[House Hearing, 108 Congress]
[From the U.S. Government Printing Office]



           ECONOMIC EFFECTS OF LONG-TERM FEDERAL OBLIGATIONS

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

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

             HEARING HELD IN WASHINGTON, DC, JULY 24, 2003

                               __________

                           Serial No. 108-12

                               __________

           Printed for the use of the Committee on the Budget


  Available on the Internet: http://www.access.gpo.gov/congress/house/
                              house04.html


                                 ______

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                        COMMITTEE ON THE BUDGET

                       JIM NUSSLE, Iowa, Chairman
CHRISTOPHER SHAYS, Connecticut,      JOHN M. SPRATT, Jr., South 
  Vice Chairman                          Carolina,
GIL GUTKNECHT, Minnesota               Ranking Minority Member
MAC THORNBERRY, Texas                JAMES P. MORAN, Virginia
JIM RYUN, Kansas                     DARLENE HOOLEY, Oregon
PAT TOOMEY, Pennsylvania             TAMMY BALDWIN, Wisconsin
DOC HASTINGS, Washington             DENNIS MOORE, Kansas
ROB PORTMAN, Ohio                    JOHN LEWIS, Georgia
EDWARD SCHROCK, Virginia             RICHARD E. NEAL, Massachusetts
HENRY E. BROWN, Jr., South Carolina  ROSA DeLAURO, Connecticut
ANDER CRENSHAW, Florida              CHET EDWARDS, Texas
ADAM PUTNAM, Florida                 ROBERT C. SCOTT, Virginia
ROGER WICKER, Mississippi            HAROLD FORD, Tennessee
KENNY HULSHOF, Missouri              LOIS CAPPS, California
THOMAS G. TANCREDO, Colorado         MIKE THOMPSON, California
DAVID VITTER, Louisiana              BRIAN BAIRD, Washington
JO BONNER, Alabama                   JIM COOPER, Tennessee
TRENT FRANKS, Arizona                RAHM EMANUEL, Illinois
SCOTT GARRETT, New Jersey            ARTUR DAVIS, Alabama
J. GRESHAM BARRETT, South Carolina   DENISE MAJETTE, Georgia
THADDEUS McCOTTER, Michigan          RON KIND, Wisconsin
MARIO DIAZ-BALART, Florida
JEB HENSARLING, Texas
GINNY BROWN-WAITE, Florida

                           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, July 24, 2003....................     1
Statement of:
    Douglas J. Holtz-Eakin, Director, Congressional Budget Office     6
    William G. Gale, Brookings Institution, Tax Policy Center....    33
Prepared statement:
    Hon. Jim Nussle, a Representative in Congress from the State 
      of Iowa                                                         3
    Mr. Holtz-Eakin..............................................    11
    Mr. Gale.....................................................    36

 
           ECONOMIC EFFECTS OF LONG-TERM FEDERAL OBLIGATIONS

                              ----------                              


                        THURSDAY, JULY 24, 2003

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10 a.m. in room 210 
Cannon House Office Building, Hon. Jim Nussle (chairman of the 
committee) presiding.
    Members present: Representatives Nussle, Shays, Schrock, 
Diaz-Balart, Hensarling, Spratt, Scott, Cooper, Majette, and 
Kind.
    Chairman Nussle. Good morning.
    This is Budget Committee full committee hearing on ``The 
Economic Effects of Long-Term Federal Obligations.'' Today we 
have two panels of witnesses who will give us an opportunity to 
delve into this in some detail and have had the opportunity to 
come before us before to discuss some of these kinds of issues.
    Before we begin, I have a fun announcement for the record. 
My Chief of Staff and the Staff Director of the Budget 
Committee on the majority side, Rich Meade, had a baby just a 
couple of nights ago. He and his wife, Elizabeth, are doing 
fantastic and their little baby, Constance, is doing well. We 
want to congratulate them. He has a little leave of absence he 
is on right now, so you can all take advantage of me while he 
is gone because he is, as you know, my right arm and does a 
great job for the entire committee but particularly on the 
Majority side. We want to congratulate him on that new arrival 
and look forward to having a chance to congratulate him in 
person in September when we come back.
    The second thing is, I just want you to know that the 
Budget Committee does have a Budget Committee library, and I 
would invite Mr. Spratt, as I have in the past, he may use that 
library whenever he would like. Just so we are clear on the 
record, if there is ever a need either during, before, or 
after--as I have invited him in the past--he may use those 
facilities as he sees fit in our spirit of bipartisanship in 
running the committee. We have a lot to argue about here, a lot 
of policy issues and things we will disagree on but thankfully 
we have run this committee in a good spirit. There is always 
good tension, but it is in a good way but we do have a library 
in case someone was wondering. It is not very big though. Where 
is it? I didn't tell you where it was but you are welcome to 
use it.
    Mr. Spratt. I am glad, Mr. Chairman, that we have a written 
and video record of that.
    Chairman Nussle. Actually it is a good time to step back 
and what happened on the floor yesterday on both sides was a 
good way to kind of remind Members that we have a lot to 
discuss and a lot of big issues to deal with. There are ways to 
do it that are very appropriate and then there are ways that 
maybe get a bit out of line. We all can be part of the problem 
and part of the solution. In our committee, I think we have 
done a pretty good job of doing that and I hope that continues. 
I think that will. If Mr. Spratt and I have anything to say 
about it, we will.
    Today the Budget Committee will hear from the Congressional 
Budget Office and our very distinguished Director, Dr. Douglas 
Holtz-Eakin. We welcome back to the committee for this purpose.
    As a little background, our last few hearings we focused on 
how Congress spends trillions of taxpayers' dollars that we are 
entrusted with each year. Specifically, we focused on the 
problems associated with our current manner of spending. First, 
that we are spending too much and in many ways, too fast. As 
has been made clear through our waste, fraud and abuse 
hearings, in many cases it is spent very carelessly.
    Second, we currently have a substantial spending induced 
deficit that all of us on both sides have agreed is 
unacceptable. So today's hearing continues our focus on reining 
in what may be an unsustainable rate of government spending 
from just a little bit different angle. Too often around here, 
we get so caught up in the issues of the day, we barely can see 
beyond the next week, what is the current amendment on the 
floor to cut or save a few million or billion dollars here and 
there. The problem with that is spending decisions Congress 
makes today have real consequences in the future. If we keep 
going like we are going, our so-called mandatory spending, that 
which is on automatic pilot, will become unsustainable. That is 
why we have asked Dr. Holtz-Eakin to be here today, to discuss 
some of these long-term implications for our ever growing 
spending obligations and their likely effects on the budget and 
the economy.
    Let us take a real quick look at where we are today in 
relation to history. Until World War II, Federal government 
spending was less than 10 percent of the economy, or about $10 
for every $100 of our Nation's gross domestic product. Today we 
have doubled that amount so that government spending now 
accounts for about 20 percent of the economy.
    Now, let us look forward. According to CBO spending 
excluding interest will hit 21 percent of GDP by the year 2030. 
At that point, the economy will no longer outgrow spending. 
Spending, as I understand it, will outgrow the economy. Chart 
42 as you see before us, our three largest mandatory programs, 
Social Security, Medicare, and Medicaid alone will claim as 
much from the economy, $20 for every $100, as the entire 
Federal budget does today. Just in the next 70 years or so, 
that is what we are looking at. The burden obviously gets 
greater after that.
    A few may wonder why that matters. So what, why is this a 
particular problem? First, because Federal spending in and of 
itself adversely can affect the economy in an adverse way. All 
spending has to be financed somehow through taxes or borrowing. 
Either the tax increases are borrowing necessary to finance 
this growing burden would become too damaging to the economy 
and unacceptable to us politically.
    Second, while we in Congress have already acted to grow the 
economy and reduce wasteful spending in government, these 
things alone will not be enough to solve the problem. I 
recognize that as much as we focus on waste, fraud and abuse, I 
have never suggested that in and of itself will get us back to 
a balanced budget and solve some of these long-term problems. 
It doesn't mean we shouldn't focus on them and we have here in 
this committee and have bee leading the way.
    I recognize and I think all of our colleagues recognize 
that in and of themselves wasteful spending cannot resolve 
these issues, but there are additional steps we can take to 
alleviate these future problems. We are going to look at those 
today. The world has obviously changed significantly since many 
of these programs came into being, and it is long past time 
that we incorporate some of the medical and technological and 
slews of other advances that we have made in order to get these 
programs up to speed on quality and efficiency so that they 
will be around for generations to come.
    I appreciate the work that you have done, Mr. Holtz-Eakin 
and your entire team in preparing for this hearing and 
preparing the information we want to consider today. I look 
forward to hearing your findings.
    [The prepared statement of Mr. Nussle follows:]

