently 
being proposed, stimulate economic growth. There is really no debate 
about this in the economics profession. The only question is how much 
will growth be stimulated. Clearly, there is great disagreement about 
this, owing mainly to inadequate statistical techniques for measuring 
different sorts of tax cuts. For example, a tax rebate and a permanent 
tax rate reduction of equal dollar size on a static basis will have 
very different effects on growth, both in the long- and short-term. But 
it is very hard for existing macroeconomic models to capture these 
effects.
    In recent years, there has been considerable discussion of tax 
scoring methodology in prominent academic journals. Almost all agree 
that dynamic scoring is feasible, although there are important 
questions still to be resolved about how to do it and when. (I append 
to my testimony a bibliography of academic research on dynamic 
scoring.) But the basic point is undeniable that the tax cut currently 
under consideration by Congress will raise growth by some degree, thus 
reducing its net revenue loss.
    In a recent study, the Heritage Foundation, utilizing the well-
respected WEFA econometric model, estimated that faster economic growth 
will recoup almost half the static revenue loss (www.heritage.org/
library/cda/cda01-01.html). Over a 10-year period, the static revenue 
loss is estimated at $1.8 trillion. But this loss falls to $939 billion 
once faster growth is taken into account.
    The Heritage estimate is probably a little on the high side, I 
admit. But it is very common for economists to get about 35 percent 
revenue reflow from a tax cut of this type. For example:
     In 1981, Richard Musgrave, dean of American public finance 
economists, told the Joint Economic Committee that the Reagan tax cut 
would recoup 30 to 35 percent of the static revenue loss.
     In 1996, Lawrence Chimerine, chief economist of the 
Economic Strategy Institute, wrote that ``credible evidence 
overwhelmingly indicates that revenue feedback from tax cuts is 35 
cents per dollar'' (Washington Post, 7-23-96).
     Just a few days ago, Martin Feldstein, Harvard professor 
and president of the National Bureau of Economic Research, found that 
the Bush plan would only lose 65 percent of its officially estimated 
revenue loss (Wall Street Journal, 2-16-01).
    I don't know what the correct reflow assumption is, but I know with 
certainty that it is not zero. Ideally, I would like to see the Joint 
Committee on Taxation and the Congressional Budget Office work together 
to come up with a dynamic estimate. Six years ago, the House amended 
its rules to allow such an estimate to be made, but in all the years 
since, no one has ever asked. I think now is the time. Even if the JCT 
comes up with an estimate more conservative than those cited above, it 
will still give a better picture of the impact of the tax cut on budget 
totals than we have now.

                           BASELINE REVENUES
    The failure to use dynamic scoring inflates the budgetary size of 
the proposed tax cut. But from the point of view of this Committee, the 
absolute budgetary levels are also of concern. In this respect, I 
suggest that the baseline revenue forecasts, both from CBO and OMB, are 
underestimating future revenue growth. Hence, even if the tax cut loses 
as much revenue as the static forecast projects, revenues may still 
rise by a greater rate than projected. In short, there may well be more 
revenue available for a tax cut, debt reduction and spending growth 
than currently assumed.
    Historically, revenue growth has closely tracked nominal GDP 
growth. Since 1963, for every one percent rise in nominal GDP, revenues 
have risen by 1.04 percent. Since the Tax Reform Act of 1986, the 
elasticity has been slightly higher at 1.18 percent. Since the 1993 tax 
rate increase, the elasticity has grown still more to 1.37 percent. In 
other words, since 1993 federal revenues have increased 37 percent 
faster than GDP. That is the reason why revenues as a share of GDP have 
risen from 17.6 percent in 1993 to 20.6 percent last year.
    Given this highly consistent trend, broken only by recession 
periods, it is very odd that both CBO and OMB are projecting future 
revenues to rise by less than the growth of GDP. Over the next five 
years, CBO estimates that nominal GDP will grow 5.2 percent per year on 
average, whereas individual income tax revenues are projected to grow 
only 4.7 percent per year. In other words, CBO expects revenues to grow 
10 percent more slowly than GDP will grow over the next five years. OMB 
is even more pessimistic about revenue growth, stating that it projects 
revenue growth ``to lag GDP growth throughout a multi-year period to a 
degree generally experienced only during recession.''
    Both CBO and OMB base much of this pessimism on an anticipated 
decline in capital gains realizations, owing to the fall in the stock 
market. However, the principal reason why revenues have historically 
grown faster than GDP is because of the progressive nature of the tax 
code. Although the personal income tax is largely indexed to inflation, 
it is not indexed for real economic growth. As real incomes rise, 
workers are pushed up into higher tax brackets in the same way 
inflation used to. Thus as long as there is real GDP growth, we will 
still get bracket creep.
    A reasonable approach to forecasting revenues would leave out the 
recent revenue bulge resulting from exceptionally large capital gains 
realizations. But I think that the post-1986 trend for revenues, in 
which they grew 18 percent faster than GDP, is far more likely than the 
excessively conservative forecasts of OMB and CBO. On this basis, the 
federal government can expect $2.1 trillion in additional revenue, over 
and above that presently estimated, between now and 2011. That is more 
than enough to pay for President Bush's tax cut and still run surpluses 
as large as currently projected without the tax cut.

                              FUTURE RISKS
    The foregoing analysis indicates that President Bush's proposed tax 
cut is easily affordable. Nevertheless, some members have expressed 
concern that unforeseen events might alter that view. They suggest that 
the tax cut should be subject to some sort of trigger mechanism. If 
budget surpluses don't emerge as expected, the tax cut would be 
canceled.
    I think the trigger idea is utterly unworkable. The principal 
economic benefit of lowering marginal income tax rates is so that 
people will change their behavior in ways that will increase work, 
saving and investment. For example, someone might seek additional 
education or training in response to the prospect of keeping more of 
their future income. Adding a high degree of uncertainty to whether 
legislated lower tax rates will emerge defeats this purpose.
    Of course, future tax rates are always uncertain to some degree. 
Congress can and does change rates and other features of this tax code 
from time to time. This is another reason why triggers are undesirable. 
In the event that economic or political circumstances change in the 
future, Congress can always pass new tax legislation, raising revenues 
if necessary.
    Some would suggest that this is unrealistic, because it is easier 
to cut taxes than to raise them. However, this view conflicts with the 
experience of recent history. According to a recent Treasury Department 
study (www.ustreas.gov/ota/ota81.pdf), there have been 15 major tax 
bills since 1980. Of these, 11 were tax increases. Ronald Reagan, the 
arch tax cutter, signed into law 6 of them, including the Tax Equity 
and Fiscal Responsibility Act of 1982, one of the largest tax increases 
in history. And of the 4 tax cuts, only the Economic Recovery Act of 
1981 was significant.
    Therefore, I would suggest that raising taxes is not nearly as 
difficult as it is painted. True, many of these tax increases occurred 
as the result of tense budget negotiations. But in most cases, the tax 
increase portion of those budget packages was their least controversial 
element. Of course, there are exceptions, as in 1990 and 1993. But the 
point still holds that Congress has shown a willingness to raise taxes 
by large amounts in recent years, when it felt that budget 
circumstances warranted it. Those who favor a tax trigger implicitly 
assume that Congress cannot or will not do the same in the future.

                               CONCLUSION
    I believe that the proposed tax cut is affordable and necessary. 
Without it, the tax burden will rise from a level that is already 
extraordinarily high by historical standards. I believe it will help 
improve the performance of the American economy in future years, and is 
appropriately designed both in size and structure.

                                APPENDIX

                 LITERATURE ON TAX SCORING METHODOLOGY
Auerbach, Alan J. 1993. Public Finance in Theory and Practice. National 
        Tax Journal, vol. 46, no. 4 (December): 519-526.
Auerbach, Alan J. 1996. Dynamic Revenue Estimation. Journal of Economic 
        Perspectives, vol. 10, no. 1 (Winter): 141-157.
Bartlett, Bruce. 1996. The Case for Dynamic Scoring. Wall Street 
        Journal (July 30).
Bartlett, Bruce. 1997. A Victory for Supply Siders. Wall Street Journal 
        (January 23).
Bopp, Michael D. 1992. The Roles of Revenue Estimation and Scoring in 
        the Federal Budget Process. Tax Notes, vol. 56, no. 12 
        (September 21): 1629-1652.
Congressional Budget Office. 1978. Understanding Fiscal Policy. 
        Washington: U.S. Government Printing Office.
Congressional Budget Office. 1982. How Changes in Fiscal Policy Affect 
        the Budget: The Feedback Issue. Washington: U.S. Government 
        Printing Office.
Congressional Budget Office. 1995. Budget Estimates: Current Practices 
        and Alternative Approaches. CBO Papers (January).
Congressional Budget Office. 1998. Projecting Federal Tax Revenues and 
        the Effect of Changes in Tax Law. CBO Papers (December).
Engen, Eric, Jane Gravelle and Kent Smetters. 1997. Dynamic Models: Why 
        They Do the Things They Do. National Tax Journal, vol. 50, no. 
        3 (September): 657-682.
Feldstein, Martin. 1994. The Case for Dynamic Analysis. Wall Street 
        Journal (December 14).
Feldstein, Martin. 1995. Revenue Estimates Should Reflect the Effect of 
        Taxes on Work and Saving. In House and Senate Budget 
        Committees, Review of Congressional Budget Cost Estimating, pp. 
        191-194. Washington: U.S. Government Printing Office.
Feldstein, Martin. 1997. How Big Should Government Be? National Tax 
        Journal, vol. 50, no. 1 (June): 197-213.
Gravelle, Jane G. 1994. Dynamic Revenue Estimating. CRS Report for 
        Congress, 94-1000 S (December 14).
Joint Committee on Taxation. 1997. Joint Committee on Taxation Tax 
        Modeling Project and 1997 Tax Symposium Papers. Washington: 
        U.S. Government Printing Office.
Kies, Kenneth J. 1995. The Revenue Estimating Process-Letting in the 
        Light and Letting Out the Hot Air. Tax Notes, vol. 69, no. 3 
        (October 16): 373-375.
Lackman, Abraham M., and John M. Bryan. 1997. Does Dynamic Scoring 
        Work? Examining the Repeal of the New York State Real Property 
        Gains Tax. 1996 Proceedings of the National Tax Association, 
        pp. 308-313.
Lyon, Andrew B. 1996. Should We Be Afraid of Dynamic Revenue Estimates? 
        1995 Proceedings of the National Tax Association, pp. 207-213.
Mauskopf, Eileen, and David Reifschneider. 1997. Dynamic Scoring, 
        Fiscal Policy, and the Short-Run Behavior of the Macroeconomy. 