  Prepared Statement of Hon. Jim Nussle, a Representative in Congress 
                         From the State of Iowa

    Today the Budget Committee will hear from the Congressional Budget 
Office on the economic effects of long-term Federal spending burdens. 
Our witness today is Dr. Douglas Holtz-Eakin, the Director of the 
Congressional Budget Office. Dr. Holtz-Eakin, welcome back.
    As a little background, our last few hearings have focused on how 
we in Congress spend the trillions in taxpayer dollars we are entrusted 
with each year. Specifically, we've focused on the problems associated 
with our current manner of spending:
    First, that we're spending too much too fast, and as has been made 
clear through our waste, fraud and abuse hearings in may cases too 
carelessly.
    Second, we currently have a substantial spending-induced deficit 
that all of us on both sides of the aisle have agreed is unacceptable.
    Today's hearing continues our focus on reigning in the current, 
unsustainable rate of government spending, but from a different angle. 
Too often around here, we get so caught up in the issues of the day 
that we can barely see beyond next week let alone the next generation. 
The problem with that is, the spending decisions Congress makes today 
will have real consequences for the future. And if we keep going like 
we're going now, our spending obligations our so-called mandatory 
spending will become unsustainable.
    That's why we've asked Dr. Holtz-Eakin here to discuss the long-
term implications of our ever-growing spending obligations, and their 
likely effects on our economy.
    Let's take a quick look at where we are today, in relation to 
history. Until World War II, Federal government spending was less than 
10 percent of the economy, or about $10 for every $100 of our Nation's 
GDP. Today, we've doubled that amount, so that government spending now 
accounts for about 20 percent of the economy.
    Now let's look ahead. According to CBO estimates, spending 
excluding interest will hit 21 percent of GDP by 2030. At that point, 
the economy will no longer outgrow spending; spending will outgrow the 
economy. And as you can see by the chart by 2070, our three largest 
mandatory programs Social Security, Medicare, and Medicaid alone will 
claim as much from the economy $20 for each $100 as the entire Federal 
budget does today. And the burden only gets greater after that. Now, a 
few of you may ask, frankly, ``so what?'' ``Why is this a problem?"
    First, Federal spending in and of itself--as I hope Doctor Holz-
Eakin will help explain--adversely affects the economy. All spending 
has to be financed somehow through taxes or borrowing. And either the 
tax increases or the borrowing necessary to finance this growing burden 
would be too damaging to the economy to be acceptable to any of us.
    Second, while we in Congress have already acted to grow the economy 
and reduce wasteful government spending, these things alone will not be 
enough to solve this problem. Over the long run, the Federal burden 
will become too great for us to simply grow the economy enough or 
reduce waste, fraud, and abuse enough to be able to continue to sustain 
the larger programs.
    But there are additional steps we can take to help alleviate the 
extent of future problems. We're going to have to take a look at the 
programs that are generating the most growth, but have not been 
significantly reviewed or updated in a long time Social Security, 
Medicare, and Medicaid, primarily.
    The world has changed significantly since many of these programs 
came into being, and it's long-past time we incorporate the medical, 
technological, and slews of other advancements we've made to get these 
programs up-to-speed on quality and efficiency so they'll be around for 
the generations to come.
    Finally, we need to look at how we can amend the budget process to 
better anticipate and provide not only for our mandatory obligations, 
but also for all of the other substantial costs we know we'll be hit 
with each year, such as establishing emergency spending reserves, and 
planning for ses on Federal insurance programs, and all of the other 
substantial spending.
    I appreciate the hard work Dr. Holt-Eakin and his team have done in 
preparing this, and I certainly look forward to hearing their findings.
    Thank you.

    Chairman Nussle. With that, I would be happy to turn to Mr. 
Spratt for any comments he would like to make.
    Mr. Spratt. Thank you for holding this hearing.
    Mr. Holtz-Eakin, thank you very much for your attendance 
and for the work you have put into it.
    We too are concerned that future generations will pay a 
price for the unfounded commitments that this generation is 
leaving behind. I think there is one point on which members of 
this committee can agree and that is that the public debt we 
are accumulating right now is an inescapable, incontrovertible 
obligation of the Federal government. Just last week, we had 
the mid-session review delivered to us by OMB, a projected and 
accumulation of $1.9 trillion in debt held by the public over 
the next 5 years. Having made that projection, OMB still called 
for another $878 billion of tax cuts over the next 10 years in 
the face of its projection this could only worsen and add to 
the deficit.
    These tax cuts are backloaded so that two-thirds of the 10 
year revenue reduction falls in the last 3 years and more than 
a fourth falls in the last year itself. Our second witness will 
show how the cost of these tax cuts which make permanent the 
tax cuts of the last 2 years is more than three times as large 
as the 75 year actuarial deficit in Social Security expresses a 
percentage of GDP.
    We have a simple chart to show that, table 10. The budget 
impact of the total tax agenda ranges from 2.3 to 2.7 percent 
of GDP. The present value of that over 75 years comes to about 
$12 [trillion]-$14 trillion. The actuarial deficit in Social 
Security over that period of years, present value, if we have 
enough money right now to put in the trust fund and make the 
system solvent would be $3.8 trillion. I mention that because 
as you add all these out year obligations over 50, 60, 75 years 
and put on the back burner GDP growth during this same period 
of time, they begin to get so enormous that they seem 
unsustainable in the chairman's word and impossible to obtain 
but in truth, the revenue base is being diminished right now to 
the point where if we had those revenues in the foreseeable 
future, there would be money there if committed to this purpose 
to make these programs solvent, Medicare and Social Security.
    As both of our witnesses will make clear today: today's 
deficits have to be financed with tomorrow's taxes. Deficits 
are consequential, they have results, they have effects, 
especially today's which are the largest in history in dollar 
terms and among the largest as a percentage of our economy, 
measured as a percentage of GDP.
    A minute ago, we had chart No. 9 and let us show it one 
more time. We cleaned this up a bit because there were too many 
things on this cluttered chart the other day but this shows our 
situation and over the last 10 years as graphically as anyone 
possibly can. The top line is outlays and as you will see, 
during the Clinton years, beginning in 1992, there was a steady 
decline in outlays, actual dollar spending of the Federal 
government to the point where it was about just over 18 percent 
of GDP, well below the peak of GDP level percentage of spending 
in 1983 which was about 23.5 percent.
    Outlays steadily declined and at the same time, the 
revenues went up. There were tax increases, there were changes 
in the tax code that tilted the code more toward upper bracket 
taxpayers and as a consequence, as they prospered during the 
1990s, they paid more revenues and the convergence of those two 
events led to the phenomenal recovery of the budget. The bottom 
line of the budget got better every year for eight straight 
years and then in the year 2000, we had a surplus which you see 
measured as a couple of percentage of points of GDP. In dollar 
terms, it was $236 billion.
    In the year 2001, we began going down. As you can see, we 
now have the reverse of the situation we had in the 1990s. 
Instead of going up, revenues are coming down and instead of 
coming down, outlays are going up, just the reverse of what you 
need to balance the budget. As a consequence, we are 
accumulating debt that has to be paid and will have to be paid 
probably ahead of the claims of the programs Mr. Holtz-Eakin is 
going to describe for us today.
    This is a matter of serious concern and I mention it 
because of all the things that will be on our table today as we 
talk about long-term obligations. The one that is most 
immediate over which we have most control is the deficit 
itself, the current deficits we are running. First in line in 
our obligations of the future for our children to pay will be 
the debt we are accumulating today. We shouldn't forget that.
    There is a lot we can do to improve our budget practices, a 
lot we have to do to make our long-term mandatory spending 
obligations obtainable and solvent. One of the things we should 
do is not forget the elephant in the room called the deficit. 
If we stop feeding that elephant, we might accomplish something 
toward the goals we are going to be talking about today.
    Mr. Holtz-Eakin, thank you again for your testimony. We 
look forward to it.
    Chairman Nussle. When Mr. Spratt and I meet at the 
beginning of the year to talk about the hearing schedule, this 
is one of the hearings he suggested and I appreciate the 
suggestion. I join him in the need to discuss these long-term 
issues. We are glad you are here to help us do that.
    We welcome you back to the committee and we will look 
forward to your testimony. Your entire testimony will be made a 
part of the record. I have asked them to turn off the clock 
because I know in 5 minutes, you can't talk about the long-term 
obligations of the country. I would ask you to elaborate and 
especially because there are fewer members here than may be 
typical, that way we can delve into some of these subject 
matters.
    Your entire testimony is a part of the record, you may 
proceed as you wish.