        National Tax Journal, vol. 50, no. 3 (September): 631-655.
Schwartzstein, Linda A. 1996. Smoke and Mirrors: Tax Legislation, 
        Uncertainty and Entrepreneurship. Cornell Journal of Law and 
        Public Policy, vol. 6, no. 1 (Fall): 61-93.
Slemrod, Joel. 1998. Methodological Issues in Measuring and 
        Interpreting Taxable Income Elasticities. National Tax Journal, 
        vol. 51, no. 4 (December): 773-788.
Sunley, Emil M., and Randall D. Weiss. 1992. The Revenue Estimating 
        Process. American Journal of Tax Policy, vol. 10, no. 2 (Fall): 
        261-298.
Triest, Robert K. 1998. Econometric Issues in Estimating the Behavioral 
        Response to Taxation: A Nontechnical Introduction. National Tax 
        Journal, vol. 50, no. 4 (December): 761-772.
Vasche, Jon David, and Hoang Nguyen. 1994. The Treatment of Feedback 
        Effects in Revenue Impact Analyses. Tax Notes, vol. 65, no. 5 
        (October 31): 599-618.
Williams, Brad, Kristin Szakaly and Jon David Vasche. 1996. Dynamic 
        State Revenue Impact Analysis: A View From California. 1995 
        Proceedings of the National Tax Association, pp. 214-221.

    Chairman Nussle. Thank you very much, Mr. Bartlett. Thank 
you to all the witnesses for their testimony.
    Let me begin the questioning first with Mr. Gale. I want to 
begin by clarifying something and really correcting something. 
I recognize that you work in a think tank and fortunately or 
unfortunately that's the kind of environment that makes this 
environment look like the real world.
    But here, I think being accurate, being direct is extremely 
important. You stated that the President was proposing to pay 
down $2 trillion in debt. That's certainly correct. That's more 
debt repayment than has ever been achieved by any country in 
the history of the world, but certainly that's more debt paid 
down over a shorter period of time than in our Nation's 
history.
    Then you suggested though that there was an additional $574 
billion that was being generated largely by the Social Security 
surplus that the President was proposing to use for any purpose 
at all. That's wrong. That is not accurate. The President's 
budget is explicit that those funds can only be used for Social 
Security. Now, you may disagree and we may all have 
disagreements about how they would be used to modernize or 
strengthen Social Security. But to suggest that they're being 
put in the budget to be used for any purpose simply is not 
correct.
    I would begin by asking you, given that those funds are 
being set aside, the Social Security funds, $574 billion, they 
cannot be used to pay down debt without incurring significant 
penalties. What would you propose to do with those funds?
    Mr. Gale. Well, first, as a point of fact, my understanding 
is that the money is not being used to pay down debt, this $574 
billion, what we're rounding to----
    Chairman Nussle. As I just stated, because we would incur 
significant premium penalties if we tried to do so.
    Mr. Gale. Well, OK, it's my understanding it's not being 
used to pay down debt and that the money is ending up in this 
so-called reserve fund of $842 billion.
    Chairman Nussle. No, let me be clear, that is not. That is 
a separate reserve fund, $574 billion, Social Security 
surpluses, that's being set aside in its own reserve fund to be 
used for Social Security.
    Mr. Gale. All right, well, my----
    Chairman Nussle. What would you propose to use those funds 
for?
    Mr. Gale. There's a number of things we can do with those 
funds. The simplest thing is to note that State and local 
governments currently hold $3 trillion of private assets, 
including $2 trillion of equities. That is 10 percent of all 
private equities in this country are held by State and local 
governments.
    Chairman Nussle. Held by governments or their pension 
funds?
    Mr. Gale. Their pension funds, but they are not self-
directed funds. They are invested by boards of trustees on 
behalf of workers. Workers do not get to choose where these 
things go. They're defined benefit plans.
    These funds earn market rates of return, less than 2 
percent of them----
    Chairman Nussle. That's fine, so you think one use would be 
for the Federal Government to buy equities, to buy stocks, to 
buy private assets that are out there?
    Mr. Gale. That's correct. The other----
    Chairman Nussle. I think that's a good idea, but that's 
certainly a legitimate point you make. But you would want to do 
that through the Social Security system, right? You're not 
saying to spend that for something other than Social Security?
    Mr. Gale. Right, to invest it in order to address future 
Social Security needs. That's a way of cordoning off the funds 
in a way that they can't be spent.
    Chairman Nussle. So you're with the President here, set 
aside the funds, use them for Social Security?
    Mr. Gale. Well, no, the President, the budget says the 
administration is philosophically opposed to investing these 
funds in private assets, even though the State of Texas invests 
$20 billion on behalf of its workers.
    Chairman Nussle. They're not supporting buying private 
assets, and again, I don't want the Government out there buying 
Microsoft stock or GE stock and to suggest that this is going 
to be insulated from political influence I think is a misnomer.
    Mr. Gale. If you'd let me finish my----
    Chairman Nussle. Insofar as setting aside the funds in a 
reserve and using those funds for Social Security, you're for 
that, correct?
    Mr. Gale. I'm absolutely for--let me be clear. The 
President, I have a feeling the administration wants to pull 
the same kind of switch on Social Security as it's trying to 
pull on Medicare, which is, it's going to try to use the $600 
billion surplus there left over to fund the privatization plan, 
which is different from setting aside the money to pay down 
future revenues. It's the same deceptive budgeting that they're 
trying to do on Medicare.
    Chairman Nussle. I'd like to maintain a decent tone, I 
think this is a substantive discussion. I'm not questioning 
your motives in putting forward your proposal for getting the 
Federal Government into the stock market, and I don't think you 
should question the administration's motives or intentions in 
setting aside these funds. I don't think the administration has 
done anything for anyone here, Democrat, Republican, 
Independent, observers, to come in and suggest that the whole 
budget's a ruse and it's part of a bait and switch. I just 
think that sets the wrong tone for looking at what is a serious 
opportunity with significant surpluses to do good things.
    Mr. Gale. I agree that this is a serious opportunity. Paul 
O'Neill has testified in Congress, I don't know if it was this 
committee or a different committee, I don't know if it was 
House or Senate, but he testified in Congress he was unwilling 
to commit that that $600 billion was going to be held to pay 
future Social Security liabilities under the existing system. 
That's about as authoritative a measure as you can get in terms 
of what the administration's economic policy is at the current 
time.
    I agree, it's very difficult to understand what the 
administration's policy is. But that's largely because they're 
trying to push a tax cut through before they've even sent up a 
budget that has all the details, as Mr. Greenstein has pointed 
out. So I agree this is a serious debate. But I don't think my 
comments were at all out of line in terms of what the 
administration's budget is absolutely proposing.
    Chairman Nussle. The administration's budget is not 
proposing to spend that money on anything other than Social 
Security. And everyone knows that the administration supports 
conceptually some very bold and progressive reforms for Social 
Security. And we can agree or disagree with those reforms. But 
I don't think it's fair to misrepresent the very clear 
statements of the budget.
    Let me talk about tax relief. You talked about a $2.5 
trillion tax relief package. You know what reconciliation is, I 
take it, you probably understand the process better that me or 
other members of this committee, given your extensive work in 
the budget. The way reconciliation is written into our budget 
resolution, it will contain a statement in the President's 
budget proposal, and if we pass a resolution that largely 
follows that, it will allow for a tax relief package up to $1.6 
trillion, correct? That's the way the reconciliation language 
is written in the budget resolution, up to the amount, up to 
$1.6 trillion.
    Given that fact, and that that's the only way we can 
protect the tax package from a filibuster in the Senate, 
explain to me the series of events or the conspiracy that will 
go on once we've passed that reconciliation number to allow 
this $2.5 trillion package to move through the Senate.
    Mr. Gale. Well, I don't think it's necessarily a 
conspiracy. But let's say the tax cut is $1.6 trillion over 10 
years. There's an interest cost associated with that which 
according to the administration's budget is almost $400 
billion. That's not technically part of the tax package, but 
that should be included in the total cost of the surplus. And 
the tax package, if it includes the provisions of H.R. 3, will 
leave a whole mess of unfinished business, namely that 36 
million taxpayers will be on the AMT as of a decade from now. 
That's one out of every four taxpayers.
    Chairman Nussle. I'll get to that point. I definitely want 
to ask about the AMT. But also on the interest costs, you've 
seen the President's budget proposal and submission, I'm sure. 
It includes the anticipated interest costs, even under static 
scoring, that would occur because of any additional spending or 
tax relief, correct?
    Mr. Gale. No, the $1.6 trillion number doesn't.
    Chairman Nussle. No, not $1.6 trillion, his budget proposal 
does. It comes to $417 billion over the 10-year period.
    Mr. Gale. Right.
    Chairman Nussle. OK. Let's talk about income distribution a 
little bit. You sort of talked about weighting the tax relief 
to upper-income earners. I, just for the record, want to get 
some figures here. If you take the top 10 percent of wage 
earners in this country, what share of personal income do they 
represent?
    Mr. Gale. I'm not sure what share of personal income they 
represent. I can tell you what share of taxes they pay.
    Chairman Nussle. Well, I want to know how much money 
they're making first.
    Mr. Gale. I don't have that in my testimony. I'd be happy 
to provide that in written follow-up.
    Chairman Nussle. If you could. I believe it's approximately 
45 percent of aggregate personal income in this country. What 
share of the income taxes do they pay on that income?
    Mr. Gale. What share of total income taxes?
    Chairman Nussle. What total income taxes do the top 10 
percent of wage earners pay in this country?
    Mr. Gale. According to CBO data, they pay 63 percent of 
income taxes and 49 percent of total taxes.
    Chairman Nussle. But 63 percent of the income taxes, but 
their share of personal income is only 45 percent. Now, I would 
just ask you in general terms, do you think that's a pretty 
fair share of the personal income tax burden?
    Mr. Gale. In a progressive tax system, you expect, almost 
by definition you expect high income taxpayers to pay a higher 
share of the taxes than of the income that they----
    Chairman Nussle. Right, so 45 percent of the income, 63 
percent of the taxes. Is that roughly where you would want it 
to be, or would you rather have them pay 75 percent of the 
taxes, 85 percent of the taxes? Does Brookings or do you 
personally have a goal for the progressiveness in the tax code 
if it's not progressive enough already?
    Mr. Gale. Brookings doesn't take institutional positions on 
any issue. If we want to talk about the progressivity of the 
tax code, and----
    Chairman Nussle. But you are arguing that this tax relief 
package is too heavily weighted toward the wealthy, which 
suggests that you do have a position on the progressiveness of 
the code.
    Mr. Gale. OK, I just said Brookings doesn't, I didn't say I 
don't have a position. And I'm trying to get to my position, if 
you'll let me finish.
    Let's go with your number that the top 10 percent earn 45 
percent of all income. I don't have that number at my disposal, 
let's go with that. They pay 49 percent of all Federal taxes. 
They paid 63 percent of income taxes, but 49 percent of all 
Federal taxes. They would get a larger share of the Bush tax 
cut than the proportion of all Federal taxes that they pay.
    Let me put it differently. The proportion of the Bush tax 
cut that goes to the top 10 percent is bigger than the 
proportion of total Federal taxes that they pay. So that will 
make the system less progressive. Now, it might make the income 
tax itself more or less progressive, depending on how you 
calculate it. But the income tax is a progressive, is the most 
progressive part of the system, other than the estate tax.
    So if you cut income tax levels generally, you're making 
the whole system less progressive. It's that emphasis on the 
whole tax system, rather than just the income tax, that is so 
important. When the President says that Americans are facing 
record tax burdens, that includes the payroll tax and three-
quarters of families pay more in payroll taxes than in income 
taxes.
    So if the President were really concerned about reducing 
the tax burden on the typical American family, he wouldn't have 
proposed the tax cut that he proposed.
    Chairman Nussle. Mr. Greenstein, I want to talk about AMT. 
You talked about the AMT and that again, regardless of the fact 
that it will include a reconciliation number up to a certain 
level that will, and only that level will be protected as a 
bill moves through Congress, you suggest that, well, there's 
another $300 billion in AMT changes that need to be made. Are 
you suggesting that we should include changes to AMT in the tax 
relief package that we move through the House and Senate?
    Mr. Greenstein. Two answers. First, yes. I do think we 
should include AMT relief. I've thought that for several years. 
We urged the Clinton administration in its budgets to go 
farther in proposing more. We all know this is a problem that 
has to be addressed.
    But Mr. Chairman, let me make another key point. I 
recognize that AMT reform will probably not be done this year. 
Might be next year, might be 2 years from now. My point is, we 
have a projected budget surplus for the next 10 years. We have 
to leave room in it for the AMT cost. And the argument that 
because it won't be in this year's reconciliation bill, we can 
ignore the cost when adding up how to dispose of the projected 
surplus I think is not responsible budgeting.
    The cost of fixing the AMT, which probably will not be done 
this year, is, according to the Joint Tax Committee, increased 
by $292 billion over 10 years by H.R. 3. Therefore----
    Chairman Nussle. And you've taken a position in favor of 
that $300 billion modification to the AMT? Is that your 
personal position or you're saying the Center for Budget and 
Policy Priorities has supported AMT reform?
    Mr. Greenstein. The Center has supported and continues to 
support AMT reform. I don't know that we've looked at it in 
enough detail to have a specific AMT reform proposal. I do 
think the single biggest problem is probably that this big 
exemption amount is an index for inflation. If you index that 
for inflation that would solve a lot of the problem.
    Chairman Nussle. I would ask you to submit just for the 
record any position papers from the Center on reforming the 
AMT. I don't follow all the work that you do and I'm sure it's 
a lot of good work. But I am unaware of the Center having taken 
a position, a clear position for AMT reform prior to this----
    Mr. Greenstein. Mr. Chairman, since you're questioning my 
veracity, could I respond to that?
    Chairman Nussle. Oh, no, I'm saying I'm aware of it. If you 
could submit a policy statement.
    Mr. Greenstein. I don't know that we have a formal 
position. We have said it in prior Congressional hearings, we 
have said it in the press. We have said it in meetings on the 
Hill. We have said it to the Treasury and OMB----
    Chairman Nussle. Terrific.
    Mr. Greenstein [continuing]. And White House officials 
during the Clinton administration. We have been very consistent 
on this.
    Chairman Nussle. And just for the record, if you could 
submit a reference to prior testimony before this committee----
    Mr. Greenstein. I'll see if we have something in paper. 
It's mostly been--I don't know that we have, we probably have 
something and I'll find it and submit it.
    Chairman Nussle. Terrific. Finally, let me talk a little 
bit about forecasting and error rates, because you presented 
some interesting information there. You referenced an error 
rate of plus or minus $1 trillion over a 10-year period. What 
10-year period were you using as a reference there?
    Mr. Greenstein. Years 2002 through 2011. These figures come 
right out of the chapter, they're based on the data in the 
chapter on uncertainty in the new CBO report issued in late 
January that covers 2002 through 2011.
    Chairman Nussle. So that's a prospective assessment of what 
the----
    Mr. Greenstein. I'm sorry, Richard is correcting me. The 
2011 figure is a 5-year total from the CBO report, and it's 
2002 through 2006.
    Chairman Nussle. But it's a prospective assessment of what 
the error rate could be, as opposed to a look-back to the 
1970's or to the 1980's or to the 1990's and saying, gee, our 
forecasting varied in the 1990's by $1 trillion.
    Mr. Greenstein. No, to the contrary, what CBO did is, it 
took the entire period for which it has done forecasts for at 
least a 5-year period. And it said, what was our average error 
in the fifth year during this period. And it expressed its 
average error for the fifth year as a percentage of GDP. That 
translates into errors over this 5 year period as a whole.
    They estimated the average error over a 5-year period and 
in the fifth year. If you simply take their average, the 
average error, if we have the same error in the next 5 years 
that they've been off on average for their whole history of 
doing 5-year forecasts, it would be $1.1 trillion in either 
direction, too high or too low.
    Chairman Nussle. Let me talk briefly about averages. It was 
something alluded to by Mr. Bartlett. Do you know what the 
average, the historic growth in revenues has been over the last 
50 years?
    Mr. Greenstein. I don't have the specific figure, but I 
would say that most economists I know would not at all agree 
with Mr. Bartlett's assessment that there is a standard 
estimate that revenues would grow by this amount.
    Chairman Nussle. No, but there is an average. There's an 
historic average which is about 7\1/2\ percent.
    Mr. Greenstein. I don't have the specific figures.
    Chairman Nussle. It is 7\1/2\ percent nominal growth in 
revenues per year. In fact, it's surprisingly consistent. If 
you go to any 10-year period during the last 50 years, you come 
up with an average annual nominal revenue growth rate of 
between 7 and 9\1/2\ percent. Do you know what the revenue 
growth forecasts are in the current budget submission over the 
10-year period?
    Mr. Greenstein. I don't have the specific percentage in my 
head, but I know, Mr. Chairman, that one of the things that's 
been taken into account is that one of the driving forces in 
revenue growth in the last few years has been huge surges in 
capital gains taxes as a result of the big increases in the 
stock market, and that there is a strong reason to believe, 
given how high the price-to-earnings ratios are, and how high 
the market already is, that it won't grow at the same rate in 
coming years and that one would therefore have to assume a 
lower rate of growth in capital gains taxes during this period.
    So we can't simply look at long-term averages. We also have 
to consider the events of the most recent period. I am not an 
expert on revenue forecasting, but I do----
    Chairman Nussle. But your point is a very good one. It's 
the same point that Alan Greenspan made. So I think you're in 
pretty good company there, that there might be something 
unusual about the revenue growth we've seen over the past 3 or 
4 years. But----
    Mr. Greenstein. There's a larger issue here which CBO 
points out in its report. That is the big unknown is the rate 
of productivity growth. We've had a higher rate of productivity 
growth in recent years, and no one really knows to what degree 
it's permanent. CBO and OMB have made a certain judgment about 
how much of it's permanent in their forecast. They could be too 
high or too low.
    The point is that CBO points out that this forecast has a 
higher degree of uncertainty, this budget forecast, than most, 
because of the degree of uncertainty regarding the productivity 
growth rate estimates.
    Chairman Nussle. I understand that. At the same time, I 
think that any observer would be hard-pressed, given the 
productivity growth rate recently, and currently, and the 
argument of economists that that productivity rate has seen a 
structural increase, to then argue that the next 10 years will 
bring a lower revenue growth rate than we have ever seen in our 
modern economy.
    Now, I'm not arguing for a wildly optimistic revenue growth 
rate. But I do want to drive home the point that the revenue 
growth rate forecast in this 10-year budget is about 5 percent 
per year. That is a full 2 percentage points below the historic 
average of the last 50 years. I apologize for taking so much 
time, and at this time yield to Mr. Spratt.
    Mr. Spratt. Thank you, Mr. Chairman.
    Do we have a vote? What is that, the 10-minute bell? Let me 
take a few minutes, then we'll come back.
    With respect to the AMT, Mr. Chairman, I would simply point 
out that the Center doesn't have to endorse the AMT reform in 
general or any specific form, other than to say that when it 
confronts 20 million taxpayers, there's likely to be clamor for 
significant change. I think that's a political fact that they 
can express their judgment upon.
    I share that judgment. I think you would, too, when we go 
from 2 million people to 30 million people affected by the AMT, 
being extended benefits under the code that are then taken 
back, we'll change it.
    Chairman Nussle. And if you would yield on that, I don't 
disagree at all. I simply wanted to point out the process 
issues of trying to include that in our reconciliation 
instructions for the Senate, if the number is $1 trillion or 
$1.6 trillion, any modifications need to be made within that 
number, and it wouldn't be right from a process standpoint to 
assume that we could easily layer the AMT reform that you 
talked about and that Mr. Greenstein has talked about on top of 
it.
    Mr. Spratt. Let me also clarify something else that you 
were questioning Mr. Gale about. If you look at the Blueprint 
for New Beginnings, page 12, it says, after achieving all these 
goals, $1.6 trillion in tax cuts, roughly $1.4 trillion in 
projected surpluses will remain. The President proposes to use 
some of these and the additional needs as a contingency to 
reserve is ultimately an insurance policy. The surpluses may 
not be as large as projected. Farm conditions could require 
additional resources. More money may be needed for national 
security.
    To get to $1.4 trillion, which they're claiming as a 
cushion fund and a contingency reserve there, you have to 
include the Social Security, some of the Social Security 
surplus. There's no other way you can add it up.
    If you turn the page to page 14, the $1.4 trillion at the 
bottom of the page becomes a $1 trillion reserve. The 
President's budget recognizes there are inherent uncertainties 
in making 10-year projections. In deference to this, it sets 
aside a large $1 trillion reserve. Once again, by my 
arithmetic, to get to $1 trillion, you have to include some of 
Social Security and all of Medicare.
    Then on page 185, there's a table, Table S1. We talked 
about it yesterday. The contingency fund there is not 
identified to any particular purpose, just a general 
contingency fund, is $842 billion. Yesterday the chairman 
opened the hearing by saying there was a lot of angst in your 
party over the fact that the administration was advocating the 
inclusion of the Medicare surplus, Medicare HI trust fund 
surplus, in some kind of a contingency fund. He wanted it made 
clear that the HI surplus could not be used for anything but 
Medicare. And the witness who was there is in charge of the 
Medicare program as the Secretary of HHS. And he said 
absolutely not, only Medicare.