 STATEMENT OF DOUGLAS J. HOLTZ-EAKIN, DIRECTOR, CONGRESSIONAL 
                         BUDGET OFFICE

    Mr. Holtz-Eakin. Thank you, Mr. Chairman. Thank you, Mr. 
Spratt.
    It is a pleasure to be here today to talk about a topic as 
important as the long run and the economic impacts of Federal 
obligations. I thank the chairman for the time to go through 
the highlights of my testimony. I will point out that those who 
know me well would suggest I can get through almost anything in 
5 minutes but I will restrict my temptation to talk just way 
too fast and go through at a pace that someone can understand.
    I really want to make five points today, and I will list 
them at the outset and go through them as time permits. The 
first is that when looking at the long run, it is appropriate 
to focus on spending. Spending in Federal programs is the best 
measure of the economic cost of those programs because it 
represents the diversion of resources from the private sector 
to the public sector. And that is the underlying economic cost 
of any Federal program--what you give up in the way of other 
activities in the private sector or between different programs 
within the Federal budget. The focus in the long run should be 
on how much is spent on alternative programs in order to 
measure their cost.
    At the moment, we face two long run problems of somewhat 
different character. The first of them is a sharp increase over 
the long-term in spending from known sources, largely the 
entitlement programs that have been discussed in many places 
and which I will return to, and the second is the ongoing 
unknown commitments of the Federal government that come from 
the fact that many Federal obligations are not accurately 
represented in the budget. Programs such as insurance and 
credit guarantees represent obligations of the Federal 
government to transfer resources to liquidate those obligations 
and their true economic cost is not accurately represented. So 
they are unknown in the long-term as to their magnitude.
    Since neither is well represented in the budget, it would 
be useful to move in a direction that did more accurately 
reflect the economic costs. The general principle that one 
should aim for in doing that is to represent in the budget the 
present value of the economic cost of an obligation when the 
government has firmly committed to that particular program or 
activity. I can come back at the end in the question and answer 
period to describe some of the difficulties in actually putting 
that into practice but as a principle, it strikes me as one 
that would enhance the comprehensiveness of the Federal budget 
and more accurately represent the economic cost of the 
different things the government does.
    Let me first lay out some of the boundaries of the 
testimony. By focusing on the long-term and focusing on costs, 
I want to make it clear that Federal programs are created for 
the benefits they provide to American citizens. The budget is 
present to reflect the cost of those programs. By focusing on 
the budget, my testimony will focus on costs. I don't mean to 
do that in denial of the benefits of these programs but in 
order to more accurately compare among programs, it is 
important to have good measures of cost so I am going to focus 
on costs.
    As I mentioned, the key issue in measuring costs is to look 
at the opportunity costs. What has the Nation given up by 
choosing to devote resources to a particular government 
program. This is not a deep or complicated concept. It is the 
concept that everyone uses in everyday life when deciding 
between buying a new car or choosing to go on vacation. The 
genuine cost of buying a car is what you give up, the vacation 
at the beach, and the valuation that one attaches to that 
particular decision is the opportunity cost, what is sacrificed 
by choosing to buy a car.
    That economic jargon suggests that in moving to better 
comprehensive Federal budgeting, all Federal programs should be 
represented be their economic cost. First, this would allow 
programs to compete on an equal footing, and second, it would 
allow a better comparison between the costs of programs and the 
benefits of the programs so as to undertake only those 
activities that the Congress decides have value sufficient to 
overcome these costs.
    A question that arises in conventional discussion of the 
cost of the Federal government is. What about taxes? Many 
people would automatically associate taxes as the cost of the 
Federal government. Over the long-term, it is appropriate to 
focus on spending because this spending will be financed one 
way or another. It may be financed by taxes. Alternatively, it 
could be financed by debt issue but the issuance of debt is 
essentially the decision to defer the raising of taxes until 
some point in the future, at which time the debt interest and 
principle will have to be paid off. So over the long-term, 
recognizing that spending is recognizing the commitment the 
Federal government has made for resources--and the tax-versus-
borrow decision is a form of financing that logically comes 
second.
    If one was setting out to design the activities, I think 
the first thing you would do would be to decide what was it you 
wanted to do and then figure out the form of financing second. 
For that reason, I think it is appropriate to focus on 
spending. In doing that, I commit a slight professional 
malpractice because it is widely recognized that in addition to 
the direct spending costs, the dollar resources taken from the 
private sector and brought to the public sector, the use of 
taxe--versus debt--has indirect costs often referred to as the 
excess burden of taxes. Those indirect costs are the costs the 
taxes impose on the economy by changing peoples' decisions for 
purely tax based reasons.
    In the absence of taxes, people would pursue the highest 
value activities on the basis of their desires and what things 
cost. In the presence of taxes, you distort those kinds of 
decisions and have people pursue things for strict tax 
advantage. That is an extra cost associated with running 
Federal programs. A similar cost arises in using debt finance 
to run Federal programs.
    I am going to defer those costs for two reasons. One, I 
think simply getting an accurate measure of the opportunity 
costs, the resources, is a very good start in pushing the 
budget to a more comprehensive framework. Two, there are very 
difficult issues of practical implementation there that I think 
outweigh the benefits of bringing those indirect costs in to 
the budget.
    In the testimony, I outlined that the essential message 
here is that there is no costless spending, that there are 
finite resources. If they are devoted to public programs, they 
are not available for other uses, and I took some time in the 
testimony to identify some tempting situations in which you 
might think there was costless spending, ways in which one 
might think perhaps a dollar of Federal programs might not cost 
a dollar because there really were unused resources that were 
available, perhaps because of a business cycle decline or 
something like that.
    What I want to do is put that aside. We can go through that 
in more detail, but I think those are illusory, and it is best 
to do budgeting under the framework that assumes there is a 
genuine opportunity cost for each dollar put into a Federal 
program.
    Sometimes that attempt comes in the form of regulations 
where one attempts to move resources from one activity to 
another without actually putting anything in the budget, simply 
by using regulatory fiat. I want to commend Congress for 
recognizing that indeed this has the same economic burden as 
using a budget item to move the resources. Something like the 
Unfunded Mandates Reform Act of 1995 brought into the budget 
process a recognition that regulation is an alternative form of 
diverting resources and that over the long-term, this will have 
the same economic cost. That represents the kind of step in the 
right direction toward the more comprehensive budgeting that is 
desirable.
    Let me spend a couple of minutes on each of the two major 
points and begin first with the known long run consequences 
which face us.
    I have shown on the chart quite vividly, the long run 
trajectory of the entitlement programs. CBO has projected that 
if one looks at the built-in tendencies for spending on the 
entitlements--Social Security, Medicare, Medicaid--makes some 
judicious assumptions about other noninterest kinds of 
spending, then one will see a rise in Federal spending as a 
fraction of GDP to a level of 28 percent by 2075. And if one 
looks within that long run pattern, one can see there is a 
sharp rise first in Medicare, which rises most quickly 
earliest, and as well in Social Security in the near term as we 
move toward 2075.
    Those represent obligations that if the government were to 
meet would exceed the previous scale of Federal government as a 
fraction of the U.S. economy and would entail sacrificing 
private sector activities.
    One thing I want to point out is that in the current budget 
process, these costs are not well represented. An example of 
that is that a 10-year budget window fails often to capture the 
nature of the commitment made when expanding an entitlement 
program. There has been lots of discussion in Congress about 
the proposed Medicare prescription drug benefit, with a number 
typically put out at about $400 billion over 10 years.
    I hasten to point out that if one goes to the next 10 years 
and takes another 10 year budget window, the cost of that 
prescription drug benefit is likely easily to exceed $1 
trillion and may approach $2 trillion. So in moving the budget 
to a more comprehensive appreciation of the commitments of 
resources in some cases, it is necessary to look farther than a 
five or 10 year budget window.
    In addition to entitlements, we face perhaps large 
obligations in the areas of defense, where over the past 3 
years, we have seen about a 50 percent rise in military and 
defense spending. And we face as well possible increases in 
areas of homeland security and environmental obligations, some 
of which are related to defense.
    I think the first long run problem which will have economic 
consequences is the known spending in these entitlement 
programs and some of the potential expansions of them. The 
second problem is that the current budgeting practices don't 
fully reflect the economic costs of Federal activities. I think 
it is important to so do, as I said at the outset, because it 
would facilitate comparisons across programs to put them on 
equal footing in making decisions. It would facilitate 
comparisons between benefits and costs so that one could decide 
which things actually passed the test of devoting resources to 
the highest value, and it would put things on an equal footing 
between the public sector and the private sector so that 
decisions to actually use more resources for public programs 
could be made in a clear and level fashion.
    Congress has taken steps, as I mentioned, to do this 
better. An important step was the Credit Reform Act of 1990, 
which recognized that the act of providing subsidies to credit 
in the economy was an act of diverting resources; it brought 
those costs into the budget in a fashion that I think has 
improved the decision making capabilities--just as I think the 
Unfunded Mandates Reform Act has contributed to that kind of 
decision making.
    There are still some shortfalls in the budget, and there 
are many ways one could imagine bringing resources from the 
private sector into the government. One could bring economic 
and budgetary advice from the private sector into the 
government by paying the CBO director an appropriation, which 
is in fact how Congress does it. There are many other ways one 
could imagine as well. One could provide the CBO Director with 
a subsidy on a mortgage and rather than an appropriated salary. 
I think a 5 percent subsidy on a $3 million home somewhere in 
the nice suburbs of Maryland would probably have induced me to 
come to the CBO as well. Those are the same economic resources 
being moved from one place to another. They should be 
represented in the budget in a level fashion.
    Anyone who knows me knows that no mortgage bankers would 
give me that kind of mortgage: they would be out of their 
minds. So I might ask you to guarantee that mortgage, and the 
mortgage guarantee would have the same economic impact as the 
subsidy would. Each should also be presented in the budget in 
an even fashion. To the extent that I require capital equipment 
that isn't paid by appropriation, one might imagine leasing it 
when it is highly specialized forecasting equipment. That lease 
is a de facto purchase of the equipment, and it should be 
represented in the budget in a perfectly level fashion.
    If Congress did desire to in perpetuity commit to having 
such direction, and I encourage it in this regard, the 
commitment should be placed in the budget with the present 
value; economic and budgetary advice would always be in this 
form. I don't want this to create the possibility that CBO 
might get closed, but in the absence of such a commitment, if 
you leave open the option to choose another avenue, then it is 
not appropriate to put the present value in the budget. Finding 
the dividing line between when that commitment is firmly made 
and when Congress has retained the option to modify a program 
is one of the hard things about implementing an opportunity 
cost-based approach to comprehensive Federal budgeting.
    I will leave it to your imagination to envision other 
possibilities for combinations of ways to move economic 
resources. My major message is that doing them all in a level 
fashion will make it clear the kinds of commitments that are 
made, make it easier for Congress to choose among programs and 
that indeed, in doing that, there are lots of opportunities. 
There are places where we could improve the Credit Reform Act 
to more accurately represent the risks present in the market; 
there are places where we could improve the budgetary treatment 
of insurance programs. An example that comes to mind is the 
PBGC. For years the PBGC has appeared to be a benefit to the 
budget where premiums came in without any recognition that 
behind those premiums was a liability, a contingent liability 
for something on the order of $2 trillion worth of pensions for 
33,000 plans. It is more appropriate to reflect that potential 
cost than to pretend an insurance program is a program that 
raises money.
    In public and private partnerships where the government has 
a controlling interest and has provided equity, it is 
appropriate to have those in the budget so that it is clear 
that this is not a private sector activity, that the resources 
came into the government and were devoted to this particular 
activity. Programs such as Amtrak come to mind in that regard. 
There are many others as well.
    I will close and be happy to take your questions by 
pointing out that this is not an easy task. I think it would be 
a useful one for Congress to point toward a more comprehensive 
and even budgeting of all Federal activities. There are many 
difficulties of implementation, among them deciding how firm a 
commitment exists; and when a firm contractual agreement 
exists, it is appropriate to put the present value benefits in 
the budget.
    One can imagine a college program in which students sign 
up, sign a contract, agree to maintain good academic standing 
and are promised 4 years' worth of college tuition as a result. 
It would be appropriate there to put the entire cost on the 
budget at the time of that contract.
    Alternatively, you could imagine no such guarantee year by 
year but rather an annual appropriation in the spirit of the 
Pell grants, in which case it would be appropriate only to put 
the first year's funds in the budget because the commitment did 
not exist four years into the future. There are many gradations 
in between. One example that comes up right away is the 
entitlement programs. In the past these programs have been 
modified. I believe it is fair to say that Congress retains the 
option to modify them in the future, so I am not one of those 
who would be in favor of immediately booking the present value 
of such obligations as a liability on a Federal balance sheet. 
Instead, I think it is better to provide supplementary 
information that informs the Congress about the nature of the 
scale of these activities. That supplementary information could 
be as simple as charts that show the dramatic rise in the 
ultimate share of GDP that they would command, and CBO has 
begun to work on the capability to provide 75 year estimates of 
impacts of changes in entitlement programs. We are working with 
you in the Congress on the issues of credit reform and would be 
pleased to work with you in any other areas you might think 
would be appropriate.
    I thank you for your patience and for the time to walk 
through what I think are the key points. I would be happy to 
answer your questions.
    [The prepared statement of Mr. Holtz-Eakin follows:]