    Well, if you back out the surplus, $526 billion, which Mr. 
Greenstein does, and Mr. Gale does, you're down to a 
contingency fund of just $316 billion. There are a lot of other 
things that would have to be taken into account. So if there's 
confusion, it's not because we're politicizing the issue, it's 
engendered by this particular blue book. Mr. Gale.
    Mr. Gale. Thank you for bringing it up. The text on page 12 
that Mr. Spratt referred to is precisely the motivation for my 
written testimony and the discussion I was having. I didn't 
have access to that, to the written text, while we were talking 
before. But that's precisely the language in the President's 
budget that leads me to the conclusions that I mentioned.
    Mr. Spratt. Thank you very much.
    Have you voted?
    Chairman Nussle. I haven't. What I would suggest, and I'm 
sure you have other questions you'd like to ask and there are 
other members, so what I would suggest is that we recess and 
come back and then we'll continue with your questioning.
    So the committee will be in recess, subject to the vote on 
the floor.
    [Recess.]
    Mr. Gutknecht [assuming Chair]. The committee is back in 
order. Mr. Spratt.
    Mr. Spratt. Listening to the four of you testify, I thought 
there may have been one strand of agreement, when it came to 
looking at the budget long term, longer than a 10-year horizon. 
Mr. Mitchell, you or Mr. Bartlett I think used a figure of $21 
trillion as the deficit in Social Security alone. I'm not 
really sure what the number represents. The number I've always 
used is $3.1 trillion as the present value of the unfunded 
liabilities for benefits promised today.
    Where does your $21 trillion come from?
    Mr. Mitchell. That's an inflation adjusted figure, taking 
the Social Security Administration's forecast between now and 
2075.
    Mr. Spratt. For all benefits?
    Mr. Mitchell. Looking at all promised benefits compared to 
projected revenue collections, taking the annual deficits that 
begin around 2015 through the 2075 year period. You add them 
all together, they come up to some enormous number well over 
$100 trillion. But you adjust it for inflation to today's 
dollars, you come up with $21 trillion. You of course put it in 
present value terms, you can get it down lower than that. I've 
always thought the inflation adjusted dollars was the most 
accurate, because Government doesn't budget using accrual 
accounting, so the present value concept wouldn't really have 
much value.
    Mr. Spratt. Well, let's just use $3.1 trillion. That number 
has some validity, it's used by lots of people. If we used 
accrual accounting and if we had a $3.1 trillion liability fund 
funded benefit, which we now could see and recognize, accrual 
accounting would require us to begin booking it right away. Our 
accountants might let us get away with incrementally booking it 
so that over a period of time we would cover that.
    But if that were true and if we had accrual accounting, we 
wouldn't have a surplus, would we?
    Mr. Mitchell. Well, I confess, I don't know whether we'd 
have a surplus with accrual accounting. I do know that 
obviously you would recognize the long-term obligations of the 
Social Security system and in some sense, I'm very tempted to 
go down that route, because it would show that Social Security 
reform is a savings, not a cost. But on the other hand, I'm 
also concerned that people might be tempted to play games by 
reclassifying Government consumption expenditures as 
investments. There might be opportunity for shenanigans that, 
well, to be perfectly honest, both parties would want to engage 
in, depending on which programs they were supporting at the 
given time.
    Mr. Spratt. But, Mr. Greenstein, would you agree with that, 
that if we were to accrue the liability for the unfunded 
present value of future benefits that we would have a marginal 
surplus, certainly nothing approaching $5.6 trillion in the 
unified budget?
    Mr. Greenstein. I don't know what the figure would be 
precisely over the next 10 years. If you had a longer time 
frame than 10 years, you would clearly see return to deficits.
    I'm reminded of a phrase that Gene Searly of the Urban 
Institute uses. He says we're on an island of surpluses in a 
sea of deficits. We came from deficits, we're going back to 
deficits. The island looks considerably larger than it did a 
year ago. It's still an island.
    Mr. Spratt. I appreciate your reminding me who said that. I 
plagiarized it this weekend and didn't know who I was supposed 
to attribute it to, so I claimed it for myself. I'll thank Gene 
Searly for it.
    Getting back to the point, though, I'm simply saying that 
when you recognize the liability for Social Security and you 
recognize the liability for Medicare in some form, there's a 
lot of talk of reforming it, but there's no way around the fact 
that medical costs are going up faster than other costs, and 
the demographics are there, they're not going away for a long 
time to come. Both of those factors means substantial 
liabilities for the future. If you factor in those liabilities, 
we have a lot less surplus than we think we have, and 
therefore, doesn't that mean, doesn't that suggest to you that 
we ought to deal with those long-term liabilities before we 
declare a surplus? And, if we can indeed pull off the kind of 
alchemy that you're talking about, with private accounts, and 
wipe out this huge liability, then we can go back and dispose 
of the remaining surplus.
    But shouldn't that come first?
    Mr. Mitchell. I would have no objection to doing Social 
Security reform before tax cuts or doing tax cuts before Social 
Security reform. I don't think they're necessarily linked. But 
if it's alchemy, we should bring all the alchemists from all 
these other countries around the world that have successfully 
done it and do it as quickly as possible. I'm glad that the 
President in his address before Congress stated that he has 
every intention of moving forward on this issue.
    Mr. Spratt. Mr. Greenstein.
    Mr. Greenstein. They're inextricably linked. And I think 
the reason they're inextricably linked is that Congress cannot 
pass, I don't see how Congress can pass Social Security reform 
or long-term Medicare financing reform unless it either engages 
in budget gimmickry to an extraordinary degree or transfers 
significant funds from the non-Social Security, non-Medicare 
surpluses into those programs.
    Take the proposal to take 2 percentage points of the 
payroll tax and put it into individual accounts. If that was 
the only thing you did, insolvency would come in 2023 rather 
than in 2037. Obviously there would be some Social Security 
benefit reductions linked to setting up individual accounts. 
But the President has said that no one who is now elderly or 
nearing retirement would have those Social Security benefits 
touched.
    While if you look at the numbers, in order to avoid 
insolvency in Social Security, you do 2 percent in individual 
accounts. If you don't touch benefits for anybody 55 years and 
over, you have to have, for example, average Social Security 
guaranteed benefit cuts for people age 30 today up around 50 
percent. And even after you factor in the individual accounts, 
it would be a net reduction, using high rates of return that 
people like Martin Feldstein use, which may be too high for 
what you get from the stock market for the individual accounts. 
You'd still have a 20 percent benefit reduction.
    Now, Congress isn't going to accept that. That isn't going 
to happen. So the only way to fit the numbers together is to 
have some transfer from the rest of the fund. Whether you do 
individual accounts or you don't, or you do Social Security 
long-term solvency the traditional way, either way, you 
couldn't put together something you could pass, because of the 
benefit cuts that would be involved, unless you lubricated, 
softened the reform by having some transfer from the rest of 
the budget so the benefit cuts wouldn't be too deep.
    The same is true in Medicare. Breaux-Frist, Breaux-Thomas, 
all these things, I forget the numbers, 70 percent, 75 percent 
of the long-term shortfall in Medicare is still unaddressed. 
Even if you raise the eligibility age to 67 and do things like 
that.
    So if Congress is to take tough actions that will be 
controversial in Medicare and Social Security, to restore long-
term solvency, in order to have that not be so controversial 
you can't possibly pass them, you're going to have to have as 
part of that package some transfer which suggests to me, you 
know, do that first, figure out how much of a transfer we need. 
I'm not talking about doing just a transfer. I'm in favor of 
some tough reforms in both programs.
    But to consume the whole non-Social Security, non-Medicare 
surplus on a tax cut and not have resources left to do as part 
of that transfer I think at the end of the day could end up 
meaning that we go another bunch of years without restoring 
long-term solvency to either program.
    Mr. Spratt. Mr. Gale.
    Mr. Gale. I agree that they are inextricably linked, both 
for policy and for economic reasons, they being Social Security 
and Medicare reform on the one hand and tax cuts on the other 
hand. One of the commonly heard arguments in favor of tax cuts 
goes along the line of, it's the people's money, give it back 
to them, we're overcharging them because we have a surplus. All 
of those arguments omit the fact that the Government has 
promised more in benefits to the American public than the 
Government has agreed to collect from the American public.
    So yes, it's the people's money. But which people? The next 
generation or this generation? If you give the money back to 
people this generation, then you're making the problem for the 
next generation more complicated. So an emphasis on the long-
term financing issues is crucial to understanding how much 
money is available for a tax cut.
    Mr. Spratt. Mr. Mitchell, Mr. Bartlett.
    Mr. Mitchell. I would just make the point that yes, in all 
likelihood, if we reform our Social Security system like so 
many other countries have done, there probably will be a 
general revenue transfer to help facilitate that process, or to 
lubricate it, as Mr. Greenstein said. But if we don't reform 
Social Security, we'll have to make a much bigger general 
revenue transfer into the program to make up for that giant 
unfunded liability that currently exists, on the assumption, 
bringing political realism into the equation, that we're not 
going to cut people's benefits by 35 percent or increase 
payroll taxes on low income workers by 50 percent.
    So the question is, if we're going to use some general 
revenue at some point in time for Social Security, do we do it 
in a way that makes it, that creates a stronger, better system. 
And does that have anything to do with tax cuts? Absolutely 
not. Countries have privatized their Social Security systems 
when they've had surpluses, they've privatized their Social 
Security systems when they had deficits. They did it not 
because it was a fiscal issue, but because it was a way of 
guaranteeing workers a better, stronger retirement system, and 
helping their economies by switching from a tax-and-transfer 
entitlement scheme into something based on private savings, 
which every economic theory that I know of, even Marxism, they 
all agree that capital formation, savings and investment, is 
the key to rising wages over time.
    Mr. Spratt. Mr. Bartlett.
    Mr. Bartlett. I don't have anything to add to that.
    Mr. Spratt. Mr. Mitchell, my only response to your response 
is that the question is, which comes first. If you have the tax 
cuts first and not enough is left over to begin to lubricate or 
facilitate the transition to Social Security and Medicare 
reform, what do you do? You're back into deficit, aren't you, 
and you're defeating your purpose? You're borrowing to prevent 
borrowing.
    Mr. Mitchell. I would refer back to my testimony. I don't 
think we should worship at a shrine of a surplus or a balanced 
budget. Let's say for some reason we had no surplus today. It 
would still make sense, as I said in my testimony, to run a 
shortrun deficit to reform Social Security in order to both 
achieve all the long-term fiscal savings and also of course, 
let's keep in mind, to create a better system for today's 
workers that will give them more security in their retirement.