  Prepared Statement of Douglas Holtz-Eakin, Director, Congressional 
                             Budget Office

    Mr. Chairman and members of the committee, I appreciate the 
opportunity to discuss the adequacy of budget measures in portraying 
the Federal government's long-term fiscal outlook. The Congress adopts 
Federal programs to provide benefits to U.S. citizens and uses the 
budget to indicate the costs of those policies. In preparing for this 
hearing, I have been especially mindful of the mission of the 
Congressional Budget Office (CBO)--to provide the Congress with 
objective information and analyses for budgetary and economic 
decisions. At the heart of that mission is CBO's responsibility to 
quantify the costs of Federal programs and policies.
    With that objective in mind, and with the strong caveat that I will 
be speaking only about costs while ignoring benefits, I want to make 
the following points in my statement today:
     Over the long-term, the U.S. Government faces enormous 
demands for Federal spending, which are not adequately reflected in the 
budget.
     Every dollar of Federal spending has a cost. It makes no 
difference if the payment is charged to the general fund, a trust fund, 
or an enterprise fund; nor does it matter if the payment purchases 
goods and services, provides income support, subsidizes an activity, or 
liquidates a guarantee or an insurance claim.
     Government spending is usually a good measure of the cost 
of government to the economy--its economic cost--because that spending 
preempts the use of resources by others for other purposes. The dollars 
spent measure the value of forgone alternatives for the private sector 
and within the budget.
     The budgetary costs of Federal commitments should reflect 
their economic costs. Even though the government commits to future 
spending in a variety of ways, including social and other insurance, 
Federal pensions, credit programs, and the support of international 
organizations, all uses of funds can be compared in terms of their 
economic costs.
     Reliable, comparable, and comprehensive cost information 
for all Federal activities would inform Congressional decisions and 
align Federal spending with the value of alternative uses of those 
funds.
     It is timely to reassess the principles of Federal 
budgeting to better measure economic costs. CBO has begun to provide 
supplementary estimates of mandatory and discretionary spending, the 
effects of expiring legislation, the effects of risks on spending, and 
costs of Federal activities not currently shown in the budget.
    Let me discuss each point in turn.