    And of course, we just talked about accrual accounting. If 
we had accrual accounting, it would show that this kind of 
reform was actually something that reduced aggregate present 
value deficits for the Government. So we can't keep switching 
back and forth between cash budgeting and accrual budgeting, 
depending on which point we want to make.
    Mr. Spratt. Thank you very much for your testimony, for 
your coming here today and for your patience. Let me yield to 
other members for questions.
    Mr. Gutknecht. Mr. Bentsen or Mr. Price, either one. Mr. 
Bentsen, if you have questions, go ahead.
    Mr. Bentsen. Thank you, Mr. Chairman.
    I want to go back to what you were talking about with Mr. 
Spratt and sort of walk through the math on this. First, Mr. 
Mitchell, I think what I hear you saying is similar to what 
Martin Feldstein and others have said in their proposal to 
reform, we'll just issue new debt to get us over. That's 
obviously one way to do it, of course, the debt's not free, 
there's a price to pay for that, both in terms of actual 
dollars as well as the associated macroeconomic costs.
    But this is something we've tried to sort of discuss in our 
hearings. Since none of you either are elected officials or 
serve in a publicly elected administration, you have a lot more 
leeway to say what you want, and not to think that others who 
have testified wouldn't have absolute candor, because they 
might be concerned with political issues or controversy, just 
as Members of Congress might not have such candor. Of course, 
that would never happen.
    If we look at the long term issues, and you look at CBO's 
numbers, on its face if we do nothing, and we could pay down 
all the debt, forgetting the question of what's callable and 
non-callable, what's redeemable and non-redeemable, by, I think 
2030, we start to see a dramatic uptake in our debt to GDP. 
Now, of course, that number backs up to 2020 the more of the 
projected surplus that you use.
    We have surpluses in Part A of Medicare and surpluses in, 
which is the Hospital Insurance trust fund, as you know, and we 
have surpluses in Social Security. We expect those to grow for 
some time and then to start to be drawn down.
    If you take those moneys and use those moneys for anything 
other than the long term benefit that they are promised to, 
aren't we in effect double counting those moneys? Because 
ultimately, you have to make those up. The only way, if we're 
not double counting, is the only way to avoid that by replacing 
those moneys somewhere else, either through benefit cuts or 
payroll taxes, or additional debt on top of that? Is that a 
fairly correct theory?
    Mr. Mitchell. I guess I think we're double counting in the 
current system. No matter whether we have a lockbox or not, 
regardless of whether the Social Security surplus is used for 
more spending, for tax cuts, or used to pay down debt, none of 
that changes the fact that at the end of the day, all that 
happens with the Social Security surplus is that the Social 
Security trust fund gets Government bonds, IOUs that simply 
represent a claim on future taxpayers.
    This is not real savings. It's not like a State and local 
pension system where they buy private assets.
    Mr. Bentsen. I see where you're going. Let me back up and 
use my simplistic sort of banker's mentality on this. Assuming 
that you have an indenture and you have a flow of funds of 
where they go, these surpluses are invested in interest bearing 
Government securities and correctly in the future, the Social 
Security trustees are going to go to the Treasury window and 
they're going to present these bonds, and they're going to say, 
we want our cash. More likely than not, the Treasury is going 
to say, fine, here's your cash, while at the same time, they'll 
roll the bond into the public market.
    But the money is encumbered. The instrument represents real 
dollars and real interest that under the indenture of the 
Social Security trust is encumbered for payment on future 
benefits. I don't think anybody has yet denied that. The point 
is, if you spend that money on anything else but those future 
benefits, and legally you would have to make that up, but 
forgetting the laws, think of the laws of economics or the laws 
of finance, the laws of mathematics, don't you also have to 
make it up? I mean, you're taking a dollar from one pot and 
putting it in another.
    Mr. Mitchell. No, but what happens with Social Security is 
that the payroll taxes automatically get credited to the Social 
Security trust fund. If we don't have enough of a benefit 
obligation that year, that money then automatically is going to 
go for something else.
    Mr. Bentsen. I understand all that. And they get a 
certificate against the dollars. I think that muddies the 
debate, though, when you say, well, it's spent on something 
else or whatever. I understand you to say that's a claim 
against future revenues of the Government.
    But the fact is, that claim is in effect a monetary 
instrument encumbered against future benefits. Whether it's 
cash or a bond, it's still encumbered.
    My question is, if you spend that cash or that bond on 
anything but future benefits, don't you have to make that up 
somewhere else?
    Mr. Mitchell. Under current law, all that matters is that 
the Social Security trust fund gets credited with a bond. What 
actually happens with the surplus cash after that doesn't 
change the size of the Social Security trust fund, it doesn't 
change the fact that, as you point out, Social Security will 
present those bonds to Treasury when they begin to run 
deficits, and that Treasury of course will redeem those bonds, 
either by raising taxes, or more likely just by rolling them, 
as you said, into the debt held by the public.
    But it's not going to affect the size of the trust fund or 
any of the underlying mechanism and operation of Social 
Security, how that surplus money is then disposed of. I mean, 
the whole lockbox concept is simply saying, we want to make 
sure that surplus is spent to buy down debt.
    Mr. Bentsen. No, I'm not talking about the lockbox. The 
lockbox is, I think, somewhat of a gimmick, myself. But there's 
a legal obligation and there's a mathematical obligation. If 
there's $500 billion that is for future benefits, whether it's 
sufficient or not, there is that $500 billion. If you take, say 
you take $250 billion of it away, don't you have to make up 
that $250 billion in one of a number of ways, higher taxes, 
additional debt on top of the $500 billion debt that's out 
there, or benefit cuts? I don't know if anybody else wants to 
comment on that.
    Mr. Mitchell. All I would say is, that's exactly what 
happens under the current system. And nothing----
    Mr. Bentsen. Well, I guess my point is, if that's exactly 
what happens under the current system, but then you reallocate 
some of that obligation, don't you make it worse by the amount 
you reallocate?
    Mr. Mitchell. It wouldn't matter whether you spend the 
money, cut taxes with the money. The point is that the Social 
Security trust fund still has this claim through this 
Government bond on future revenues from the Treasury 
Department. The only way that could actually be changed is to 
say that the Social Security surplus from now on is going to be 
invested to purchase private assets.
    Mr. Bentsen. The Chairman is indulging me, I guess maybe--
let me rephrase it this way. If you transfer the claim, if you 
say the trust fund is a claim, and we're going to use part of 
the claim, rather than for future benefits, we're going to use 
it to privatize the system in some way. Then you have to make 
up the deficit in that claim.
    Would that be correct? Does that make sense?
    Mr. Mitchell. I suppose one could design a reform plan that 
did that, and presumably, if it occurred that way, it would be 
accompanied by some general revenue transfer to hold them all 
harmless.
    Mr. Bentsen. Well, let me try one more time, Mr. Chairman, 
if I might. Larry Lindsay, the President's Chief Economic 
Advisor, whatever his title is, but de facto Chief Economic 
Advisor, talked about the idea of taking $600 billion of the 
projected Social Security trust fund and using that to 
privatize Social Security. He thus is taking $600 billion worth 
of claims or obligations, claims against future obligations, 
and using it for another purpose, albeit within the system, but 
using it for another purpose.
    So don't you have to make up that $600 billion some way?
    Mr. Mitchell. Yes, I understand the point you're making 
now. Yes, of course you would, and that's what people mean by 
talking about the general revenue transition financing to make 
the system work.
    Mr. Bentsen. So it would be through general revenue or what 
else?
    Mr. Mitchell. It would be through general revenue, 
borrowing, reductions in other Government programs, that's 
something lawmakers will have to decide, as they've done in all 
these other countries that have made the reforms.
    Mr. Bentsen. Anyone else want to comment on that?
    Mr. Greenstein. That's precisely the point. This is 
precisely why the tax cut is too big and we shouldn't be doing 
it now. We need to figure out how much money we need to 
transfer to Social Security. Whether it's for a transition to 
individual--it is in individual accounts that give you a higher 
rate of return. I think this is pretty clear in the economics 
profession.
    Two things give you higher rates of return, advance 
funding, so the money earns interest, it could earn interest in 
the trust fund, it can earn interest in individual accounts, 
and a diversification of investments. You can do it through 
individual accounts, you can do it through allowing the trust 
fund, through an independent board, to be able to invest in 
index funds.
    Things that give you the higher rate of return and the 
advance funding and the equity investment, you don't have to do 
either through private accounts, you can do them for private 
accounts. I think doing through private accounts is preferable, 
low administrative costs, better guarantees for the 
beneficiaries. But that's another discussion.
    But the point is, is you want to go to advance funding to 
ease these long-term liabilities and to be able to get higher 
rates of return, you have a transition issue and you have to 
get the money from somewhere. And if there's no money left in 
the general fund, because it's all gone for a tax cut, then you 
either can't proceed with Social Security reform or you're 
going to proceed by virtue of doing substantial on-budget 
deficits. Those are the choices.
    Mr. Gale. It might help, it might not, to think about a 
family that's trying to plan for their retirement. They have a 
mortgage that they're trying to pay off, and they have assets 
that they're saving. If the family raised its mortgage debt and 
put the loan proceeds in the retirement account, it would not 
be correct to say that its wealth went up, because it now has a 
bigger liability on the mortgage side. This is just another way 
of making the exact same point that Mr. Greenstein is making 
and that you are making, which is if you take the money out of 
one pot and move it, you haven't increased the total amount of 
money they're saving for retirement. You've just shifted it 
from one set of claims to another set of claims.
    Mr. Bartlett. I think one of the important things to keep 
in mind here, if we're going to talk about the long-term 
sustainability of Social Security, is that it is currently 
unsustainable. I mean, changes in the law will have to be made 
at some future date, because current tax rates are insufficient 
to pay benefits, all the benefits that have been promised. So 
there's already a fundamental disconnect. We've made a promise 
for which we have not provided the funding, and now we're 
concentrating solely on the promise element of it, when the 
promise was in effect fraudulent to begin with.
    We don't have a funded system. The analogy between the 
Social Security trust fund and a private trust fund held by a 
responsible financial institution I think is a flawed analogy. 
And I think also that it's important to remember that benefits 
formulas have been changed many times in the past. The Supreme 
Court has even ruled that you don't have a right to Social 
Security benefits.
    A few years ago, for example, we increased taxes on Social 
Security benefits, which had previously been untaxed. So I 
think that treating some of these numbers out into 75 years as 
if they can never be changed for any reason whatsoever is 
extremely unrealistic. Obviously, changes will have to be made, 
very substantial changes.
    I think everybody understands that there's going to be a 
tradeoff of some kind in terms of those people who move into a 
more privatized system will give up future benefits. If you do 
all that on a present value basis, it can work out. The problem 
is, you have different sizes of cohorts and things of that 
sort, so that the cash flow isn't the same every year.
    So getting from here to there, in other words, is a very, 
is a difficult political and accounting problem. But it's not 
an insurmountable economic problem. If you could just sort of 
throw all that accounting stuff out of the way, it would be a 
lot easier to design something that would work. I think most 
economists would say that there's nothing wrong with floating 
some new debt to pay to get rid of another kind of debt. I 
mean, people refinance their mortgages all the time, and people 
don't say that that's phony baloney. You obviously save 
something in the process, or you wouldn't do it. And that's 
part of what I think is going on here, is the idea of in 
effect, refinancing the Social Security debt into one that is 
more manageable under a different set of rules.
    Mr. Bentsen. That is true as long as it's an economically 
beneficial refinancing, and not one that costs you more or is 
equal.
    Mr. Bartlett. Of course.
    Mr. Gutknecht. Mr. Price.
    Mr. Price. Thank you, Mr. Chairman.
    I want to thank the panel this morning. I appreciate all of 
you being here. I'd like to pick up on Mr. Spratt's search for 
possible common threads of agreement, even though you've 
disagreed on many things, and I suppose on most of the major 
questions confronting us, as to the optimal size of a tax cut 
and the fairest distribution of the benefits.
    In terms of budget process and what we're going through in 
this chamber today, is there any one of you that would want to 
say it's sound procedure to vote through the major portion of 
this tax cut before we have a budget? Is there anybody who 
would wish to defend that process or that procedure?
    Mr. Bartlett. Well, before I walked in here, I was handed a 
sheet of paper that was prepared by the staff of the Budget 
Committee that indicated that you're operating under the 
current budget. That is, the one that was passed last year, 
that for the current fiscal year you're in. So there is a 
budget.
    Mr. Price. Do you think that's a credible claim? I'm aware 
that is the legal claim that's been made: that we're actually 
operating as the budget law intended, and not just the letter 
of the law, but the principles of sound budgeting. Do you think 
that's a credible claim, that we're doing all this under the 
fiscal 2001 budget resolution and therefore it's just fine?
    Mr. Mitchell. I would agree that perhaps this is not what 
the drafters of the Budget Act envisioned would normally 
happen. But I think that to simply note that this is an unusual 
step doesn't in any way indicate that there's something 
irresponsible about taking a step in terms of tax relief that 
is part of an overall budget framework that's been presented 
and is going to be digested throughout the year.
    Mr. Price. But you seem to be suggesting there might be 
some burden of proof on proceeding in this way.
    Mr. Mitchell. I just think it's an unusual step. That 
doesn't make it irresponsible or wrong or reckless in any way.
    Mr. Price. Well, if it's unusual, what might justify it? 
What do you think is the justification?
    Mr. Mitchell. I think the justification is that many 
lawmakers are concerned about the state of the economy and want 
to move quickly on tax relief.
    Mr. Price. And this tax package has a reasonable chance, 
you think, of turning the economy around?
    Mr. Mitchell. I've always preferred to think of tax policy 
in terms of what's going to help the economy's longrun 
performance. But having said that, I think the sooner you can 
cut tax rates and improve people's incentives to work, save and 
invest, the sooner you're going to realize some of the 
benefits. So if anything, I think that the majority is being 
too cautious and too slow with its tax rate reduction package.
    Mr. Price. All right. I wonder if anyone has a different 
view? In light of what we all know is awaiting in the Senate, 
it just doesn't seem to be a credible claim that violating the 
procedures in this way meets any kind of burden of proof in 
terms of what budget law requires and what sound budgeting 
procedures require.
    Mr. Greenstein. There were two justifications just offered. 
One was, we're operating under last year's budget resolution, 
and the other is that the economy needs an injection, the 
sooner the better. I think both of those fall apart very 
quickly upon close examination. If we're operating under last 
year's budget resolution, this tax cut busts it. It is much 
larger than the amount of the tax cut that was allowed under 
last year's budget resolution. My understanding----
    Mr. Price. And would be in total violation of any kind of 
pay-go rules or pay-go standards?
    Mr. Greenstein. It would be in violation of the pay-go 
rules, it's in violation of the budget resolution. My 
understanding, it's going to the floor with a waiver of the 
revenue floor in last year's budget resolution.
    Mr. Price. So the notion that this is kind of flying under 
last year's budget resolution is really a fig leaf if by that 
resolution you mean the explicit constraints imposed on revenue 
reductions?
    Mr. Greenstein. Precisely. And with regard to an injection 
into the economy, this tax cut provides in 2001 a tax cut equal 
to 5/100ths of 12 percent of GDP. I think it would be pretty 
hard to find anybody who would argue that you get any 
noticeable stimulative effect from a tax cut equal to 5/100ths 
of 1 percent of GDP.
    Mr. Price. Let me move on to Mr. Gale and some questions 
about the distribution of the benefits of this tax cut. 
Secretary O'Neill, in an appearance before the committee last 
week, derided what he called advocacy statistics, with explicit 
reference to a couple of our witnesses this morning. But 
speaking of selective statistics, the administration has said 
that the average benefit for taxpayers under the Bush tax cut 
plan would be $1,600.
    Now, going back to statistics 101, I wonder if the mean 
here is the figure that gives us the best picture of how the 
average American would be affected, or the greatest group of 
Americans would be affected by this tax cut. Mr. Gale, what 
percentage of taxpayers would actually get that $1,600 tax cut 
or more? And then could you instruct us maybe on the difference 
between the mean and the median and tell us what the median 
figure is?
    Mr. Gale. Sure. Thank you. The mean of course is just the 
average of all the tax cuts. The median is what the typical 
person or the 50th percentile, the midpoint in the 
distribution, would get. According to the estimates that I've 
seen and view as reliable, upwards of 90 percent of families 
would get less than the $1,600 that the so-called typical 
family would get.
    Mr. Price. So 90 percent of the taxpayers would be below 
the $1,600 mean figure?
    Mr. Gale. That's right, including about 95 percent of 
households in the bottom 80 percent of the distribution. So 
almost all households in the bottom 80 percent of the 
distribution would get less than $1,600, and about half of 
households in the bottom 40 percent of the distribution would 
get nothing from the tax cut. And in the top 1 percent, the 
estimates are in the 20's or 30's of thousands of dollars per 
year.
    Mr. Price. What would the median taxpayer receive? Do you 
have that figure?
    Mr. Gale. The median taxpayer would receive about $400 in 
tax cuts.
    Mr. Price. So you're looking for the figure whereas many 
taxpayers would get that or more as would get that or less.
    Mr. Gale. Right.
    Mr. Price. Then you're looking more at the $400 range, 
rather than $1,600, is that accurate?
    Mr. Gale. It's on that order. Twenty-seven percent of 
taxpayers would get no tax cut. And in the bottom 40 percent of 
the distribution, the average tax cut is about $100.
    Mr. Price. If you want to refine those figures for the 
record, I would appreciate it.
    Mr. Gale. Sure. I'd be happy to.
    Mr. Price. But I think that gives us the picture.
    Mr. Chairman, if I could ask one last question here, since 
we've had a rather discombobulated session this morning. I 
would like to go back to Mr. Mitchell and his quote that the 
national debt is a minor irritant. I think those were the words 
you used. Do you regard $200 billion plus a year in interest 
payments on the publicly held debt as a minor irritant in terms 
of other uses to which those funds might be put in terms of 
either public or private investment? And picking up on your 
conversation with Mr. Bentsen, quite apart from the 
technicalities of how the Social Security trust fund works and 
how those obligations are going to be met, isn't it true that 
when the cash flow reverses, as the baby boomers retire, and if 
general funds have to be used to make good on those obligations 
that the trust fund holds, wouldn't we be in a stronger 
position to meet those obligations with those interest payments 
being off our collective backs?
    Mr. Mitchell. I guess it depends on what your long term 
goal is. Simply paying down debt today so we can borrow it all 
back and then trillions of dollars more in the future doesn't 
strike me as a very feasible or fiscally prudent plan. On the 
other hand, if we use some of the money today to restructure 
our program so it will be much stronger in the future, then I 
think there's a lot more merit to that approach.
    Now, obviously, referring to the first part of your 
question, if we had somehow never run any deficits in the past 
and had no debt and didn't therefore have $200 billion of 
interest payments, of course that would be wonderful. But I 
suspect it was probably well worth the cost to win World War 
II, to win the Cold War, and many of the other things that we 
wound up incurring debt for. Then again, some of the expenses 
I'm sure weren't very valuable.
    The point I'm simply making is, that at the end of World 
War II, our national debt was over 100 percent of GDP. Now it's 
down around what, 30 to 35 percent of GDP. And if we do 
nothing, don't pay down a single penny of debt for where we are 
now, it will fall even further just because our economy will 
grow, and the difference between the numerator and the 
denominator will cause that to happen.
    I'm simply saying that we don't want to be so myopically 
focused on that one statistic that it prevents us from 
undertaking other economic policy reforms that will strengthen 
our economy in the future.
    Mr. Price. Well, I understand, and I think every member of 
this committee would express huge relief at the fact that we're 
now dealing with surpluses rather than deficits, and we are 
systematically bringing down the debt. Both parties are 
committed, as you know, to using proceeds from the Social 
Security surplus for that very purpose. There's a lot more 
agreement on that than the rhetoric sometimes indicates.
    But I also think that not a single member of this 
committee, and not just for political reasons, would describe 
the current publicly held debt as a minor irritant. Nor would 
we describe the third largest item in the Federal budget, 
namely debt service on that debt, as of minor importance. It 
seems to me to continue to reduce that debt, to get that 
interest burden off of our back, for whatever purposes, is a 
worthwhile objective. We have an obligation to assure 
ourselves, as we debate this tax cut and the budget resolution 
eventually, that we're providing for the disciplined, 
systematic reduction of that debt.
    Would you disagree with that?
    Mr. Mitchell. I guess I'm speaking in relative terms and 
you're speaking in absolute terms. I think the national debt we 
have today is minor compared to a national debt of over 100 
percent of GDP. Now, obviously, $200 billion is a lot of money. 
I'd like to have it. I'm sure lots of people would like to have 
that money used either for, as you said, returning it to 
taxpayers or spending it on other Government programs. But in 
relative terms, which was the context that I was using, our 
national debt is not a significant economic impediment, 
especially when you compare the situation we're in to the other 
industrialized nations of the world, many of them who have 
debts well in excess of 100 percent of GDP.