             The Long-Term Outlook for Government Spending

    It will not be news to members of this committee that the United 
States faces severe fiscal demands in the decades ahead. CBO projects 
that, on the basis of current rules for benefits, Federal spending, 
excluding interest payments, will rise as a share of national income 
from the level of roughly 18 percent in 2002 to about 28 percent by 
2075 (see Table 1). Little disagreement exists about the cause of that 
situation. It stems primarily from Federal policies aimed at improving 
the well-being of retirees, the disabled, and the chronically ill.
    Other commitments, such as defense spending, may also claim a 
substantial share of society's resources. Additional potential demands 
include the war on terrorism, homeland security, environmental cleanup 
(including that resulting from defense activities), and settlements of 
asbestos claims.
    In short, the Federal budget faces known, growing demands that will 
absorb an increasing share of the U.S. economy.
    In addition to those relatively predictable demands, the government 
faces significant fiscal exposures that are not fully counted in the 
budget, including those arising from its insurance and guarantee 
programs--as exemplified by the Pension Benefit Guaranty Corporation 
(PBGC), through which the government insures over $2 trillion in 
projected benefits in 33,000 defined-benefit plans. For years, the PBGC 
generated more money in premiums than it paid out in benefits, and the 
budget reflected that positive cash flow instead of the underlying 
liability. Currently, insured pension plans are underfunded by an 
estimated $300 billion, so the ultimate cost of pension insurance to 
the government could be significantly larger than current figures would 
suggest.
    For many programs, the Federal budget fails to extrapolate costs 
over an appropriate horizon. While 5- or 10-year projection horizons 
may be adequate for some budget decisions, they are especially 
deficient when evaluating the implications of changes in entitlement 
programs. For example, the proposed Medicare prescription drug benefit 
is estimated to cost roughly $400 billion from 2004-13, but, under 
reasonable assumptions about future drug spending and demographics, 
costs would exceed $1 trillion and could approach $2 trillion during 
the following decade.
    Thus, the United States faces huge fiscal demands in the coming 
years, yet the Federal budget does not adequately capture future 
commitments.

                               TABLE 1.--FEDERAL OUTLAYS BY CATEGORY, 1950 TO 2075
                                            (As a Percentage of GDP)
----------------------------------------------------------------------------------------------------------------
                                                                      Social           Other
                                                                     Security,       spending,        Total,
   Fiscal year        Social         Medicare        Medicaid      Medicare, and     excluding       excluding
                     Security                                        Medicaid        interest        interest
                                                                     combined         expense         expense
----------------------------------------------------------------------------------------------------------------
        1950               0.3            n.a.            n.a.             0.3            13.5            13.8
        1960               2.2            n.a.            n.a.             2.2            14.2            16.4
        1970               2.9             0.7             0.3             3.9            12.8            16.7
        1980               4.3             1.2             0.5             6.0            13.7            19.7
        1990               4.3             1.9             0.7             6.9            11.7            18.6
        2000               4.2             2.2             1.2             7.6             8.5            16.1
        2010               4.4             2.7             1.8             8.8             7.6            16.4
        2020               5.4             3.6             2.3            11.3             7.1            18.4
        2030               6.2             4.9             2.8            13.9             7.1            21.0
        2040               6.2             6.0             3.4            15.5             7.1            22.6
        2050               6.0             6.7             3.9            16.7             7.1            23.8
        2060               6.1             7.7             4.3            18.1             7.1            25.2
        2070               6.2             8.9             4.9            20.0             7.1            27.1
        2075               6.2             9.6             5.3            21.1             7.1            28.2
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: n.a.=not applicable.

                 The Economic Costs of Federal Spending

    As a general rule, the best measure of the economic burden of a 
government program is its spending. Consider, for example, a 
discretionary program financed by annual appropriations. Spending by 
such a program diverts productive resources from private consumption or 
investment to government use. If the activity replaces private 
consumption with government consumption, the costs are felt in the 
present. If, however, the effect of government spending is to displace 
private investment, the cost is forgone growth in the capacity of the 
economy to produce--a loss that persists into the future. Federal 
financing of expenditures, either through taxes or borrowing, reduces 
the resources available in the private sector, and the people deprived 
of those resources bear the burden of government spending.
    Resources are limited. The use of resources for one purpose 
necessarily denies them to others--a fact of life that is sometimes 
easy to forget. For example, much of the discussion about future 
spending for Social Security and Medicare has focused on whether 
revenues earmarked for those programs will be sufficient and whether 
their trust funds will become insolvent. Although those issues may be 
important, they should not distract from the more fundamental economic 
consideration: the resources expended on those programs must be 
financed either by taxes or by borrowing, which implies future taxes. 
Thus, that spending will be just as costly as any other Federal 
spending.
    In economists' jargon, every dollar spent on a government program 
has an opportunity cost: that dollar is not available to be spent on 
something else. The cost, then, is whatever is forgone. When, as an 
individual consumer, I am deciding whether to buy an automobile, I am 
(at least implicitly) determining whether I would get more value using 
the money for that purpose than for any other. When, as elected 
representatives, Members are deciding whether to spend $100 million for 
a Federal program, they are making a similar determination: is that the 
best use for taxpayers' money, given the possibility of other uses? 
Even though most such legislative decisions are not directly tied to 
decisions about taxes, the result is the same: unless other 
expenditures are reduced, current or future taxpayers will be required 
to give up the benefits from their use of those funds.
    A distinction is sometimes drawn between the economic costs of 
government activities in which the government directly purchases goods 
and services, such as military procurement, and other government 
activities in which the government transfers purchasing power to 
recipients, such as the Social Security program. In the first case, the 
government is causing taxpayers to have fewer resources at their 
disposal so that it can use those resources to purchase specific goods 
and services. In the second case, the government is reducing the 
resources available to taxpayers in general and is increasing the 
resources available to the program's beneficiaries but is not directly 
purchasing specific goods and services. Recipients can use the 
resources to buy whatever they want or save them for themselves or 
their heirs. In both cases, however, taxpayers are giving up control of 
resources. Whether their tax payments are then used by the government 
to purchase aircraft or by the recipients to purchase consumer goods or 
anything else does not affect the cost to the taxpayers.
    Although I am stressing spending as a measure of economic burden, 
it is worthwhile to note an additional cost of public programs financed 
through tax revenues. The existence of taxes may change the behavior of 
the taxpayers in ways that reduce their well-being, a cost referred to 
as the excess burden of taxation. For example, a tax on wages may cause 
some people to work fewer hours or to retire earlier than they 
otherwise would have. A tax levied on a good or service will induce 
taxpayers to reduce consumption of the taxed item to avoid the tax. (Of 
course, in some cases, the tax is designed to reduce consumption, as 
with the taxes on alcohol and tobacco, because consumers may not fully 
cover the adverse costs of their behavior.) Taxes that distort economic 
decisions thus have two costs: the amount collected and the loss to 
individuals from induced changes in behavior. The latter cost, however, 
would be quite difficult to estimate, which suggests that focusing in 
the budget on the direct burden of government spending is the most 
valuable immediate objective.

                  No Free Lunch: No Costless Spending

    It is human to hope for magical solutions to thorny problems. 
Accordingly, policymakers sometimes encounter proposals for 
``costless'' spending based on the existence of unused capacity, gains 
from public investment, or regulation. None of those lives up to the 
promise of magic, however.
    When the economy is operating below full employment, the 
opportunity cost of government spending can be smaller than at full 
employment. For example, when there is large-scale unemployment, 
putting people to work on Federal jobs may divert few resources from 
other productive activities. The timing of such projects, however, is 
tricky. By the time they are launched, the labor market is already 
likely to have tightened. That is, over the long-term, the economy 
tends to return to full employment of its human, technological, and 
financial resources. For example, by CBO's projections, today's 
relatively high unemployment rate of 6.4 percent (as of June 2003) will 
gradually decline to 5.2 percent by 2007 and remain at that level. 
Therefore, to assume that the resources used for a government program 
otherwise would have been idle is not judicious.
    In principle, one might also argue that Federal spending for 
investments would result in more resources for other uses, not fewer. 
That would be the case if the rate of return on the Federal investments 
exceeded the returns that could have been earned by taxpayers 
themselves. But that characteristic is rare for a Federal program. Many 
Federal investments substitute for state and local spending or private 
investments that would otherwise occur. In any event, only a small 
fraction of Federal spending is for investments. (The Office of 
Management and Budget estimates that outlays for major Federal 
investments, such as the acquisition of military equipment, research 
and development, and grants to state and local governments for 
transportation infrastructure and education, accounted for about one-
sixth of total Federal spending in 2002.) The argument does not apply 
to the bulk of government spending, which goes to consumption, or to 
income transfers to support consumption, including those for Social 
Security, Medicare, and Medicaid.
    Similarly, one might cite the social benefits effected by certain 
laws or regulations with low or no Federal costs. Through law and 
regulation, the Federal government frequently requires other levels of 
government and private entities to expend resources to achieve Federal 
policy goals. For example, the Federal government has enacted laws 
mandating that new cars meet certain safety and fuel-efficiency 
standards. Consequently, automakers' production costs and the prices 
that they pass along are higher, causing some consumers to seek 
alternatives to new cars, including keeping old cars in service longer 
or purchasing used cars (which, presumably, are less safe and less 
fuel-efficient). The benefits provided by regulation are no more 
``free'' than those that derive from spending.
    That economic fact has not been lost on the Congress. The Unfunded 
Mandates Reform Act of 1995 (UMRA) was enacted to focus attention on 
regulatory costs. One provision of UMRA requires CBO to estimate the 
costs of Federal legislation that would impose mandates on public- or 
private-sector entities. Such information aids the Congress by enabling 
Members to consider the costs of proposals beyond those currently 
reflected in the Federal budget.
    Some proposals for ``costless spending'' that come before the 
Congress lack even the veil of legitimacy assumed from promising to use 
unemployed resources, invest in particularly high-return projects, or 
improve welfare through regulation. Those efforts to hide budget costs, 
sometimes referred to as innovative financing, and at other times as 
budget gimmickry, come in many guises, including public/private 
partnerships, government-sponsored enterprises, off-budget special-
purpose entities, and directed scorekeeping.
    A common method of hiding the cost of government is through ``tax 
expenditures,'' by which the government selectively reduces tax 
liability to substitute for spending. They are employed to finance 
education, housing, and health expenditures; to provide assistance to 
particular industries; and to aid state and local governments, to name 
but a few uses. By appearing as reductions in receipts in the budget, 
they mask costs. But they have many of the same attributes as more 
spending, diverting resources from other uses in the economy and 
causing higher tax rates to make up for the reduced tax base.

            The Relevance of Economic Costs to Public Policy

    Policymakers constantly weigh the costs and benefits of proposed 
and existing legislation. Just as markets work best in allocating 
resources to their highest valued uses when prices reflect the true 
costs of goods and services, the Congress is best served when Members 
have the most comprehensive and accurate information about the costs of 
legislation. Moreover, because Federal budgeting affects the allocation 
of resources between private and public uses as well as among public 
uses, the relevant cost is the highest valued alternative to all other 
uses, private as well as public. All alternatives can be better 
compared when budgetary costs reflect economic costs.
    Spending is a good measure of cost because it will have to be 
financed, at least eventually, by taxes. Thus, a guiding budgetary 
principle should be to recognize in the budget the amount of taxes that 
will be needed to finance a commitment. Further, at the point when the 
commitment has been made, its cost should be recognized in the budget, 
even if the spending will not occur immediately. Nevertheless, I 
acknowledge that it is sometimes difficult to distinguish exactly when 
a commitment to spend has been made and how durable that commitment may 
be.
    While a one-time appropriation may reflect a commitment with clear 
timing, relatively few spending decisions are that straightforward. In 
fact, many programs that are nominally controlled by annual 
appropriations are ongoing functions'such as defense, transportation, 
and education--that the Federal government could reasonably be expected 
to continue, and baseline budget projections reflect that expectation.
    The difficulty of determining the timing of commitments is 
illustrated by a Federal policy to provide financial assistance to low-
income students enrolled in higher education. That policy might be 
regarded as a commitment to spend for students who are now eligible and 
for students who become eligible in the future. However, because the 
commitment is not contractual, the Congress retains the right to change 
the law defining eligibility or to substitute a different form of 
assistance. Clearly, the current program cannot be regarded as 
irrevocable; therefore, the present value of the assistance should not 
be recorded in the budget.
    Indeed, for social insurance programs, it seems fair to say that 
although the commitments are clear in current law and are so reflected 
in baseline budget projections, the government has not firmly committed 
to paying the current level of benefits to all future generations. In 
other cases, such as loan guarantees and insurance, the government's 
commitment to spend may be contractual and firm, but the value of the 
dollar payments may be uncertain and difficult to estimate.
    I suggest that the principle of recognizing the cost of commitments 
in the budget when they are incurred implies that the mere expectation 
of future spending is not sufficient to warrant recognition in the 
budget. The government's obligation in the future must be firm to 
justify including the costs for it in the budget today. However, I also 
suggest that the principle of being timely in recognizing costs in the 
budget never excuses an estimated cost of zero just because the amount 
is not yet certain.

      Economic Costs in the Budget: Accomplishments and Challenges

    The objective of recognizing economic costs in the budget reminds 
me of an exchange that occurred years ago between the chairman of a 
House committee and a representative from the administration, who was 
advocating the creation of a program. In answer to the chairman's 
question, ``How much will this cost'' the witness replied, ``Do you 
want that in budget authority, outlays, or discounted present values?'' 
To which the chairman thundered, ``I want it in dollars!''
    I sympathize with that chairman's desire for transparency and 
simplicity in the budget. When the amount of dollars spent adequately 
captures the economic cost of a Federal activity, as it does in most 
cases, we should look no further for an appropriate cost measure.
    In spite of the efforts of many to improve the budget process over 
the years, much more remains to be done. Some activities currently 
classified as nonbudgetary, such as those of Amtrak, may be more 
appropriately considered within the budget. Similarly, other types of 
contract-specific activities, such as the construction and leasing of 
buildings for military housing and Federal offices, may warrant 
budgetary treatment that is different from the way they are currently 
handled. Federal exposure under insurance programs is another area in 
which the current budgetary presentation could be enhanced. Also, 
information about the long-range commitments for social insurance 
programs could be more prominent in budget documents.

                           BUDGETING FOR RISK

    A particularly difficult and increasingly important issue is the 
treatment of risky activities like providing loans and guarantees, and 
insurance. Indeed, Federal direct loans and guarantees constitute an 
area of budgeting where the Congress addressed accounting shortcomings 
through passage of the Credit Reform Act of 1990. Prior to that law, 
both direct loans and guarantees were treated on a cash basis in the 
budget. For direct loans, cash flows in any single year consist of 
outlays for new loans and repayments for some outstanding ones. The net 
cash flow in any single year is a meaningless amalgam of the amounts of 
cash in and out. The cost of new loan programs is especially overstated 
on that basis because nearly all the cash flows are out in the early 
years. For guarantees, single-year cash flows are a mix of fee 
collections, payments for defaults, and inflows from recoveries. Before 
credit reform, the misstatement of costs for new guarantee programs was 
especially perverse because cash flows in the early years often were 
dominated by the inflow of guarantee fees, with few outlays for 
defaults.
    Under the Credit Reform Act, the cost of a direct loan or loan 
guarantee is the net present value of all cash flows over the life of 
the loan, recognized when the loan is disbursed. Net present value is 
calculated by discounting cash flows with interest rates on Treasury 
securities of the same maturity. Credit reform was a much needed step 
toward getting the economic cost of credit programs in the budget, and 
it follows the principle of recognizing budgetary impacts at the time 
loans and guarantees are extended. In my judgment, the budget 
information now available to the Congress on the cost of credit 
programs is far superior to what existed before.
    With the experience of the past 10 years or so, however, it may be 
time to revisit the credit-reform model and its application. One 
shortcoming of the current approach is that it appears to understate 
the economic cost of Federal credit programs because the discounting of 
expected cash flows at the government's risk-free borrowing rate 
ignores certain costs of risk. Private investors, by contrast, require 
compensation to induce them to bear risks that cannot be eliminated by 
diversification--for example, market risk. The compensation to 
investors for market risk comes in the form of an expected return that 
is higher than the rate on government debt that is used to value loans 
and guarantees under the credit-reform model.
    Turning to other areas involving the Federal treatment of risk, I 
would point out that the current budgetary accounting for Federal 
insurance programs, such as deposit and pension insurance, still falls 
far short of the objective of assigning full economic costs to those 
activities. Currently, the costs of those activities are reported on a 
cash basis, which does not reflect the multiyear nature of the 
commitment. One result is that the programs report negative spending in 
most years, suggesting that they provide net income to the government, 
when in fact they represent a potentially enormous contingent 
liability. Consequently, alternative approaches may be needed to 
recognize the economic costs of insurance programs in the budget, 
perhaps building on the principles underpinning credit reform.