    And also, speaking again in relative terms, the national 
debt, the official national debt I think is a minor problem 
compared to the implicit debt of the Social Security system, 
which as I mentioned earlier, is seven times as large as the 
official national debt. So again, I'm speaking in relative 
terms. I'm not saying that in absolute terms it's not 
unfortunate that we're spending $200 billion in interest on the 
debt.
    Mr. Price. I see. Any other witnesses have a comment?
    Mr. Bartlett. Congressman, I think that this whole issue of 
debt paying off has gotten really blown out of proportion. I 
mean, if a corporation decides that it wants to make an 
investment, it might float debt or it might float equity or it 
might decide to take money out of retained earnings. There's no 
value judgment placed on one versus the other. It's simply what 
makes sense at a given moment in time.
    I think that the implication that we should use all the 
money that is coming in over and above what the Treasury needs 
to pay its bills, solely for one exclusive purpose, is like 
telling your constituents, don't buy a new car, don't buy any 
new clothes. Pay off the mortgage on your house before you do 
anything else, because that's the only thing that you should be 
spending your money on.
    I think that that makes no sense, and I think it equally 
makes no sense to pick this one particular purpose that could 
be used for the current cash surplus of the Government, when 
there are other things it could be used for. You mentioned 
spending money for various projects. I'm sure there's things we 
could probably agree upon. And I think tax reduction is one of 
them. I think the main benefit of paying off the debt is that 
we free up these interest payments and don't soak the taxpayers 
for them.
    So I think that it's something that's desirable, but it has 
to be looked at in context, rather than elevating it above 
everything else.
    Mr. Price. I understand your point. I also think as we 
conceptualize this and think about giving taxpayers their money 
back, we also need to understand this debt is also a shared 
obligation on the part of the American people. Surely we ought 
to have that same attitude about benefiting taxpayers, but also 
meeting the responsibilities of the citizens in this country to 
take care of these accumulated obligations.
    My time has expired. If one of the others has a comment, 
we'd be glad to hear it.
    Mr. Gale. I just wanted to respond to two things that Bruce 
said. One is the idea that Treasury has enough money to pay its 
bills and it has money left over. The only reason we think that 
is because we're not accounting for these long-term liabilities 
that we're talking about. In fact, again, to emphasize it, if 
the Government kept its books like a business it would show 
these huge unfunded liabilities in its pension and retiree 
health programs and would not think of itself as wallowing in 
cash.
    The other thing, Bruce used a family example, which I think 
is a good way of thinking about these things. But I would give 
a slightly different family example. The United States right 
now is sort of like a middle aged family that's in its peak 
earnings years, but has saved nothing for retirement. So if 
that family gets a bonus, the question is, should they blow 
that bonus on a vacation or should they put it away and start 
setting their retirement accounts right?
    And put in that context, I think the responsible thing to 
do, no question, is to save the funds. It's not a matter of 
just having excess cash around and maybe we buy a car, maybe we 
go to a nice dinner. The problem is that we have a current cash 
flow surplus for a few years, that's the island of surplus that 
Mr. Greenstein mentioned. Then we have these retirement issues 
looming on the horizon. So a responsible family would do what a 
responsible government would do, which would be to put that 
money away.
    Mr. Bartlett. Can I add something to that, just briefly? I 
think part of the Social Security debate here is not whether we 
should save the money or blow it on a weekend in Vegas, but 
whether we should put the money into a passbook savings account 
that gives us 3 percent or put it into the stock market where 
you can get 10 percent over a long period of time. I think 
that's really a lot of what the debate here is. It's not just 
whether you save, but how you save and what is the most 
appropriate way to save for the particular purpose you're 
saving for.
    Mr. Greenstein. If I could just add a quick point. If you 
look at the GAO and CBO long-term forecasts, they both warn us 
that under the current policy path, even if we don't do a tax 
cut or any spending increases, that eventually, when the baby 
boomers retire, deficits return, debt rises as a percentage of 
GDP and it eventually reaches levels that are not sustainable 
for the economy and would cause serious economic damage.
    Now, it's true that that isn't at a level today that causes 
economic damage. But the forecast is that it will get there.
    Now, it seems to me that if you see that on the horizon, 
you want to be doing things now to ease that problem on the 
horizon. One of them is paying down as much debt as you can now 
to get that debt-to-GDP ratio as low as you possibly can, 
knowing that whatever we do on Social Security and Medicare, 
when the boomers retire, that ratio is probably going to go 
back up.
    Mr. Price. Thank you very much. Thank you, Mr. Chairman.
    Mr. Gutknecht. Thank you.
    Mr. Mitchell, my understanding is you need to leave. I have 
some questions, but if you do need to leave, I think we 
promised you to be out of here by 11:30. If you need to leave, 
please feel free to do so.
    Mr. Mitchell. Well, it's a meeting with a Congressional 
staffer where several other people are going to be at as well. 
As much as I think I probably would add to the discussion, 
they'll say the same thing I would say anyhow. So I don't know 
that there's a crisis in me being late for that meeting.
    Mr. Gutknecht. I just wanted to respect your time. Let me 
ask, first of all, this has been a great discussion today. I've 
really enjoyed listening to all the different vantage points. 
You've provided us with a lot of things to think about.
    Let me go back to the issue that's here today, and Mr. 
Greenstein, I'm not sure if you're aware of what our resolution 
provided for last year for tax relief, the budget resolution 
that we're currently operating under. Are you aware of what 
number that is?
    Mr. Greenstein. Yes. My understanding is, Richard was 
informing me that it was $150 billion over 5 years.
    Mr. Cogan. As it was passed last year, it was $150 billion 
over 5 years.
    Mr. Gutknecht. But then wasn't there also a provision 
within that budget that allowed for an update in July and 
August, and that CBO update would be included in that 
resolution, isn't that also correct?
    Mr. Cogan. At the option of the chairman, the increase in 
the forecast CBO provided for last July, when they made their 
estimate, could have been added to, subtracted from the revenue 
to allow a larger tax cut.
    Mr. Gutknecht. Right. Maybe we should invite you up to the 
table. Instead of making you do that, Richard, which I'm not 
interested in making you do, I think the bottom line here is 
that the budget resolution of last year permitted a tax cut 
over 5 years of $284 billion. Certainly, yes, there were 
prerogatives that were allowed to the Chair, they were extended 
last year. And so there is a $284 billion technical, now again, 
whether or not people determined that that is in the best 
interests of our country or whether that's in the best interest 
of the budget is a judgment decision that people have to make.
    But the parliamentarian, just so we're clear, Mr. 
Greenstein, the parliamentarian disagrees with your position. 
CBO disagrees with your position and suggests that not only is 
this current tax cut is smaller than that amount that was 
allowed for in that budget resolution, but it does in fact fit 
within last year's budget.
    Now, I'm not arguing the point with you, you suggest that 
we should do a budget first, this year, first, that's fine, 
that's your opinion. But there is a technical issue here that 
we do have to follow, at least for the purposes of this budget. 
The rulings by the officials who are in charge of the budget 
and in charge of the rules of the Budget Act and in charge of 
the rules of the House disagree with you.
    Mr. Greenstein. Mr. Chairman, I believe my answer would 
have been correct yesterday. Richard informs me that in the 
last 24 hours, a mechanism was used under the budget resolution 
to adjust the revenue floor. I was not aware of that when I 
mentioned it earlier. But the general point I'm making still 
fits.
    Mr. Gutknecht. And I respect your opinion on the general 
point. I just wanted to make sure that at least for the 
record's purposes, that we were correct on that, and that you 
were at least aware of that.
    Mr. Greenstein. I have been made aware that the adjustment 
just occurred in the last 24 hours.
    Mr. Gutknecht. Well, that, there's nothing unusual about 
that type of procedure being used throughout many Congresses ad 
infinitum.
    One other thing that I just wanted to ask, you had 
mentioned that the tax cut was too big, because you needed to 
have, you were suggesting that at some point in time there will 
be transfers that are needed in order to deal with some of 
those other looming problems. I think there was general 
agreement, I would agree that those looming problems are Social 
Security and Medicare, at least two big ones. There are some 
others, I think Ross Perot described them as crazy aunts in the 
basement that you're in the attic that you have to deal with. 
But those are the two most prominent members of the family that 
we know that are out there that we're going to have to deal 
with.
    What size or how much of that tax cut would be needed, are 
you suggesting? All of it would be needed? What size of a 
transfer are we talking about here, how big of a hole is in 
Social Security?
    Mr. Greenstein. It's hard to know until we actually get 
into Medicare and Social Security. We did an estimate last year 
in which we looked at the question, if you were to close 70 
percent of the long-term hole in Medicare and Social Security 
through other means, and I do not think Congress can agree on 
things that will close 70 percent of the Medicare hole through 
other means, but if one heroically could, and you only needed 
to cover 30 percent of the hole through transfers, you'd need 
about $500 billion over 10 years. In reality, my guess is 
probably somewhere between $500 billion and $1 trillion.
    But I think that's not the only problem in terms of the 
size of the tax cut. Mr. Chairman, I cannot believe that over 
the next several years, Congress is going to agree on a 
Medicare drug benefit that only costs $153 billion over 10 
years. For that level, you probably can't even cover 50 percent 
of drug costs until out-of-pocket costs are $11,000 or $12,000 
a year. You're going to inevitably end up with a larger drug 
benefit than that. You're going to inevitably, even if it isn't 
this year, fix the AMT issue. We don't have a price tag yet on 
national missile defense.
    So when we add all of those pieces together, of which 
perhaps the biggest one is the needed transfer, I think the 
numbers simply don't add up unless we're lucky and the 
surpluses keep growing. But we don't know at this point that 
they will.
    Mr. Gutknecht. But the number for Social Security you would 
put at somewhere between $500 billion and $1 trillion?
    Mr. Greenstein. Yes.
    Mr. Gutknecht. Add to that what would be your estimate with 
regard to Medicare?
    Mr. Greenstein. I would--now, this may be phased in. You 
know, the Clinton proposal last year was about $350 billion 
over 10, when you looked at the percentage of drug benefits 
that covered. I'm not making a judgment of how big I think a 
drug benefit should be. I think at the end of the day, and it 
may take several years to get there, I would guess you're 
talking about a drug benefit that ultimately is going to be at 
least $500 billion over a 10-year period.
    Mr. Gutknecht. So that may be as much as $1.5 trillion of 
needed transfers during that period of time.
    Mr. Greenstein. Clearly, we need to make some Medicare 
reforms as well, without question. But even factoring those in, 
if you're covering the drug benefit cost and then you're doing 
reforms, assuming that we would only need $500 billion to $1 
trillion in transfers assumes significant and controversial 
Social Security and Medicare reforms.