                           FUTURE DIRECTIONS

    The line between concrete, and therefore budgeted, commitments and 
less firm spending plans is not always clear. For a commitment that is 
contractual, the estimated cost is its present value when the 
commitment is made. But for a commitment made under policies that are 
subject to periodic revision, like the major entitlement programs now 
fueling increases in spending, the economic costs for the entire future 
of the program should be recognized in the budget only to the extent 
that the commitment is not subject to revocation. For such programs, 
however, it is useful for the budget to include additional 
supplementary disclosures. Where the government's commitment to spend 
is very strong but not irrevocable or unalterable, determining the 
appropriate budgetary treatment for those programs will be difficult.
    CBO's annual report on the budget and economic outlook already 
includes alternative projections for discretionary spending, as well as 
estimates for extending tax provisions that are scheduled to expire. 
Similarly, for the few mandatory spending programs (such as those 
providing aviation terrorism insurance or the Federal backstop for 
property and casualty terrorism risk insurance) that are allowed to 
expire under the procedures for CBO's baseline, the agency could report 
estimated costs under the assumption that the programs will not 
terminate as legislated.
    CBO is developing the capacity to provide long-term projections for 
Social Security and Medicare to more accurately estimate future 
commitments under those programs. It will also use a long-term model as 
a basis for cost estimates for changes in those programs. In addition, 
I will soon become a voting member of the Financial Accounting 
Standards Advisory Board, which considers government standards for 
financial reporting with a view toward comprehensive disclosure of the 
costs of Federal activities. Further, CBO is expanding its use of 
techniques of modern financial analysis, which will enable the agency 
to better assess the risk exposure of the Federal government through 
its guarantee and insurance programs and public/private partnerships.
    Such issues and developments, along with the huge impending demands 
on Federal spending, make it timely to reassess the principles 
underlying Federal budget accounting. Specifically, participants in the 
process need to renew their commitment to the objective of getting the 
most relevant measures of cost into the budget in support of 
congressional decisions.