    Mr. Gutknecht. So under the budget that you would 
construct, and under that scenario, the tax cut is not only too 
big, but it's nonexistent. It would be pretty difficult to 
envision any, and there are those who are suggesting that while 
$1.6 trillion is too large, that in fact there's a whole other 
party that is suggesting that we should do it at $900 billion. 
Nine hundred doesn't fit, according to your calculations. That 
would be irresponsible. Sounds like we're all being 
irresponsible, according to your, which is fair, if that's what 
you're telling us.
    Mr. Greenstein. There's a question of the perfect being the 
enemy of the good. If we were totally responsible on this one, 
I prefer a tax cut of probably around $500 billion. But 
basically, given these big unmet needs, 900 is better than 1.6; 
1.2 is better than 2.0. We're not going to deal with all of 
these things right now. But I think it is a very serious 
concern.
    And yes, in my view, even $900 billion is larger than would 
be desirable, but less undesirable than $1.6 billion or $2 
billion or $2.5 billion.
    Mr. Gutknecht. What has changed in your opinion over the 
last 5 years, 10 years, 15 years, 20 years? I mean, the issues 
involving Social Security and Medicare as far as an unfunded 
liability have been there for quite a while. I mean, I don't 
recall, and I'm not challenging you, maybe you did, and maybe 
others did. But I don't recall anybody running in here before 
and saying, don't increase spending because we've got an 
unfunded liability out there, don't increase the welfare 
programs because we have an unfunded liability out there, don't 
increase children's health care because we have an unfunded 
liability out there. Don't increase the deficit, because we 
have an unfunded lability out there.
    For years and years and years, in fairness, both sides have 
been putting forth priorities which arguably could eat into, 
depending on the economics, eat into that future unfunded 
contingent liability that is out there. So while I respect that 
you and many others would come forward today and suggest that, 
what I would hope that we maybe could do, because I think part 
of this is politics on our side, certainly, we put forward a 
plan that we believe in, others put forward a plan that they 
believe in, what I would like to focus on is, what are some of 
these long-term liabilities. You mentioned two huge ones today, 
Medicare and Social Security.
    I would invite the others on the panel, because we will be 
later this year holding a hearing on some of these unfunded 
liabilities and what we should do 2, 5, 10, 20 years out in 
order to deal with them. Aside from the context of today's 
debate of juxtaposing those with tax cuts, which is interesting 
but I think as we all hear the debate on the floor, it's the 
train already left the station on that issue.
    What other unfunded liabilities would you propose need to 
be added to the mix for us to discuss as a budget committee as 
we're looking at that horizon? I'll start with you, Mr. 
Greenstein, and we'll move down the aisle for comments.
    Mr. Greenstein. I think it's the things I--it's Social 
Security and Medicare. Then there are things that, I don't know 
if you'd call them an unfunded liability, but we know the 
political system will address them, so we need to leave room 
for them. A Medicare drug benefit, AMT reform, some form of 
continuation of payments to farmers, which isn't included in 
the budget.
    Mr. Gutknecht. If I could interrupt, that horizon may be 
next week. I'm talking about what is on the horizon, and I'm 
very serious about the question. I understand the--let's get 
the politics out of here for just a moment. What is 10 years 
out that's going to come up and bite us? Social Security and 
Medicare is obvious. We've been hearing about that for 20 
years. What haven't we heard about yet, or what aren't we even 
considering to address? We're going to address agriculture and 
we're going to address prescription drug benefit. But what 
haven't we even been talking about?
    I had a gentleman mention to me, for instance, that some of 
our nuclear waste and hazardous waste is an issue that has a 
10-, 20-year horizon that we aren't even talking about yet. And 
part of my question is, what else do you see out there that has 
that kind of horizon?
    Mr. Greenstein. I think one that we're all starting to talk 
about is AMT. I think another, which I hesitate to mention, 
because my level of knowledge in it is pretty limited, but 
there's increasing evidence that the global warming problem is 
real. Some of the changes that may be needed to deal with it 
may entail various kinds of cushions in Government expenditures 
of some sort, or Government tax breaks of some sort. I'm not an 
expert on exactly what we ought to do on that front.
    I'd also note on the unfunded liability front, you know, at 
the time after the 1983 Social Security Commission, it was 
thought that solvency had been restored for 75 years. Now we're 
both getting closer to the boomers' retirement, and we have 
newer and better figures, so we all realize this is more of a 
problem.
    Just in terms of what various of us said in the past, just 
as a brief point for the record, I'd note that for example, in 
1995 at a press conference our Center held, we said we thought 
the most responsible budget before the Congress then was 
neither the Democratic budget, the Clinton budget, the 
Republican budget, but was rather the Blue Dog budget. I got no 
end of grief from the Clinton White House for having said that 
at the time. But I think we've been talking about these issues 
for a while.
    Mr. Gutknecht. Mr. Gale.
    Mr. Gale. Thank you. I certainly would second everything 
Mr. Greenstein just said and just add a couple more 
possibilities to the list, with the emphasis of course that 
these are prospective issues.
    One is that Medicaid spending is projected to rise faster 
than the rate of inflation. That in conjunction with Medicare 
and Social Security is projected to eat up an increasing share 
of GDP over the next 50 years.
    Mr. Greenstein. Particularly because of long term care.
    Mr. Gale. Right. And the CBO and the GAO outline those 
projections very clearly. A second issue may be Government 
pensions, that's pensions for military and civilian workers, 
which again, in the current budget, the assets of those funds 
are included but the liabilities are not.
    And the third issue, I'm not certain about this, but I 
would speculate that we probably haven't been doing enough to 
maintain the physical infrastructure of the country and roads 
and bridges and things like that may need to be thought about 
in terms of being built up.
    I also want to mention two things. One is, I think that's a 
great question to ask, and I'm glad that we're having this 
conversation in the context of a discussion also of the tax 
bill, because the two are linked. But also, the main thing 
that's different between now and 20 years ago or 30 years ago 
is that the baby boomers are about to retire. In these 
demographic patterns, where you're dealing with these things, 
10 years is not that long of a time.
    So I think the main issue is not a day-to-day urgency, 
nothing's going to happen this week or next week if we don't 
fund this immediately, but the problem is getting much closer, 
the leading edge of the baby boom turns 62 in 2008. In the 
years after that, we will have many, many more people that are 
of retirement age. So I think that's the main difference 
between now and 20, 30 years ago.
    Mr. Gutknecht. Mr. Mitchell.
    Mr. Mitchell. Well, first, let me give the caveat there are 
plenty of issues I don't know anything about, like nuclear 
waste. So whether they're big, long-term problems, I'm the 
wrong person to ask. In terms of sort of the traditional fiscal 
policy issues, I think there's widespread agreement, even among 
the diverse opinions on this panel, that demography is driving 
much of this, Social Security, Medicare, Medicaid, those are 
all really demographic problems. I think it appears there is 
some agreement that advance funding is the way to go. And I 
think Mr. Bartlett raised the appropriate question, do you want 
a 3 percent passbook savings account by having in effect the 
Government owe the money to itself, or do you want advance 
funding in the sense of defined contribution accounts that 
individuals control?
    Mr. Gutknecht. Mr. Bartlett.
    Mr. Bartlett. Just to add something new to the list of 
what's been discussed, I'm becoming increasingly concerned 
about the contingent liability of all the Government sponsored 
enterprises. The debt of Fannie Mae and Freddie Mac is just 
exploding. It's just going through the roof. And although they 
always make these arguments that, oh, they're private, 
everybody in the financial markets knows that there's an 
implicit Government guarantee of their debt. There's a serious 
moral hazard problem. If everything goes along fine, that's 
great. But there's always risk of some sort of financial 
problem that would make the S&L problem a few years ago seem 
trivial by comparison.
    I would certainly urge the committee, at the very least, to 
pay much, much more attention to these off budget contingent 
liabilities than I think has been the case.
    Lastly, I would just like to agree with Mr. Greenstein that 
the cost of any prescription drug benefit that Congress passes 
will, by definition, be vastly larger than anybody estimates, 
because it's going to change people's behavior. I think that 
also, the recent history suggests that the greatest 
breakthroughs in the areas of medical technology are mainly in 
the drug area.
    I think the prospect of having more money available to pay 
for prescription drugs will certainly drive the drug companies 
to produce more drugs, more expensive drugs. And given the 
testing process--we all know it costs $500 million to bring a 
drug to market--I think that the consumers will change their 
behavior. The drug companies will change their behavior. 
Everybody will change their behavior so as to take advantage of 
whatever benefit Congress enacts.
    I believe it's potentially a black hole of Government 
revenues for which there is absolutely no bottom. Frankly, I 
would urge you not to step into that hole, but I guess 
political factors may overwhelm my judgment in this area.
    Mr. Gutknecht. Well, I want to thank you, because part of 
what I'm considering doing, and I've talked to Mr. Spratt about 
it, and I don't want to put words in his mouth, but I think he 
shares some interest in this as well, and that is that the 
committee, over the last 20 years, has been a committee that 
has dealt with today's budget, the here and now. Balance was 
the grail that everybody was searching for. I guess we got it 
now, finally, at least under some definition of balance.
    But the point is that now that we've achieved the here and 
now, we have a responsibility, we're really the only committee 
that can do a good job of looking at the horizon and saying, 
what's coming up from a situation in our country that's going 
to come and bite us at the Federal level, from a fiscal policy 
standpoint. That's part of the reason that this year, when we 
get through with the here and now budget, we want to lift our 
sights a little bit and look at that horizon.
    So I appreciate the list that you're giving us. That's part 
of the outlook that I was hoping you would give us today. If 
you have additional thoughts or ideas about that horizon, 
issues that you think we should pay attention to, I would 
appreciate it. Because I believe that that can be an exercise 
that can be done in a very nonpartisan, just American, 
patriotic way. That's not an issue, I mean, the politics of 
here and now, we'll deal with that. We'll have our tax cut 
versus whatever debate and we'll have that out as we're having 
today.
    But whether or not hazardous waste or whether or not the 
AMT or whether or not global warming or whatever it might be is 
out there, and from a budgetary standpoint maybe something we 
need to pay attention to is yet an issue that Congress is not 
really trying to address. I think this is the committee that 
needs to at least begin to approach that.
    So I appreciate the exercise of at least giving me some of 
those ideas. I appreciate your testimony today and thank you 
for your indulgences all the way until noon.
    Unless anybody else has anything else, the committee will 
stand in recess until 1:30, where we will continue the Members 
Day hearing panel. Thank you.
    [Whereupon, at 12 noon, the committee was recessed, to 
reconvene at 1:30 p.m. the same day.]