    Chairman Nussle. Thank you. That was very instructive, and 
we are already gaming how we can change your salary and benefit 
package up here in the next budget.
    You made a point in your testimony and I just want to 
emphasize it because the chart you show I assume and I guess I 
want to understand this for the record, it assumes that nothing 
new by way of entitlements come on line. I assume in the 
Medicare portion of this slice on the chart, let me ask are you 
assuming the prescription drug benefit?
    Mr. Holtz-Eakin. No. This is an extrapolation of current 
law.
    Chairman Nussle. So the prescription drugs is not in there. 
Therefore, I assume that no new entitlements, concurrent 
receipts or any other expenditures would be part of this curve?
    Mr. Holtz-Eakin. No.
    Chairman Nussle. That gets me to the next question. From a 
budgetary standpoint as a way to solve this or resolve this, it 
looks as though, and I know this is based on a percentage of 
GDP so it doesn't show the true growth of these programs. 
Certainly it shows Medicare is growing but it doesn't show the 
actual dollar growth. It shows its growth as a percentage of 
GDP. So it makes it look arguably a lot less than it would if 
you showed it on a dollar, on a nominal basis.
    That is one thing I observe here and I am wondering would 
it be an acceptable budgetary method to try and bend the curve? 
What we are looking at here is fairly daunting but I would 
assume if you can start to bend the growth curve slightly in 
the first few years, it pays huge dividends in the out years. I 
know part of this is a political or policy decision we are just 
going to have to come to grips with but what number should we 
look at? What percentage should we try and strive for as we 
consider bending that growth curve and tilting it slightly less 
dramatic as it shows in the chart before us? What percentage 
should we look at? I know that is a discussion currently going 
on in the Medicare conference as an example to try and bend the 
growth curve in order to accommodate some of these new 
benefits?
    Mr. Holtz-Eakin. The percentage toward which Congress aims 
is ultimately a policy decision. I can give you some guidance 
on both the numerator and the denominator of that particular 
curve. In the denominator, that is growth in GDP and to the 
extent that in meeting other policy objectives, you can enhance 
growth in GDP, you will by definition slow the rise in that 
particular outlay as a fraction of GDP. So that is a 
denominator-based view of what the policy decisions need to 
address.
    In the numerator, the growth in Medicare is widely assumed 
to simply be the aging of the population, and indeed that 
contributes about 30 percent of the rise in Medicare as a 
fraction of GDP. The residual 70 percent, however, stems from 
the fact that health care costs have grown historically at a 
pace faster than GDP has grown. Indeed these projections make 
the assumption as do the Social Security and Medicare trustees 
that those costs will ultimately grow 1 percentage point faster 
than GDP. That is slower than history. History is that they 
have grown about two and a half percentage points faster than 
GDP. So attempts to move that rapid growth in health care costs 
toward 1 percent will simply achieve this curve, moving it 
further below will bend that curve down.
    Chairman Nussle. Is there a magic number at which these 
expenditures begin to be a profound drag on the economy? Is it 
15 percent of GDP, is it 20 percent? Is there a school of 
thought on when this becomes unsustainable for economic growth 
on the macro level before we talk about what the annual growth 
rate would be?
    Mr. Holtz-Eakin. Economics is inherently averse to knife 
edge solutions where one approaches to exactly a magic point 
and then falls over. Instead, as I said in my remarks earlier, 
any of these outlays will have to be financed somehow. If you 
assume they are financed by taxes, it is well known that the 
second component of the financing costs, the excess burden, 
rises more rapidly than does the tax rate. And so one will 
simply make the indirect cost of financing more and more 
expensive as the amount of taxes levied has to rise.
    Where some of the direct and indirect costs balance the 
benefits of such programs is ultimately a policy call but there 
isn't a magic number. There is simply an increasing opportunity 
cost of these funds in the Federal government budget.
    Chairman Nussle. But on an annual basis, eventually if you 
are growing faster than GDP, you are going to wind up in 
trouble?
    Mr. Holtz-Eakin. Oh, there is no question that if we 
continue to grow 1 percentage point faster than GDP forever, 
stopped in 2075, it simply is numerically impossible to 
continue that. Stein's law dictates that if something is 
growing faster that GDP, it just can't last forever. That is 
the position where one finds oneself when looking at Medicare 
and other health related programs.
    Chairman Nussle. On the pension benefit, on the PBGC, you 
mentioned that in your testimony, is there a way we can begin 
by whether it is phasing into our budgetary practices a way to 
show that within our budget in a more responsible way? It may 
not be something we do next year but picking a time in the 
future, is it accrual accounting, how do we better demonstrate 
this in our budget so that we can be better at planning as well 
as recognizing the long-term obligations that some of these 
programs stand for in government?
    Mr. Holtz-Eakin. In general with insurance programs, I 
think the key is to try to put in the budget the expected 
present value of the commitment and that would include not just 
the inflow of premia, but the probability that there will be a 
pension line taken over by the PBGC. The obligation of Federal 
funds is the guarantee for that pension plan; it can easily 
follow the model of credit reform in terms of the principles of 
bringing that into the budget.
    In practice, the kinds of things that go into that 
calculation--probabilities of pension plan default, differences 
across industry--are all complicated and hard to imagine the 
details at the start. So if Congress was interested in 
recognizing the existence of these liabilities, one 
possibility, and there are many others, would be to begin by 
simply showing some sort of flag in the spirit of the UMRA 
regulation where if something exceeded a certain threshold it 
was noted in the cost estimate or it was noted in the budgetary 
process so that Congress was aware of the implications in the 
insurance program. As people became more proficient and 
familiar with digesting the numbers, the actual estimates of 
the budgetary costs, it could be moved in in a more formal and 
numerical fashion.
    There are many ways to get from where we are now, a lack of 
recognition, to a place where it was fully recognized in a 
dollar fashion.
    Chairman Nussle. Thank you.
    Mr. Spratt.
    Mr. Spratt. Thank you very much for your testimony.
    In dollar terms, what is the actuarial shortfall in Social 
Security over the next 75 years?
    Mr. Holtz-Eakin. I don't know off the top of my head.
    Mr. Spratt. Does $3.3 trillion, something in that range 
ring a bell?
    Mr. Holtz-Eakin. One hears numbers of that scale, yes.
    Mr. Spratt. We have here the Social Security actuarial 
deficit as a percent of GDP is .7 of 1 percent and the present 
value in dollars is $3.8 trillion over the next 75 years. Do 
your records agree with this?
    Mr. Holtz-Eakin. We can certainly check them. The precise 
numbers, I don't know for sure.
    Mr. Spratt. Would you take this back and give us an answer 
for the record as to whether or not the way we have calculated 
the actuarial deficit of Social Security is correct?
    Mr. Holtz-Eakin. Certainly.
    Mr. Spratt. Looking at your chart, your layer chart with 
Medicaid, Medicare, and Social Security, I don't know who has 
control over that but in any event, Social Security, according 
to your table and your testimony, does go up by a significant 
amount. It goes up from 4.2 percent of GDP today, probably a 
bit more in 2003, to a peak of 6.2 percent, 2 percentage points 
of GDP. That is not inconsiderable given the growing size of 
our GDP pie, $11 trillion today, more in the future, but we 
have moved around portions of our budget, wedges in the budget 
pie of that magnitude before. Defense grew by that much in the 
1980s, for example.
    Would you agree that 2 percent of GDP is something that 
should be sustainable and manageable?
    Mr. Holtz-Eakin. As an outlay?
    Mr. Spratt. By itself, as an outlay, yes, over the next 70 
years?
    Mr. Holtz-Eakin. Starting at what point and with what else 
held constant? I want to make sure I understand the question.
    Mr. Spratt. While it is substantial in dollar terms, 
looking at other budget reallocations over time, we have been 
able to do that, have we not, without really dislocating 
anything of great significance?
    Mr. Holtz-Eakin. Whether you have dislocated things of 
great significance is a policy call. Reallocation could take 
place. I guess my take on this chart would be that this is a 
sharp increase in overall demand for resources in the 
government sector, and if reallocations were to bring them into 
control, then that would make the problem more easily solved. 
But the resources are being added up in this presentation.
    Mr. Spratt. I look at that and I say Social Security by 
itself would be a problem but it is a manageable problem. When 
you add it to Medicare and to Medicaid, then it becomes a real 
difficult burden for the budget to bear and a burden for the 
economy to sustain. Would you agree with that?
    Mr. Holtz-Eakin. I think the nature of the problem is 
different. In Social Security, one sees two sources of growth 
in the outlays. The first is aging, shared with Medicare and 
Medicaid. The second in Social Security's case is that the 
benefits are indexed to real wages, and as real wages go up, 
the purchasing power of benefits goes up. Those are 
mechanically two sources of the rise in outlays. To the extent 
that one was comfortable with the overall level, then one could 
just stay with that.
    With Medicare and Medicaid, you have the aging plus this 
growth in health care costs which thus far has proven to be 
quite intractable and where policy instruments are much harder 
to deploy.
    Mr. Spratt. Looking at Medicare, you have not factored in 
there the prescription drug benefit?
    Mr. Holtz-Eakin. No, I have not.
    Mr. Spratt. Because it is not a done deal. Basically, the 
beneficiary populations are the same between Social Security 
and Medicare. They are a little different at the margin but 
they are not greatly different. So the real increase in 
Medicare which is rising sharply as a percentage of GDP from 
about 2.2 percent in 2000 to about 6.0, almost 4 percentage 
points of GDP. Basically that difference is not due to 
beneficiary population growth because those are constants but 
it is due to the increasing cost of health care?
    Mr. Holtz-Eakin. As I said, 30 percent is aging, shared by 
Social Security; 70 percent is rising health care costs. And 
for Social Security about 55 percent or so is aging, and 45 
percent is the rising value of real benefits. So they share 
that common aging component, but they differ in the other 
dimensions.
    Mr. Spratt. So we say it is a demographic problem but it is 
also a cost control problem and the larger part of the Medicare 
problem is a cost control problem, correct, 70 percent of it?
    Mr. Holtz-Eakin. Yes.
    Mr. Spratt. That is a major difference between it and 
Social Security.
    Mr. Holtz-Eakin. Yes.
    Mr. Spratt. You have had something intriguing in your 
comments about the Medicare prescription drug benefit, 
estimated the cost at roughly $400 billion between 2004-13 but 
under reasonable assumptions, you said by future drug spending 
and demographics, cost would exceed $1 trillion and could 
approach $2 trillion during the following decade. What would 
those assumptions be?
    Mr. Holtz-Eakin. The nature of that calculation is that if 
one goes to 2013 and takes a ballpark estimate of $75 billion 
as the direct spending for prescription drugs, common to the 
different bills that came out, H.R. 1 and S. 1, and has that 
grow at a 10 percent rate over the next 10 years, one is at 
about $1.3 trillion. That is a rate of growth in prescription 
drug spending that has been absolutely a common experience in 
recent years. That is without layering in any demographics, 
having more beneficiaries without altering any assumptions 
about utilization. So that is the nature of the calculation.
    Mr. Spratt. In the first 10 year time frame, if we assume 
drug prices will continue to grow at their previous rate of 
growth, then the cost of the package could easily be $1 
trillion or more?
    Mr. Holtz-Eakin. The spirit of the calculation is 
illustrative, it is not a precise calculation but it is to make 
the point that in these entitlement programs, there are some 
things that get baked in the cake; and given the structure of 
the programs, they will continue in a way that the 10 year 
budget window does not capture. These drafts are meant to 
illustrate that. That calculation is also meant to illustrate 
it. It is just the next 10 years in addition to what is already 
baked in the cake, there is additional layer of icing being 
added.
    Mr. Spratt. So the key to making prescription drug coverage 
affordable is also controlling cost?
    Mr. Holtz-Eakin. It may be the case that the Congress 
decides to spend this money. This is just the cost side. 
Whether it is affordable or not is a value question. That 
depends on the value you place on the program. As I said at the 
outset, the testimony is focused on cost. It is a policy 
decision as to whether the benefits are large enough to merit 
that.
    Mr. Spratt. I haven't seen your estimate of the two House 
and Senate proposals now in conference. Did you elaborate upon 
these possibilities in your cost estimate of those two options?
    Mr. Holtz-Eakin. No. The cost estimates were designed to 
elucidate the first 10 years, as is standard practice in cost 
estimates and to explain not just what the numbers were but the 
basis for those estimates: the kinds of impacts we had 
perceived in terms of formation of delivery of the 
pharmaceutical benefit through private sector entities and the 
impact on the delivery of the AB benefit through PPOs, HMOs, 
things like that. That was the scope of that analysis.
    Mr. Spratt. You addressed the problem of capturing these 
likely costs in the budget which we are not doing today, not 
even on a present value basis, not for Social Security and not 
for Medicaid or Medicare. Medicaid, there are so many variables 
in there, it might be harder to predict than Medicare.
    How do we do it? How would you propose we do it, as a 
supplement to the budget that is done on a regular basis or by 
integrating this information into the budget itself?
    Mr. Holtz-Eakin. In the end, I think that would become 
Congress' decision, what it wanted.
    Mr. Spratt. We want your advice. You are going to be 
serving on the FASB and one of the things you will find on the 
FASB is that we do things in the Federal budget that we are not 
going to let private corporations get away with. If a private 
corporation had a pension fund that was underfunded by as much 
as ours and Medicare benefits too, then it would have to make 
adjustments. All we have to do is declare it and profess our 
intention to deal with it in the prospective future and walk 
on.
    Mr. Holtz-Eakin. The spirit of my remarks would be in fact 
to include more in the budget in some cases and more in 
supplementary information in others. For example, I think we 
could move toward a better recognition of the budgetary cost of 
insurance programs, given the experience with credit reform. We 
could improve our estimates in credit reform. There are some 
things that with time and effort could be brought into the 
budget in the same fashion that credit reform estimates are 
now.
    In other cases, for example, with these entitlements, I 
would argue they should be kept as supplementary materials. As 
I said, the dividing line between contractual/firm commitments 
and those which Congress retains the right to modify is far 
from a distinct one. Ultimately it will be a congressional 
decision but to the extent that option has been retained, I 
don't think it is appropriate to put the present value in the 
budget.
    I am also not uniformly a fan of the present value 
calculations as supplementary pieces of information. Present 
values are designed to ignore timing. That is literally the 
point of them. In some cases, I think simply knowing the level 
of outlays that will ultimately have to be financed is the key 
piece of information along with the timing of the increase. As 
you pointed out, the more rapid increase in Medicare as opposed 
to Social Security is information that gets lost in the present 
values. So to the extent that the timing of the rise in Federal 
spending is important, present value misses that.
    Mr. Spratt. Let me ask you a couple of things and I will 
let other members move on with it.
    Are you working at CBO on some sort of formulation so that 
we would get a warning as to the looming liabilities of Social 
Security, Medicare and Medicaid before we undertook big 
spending increases, big benefit increases or big tax cuts?
    Mr. Holtz-Eakin. I know my predecessor, Dan Crippen, 
started a long-term modeling group designed to be better able 
to understand the long-term implications of legislation in 
these entitlement areas. We continued that work. It is far from 
complete or perfect in any way, but we are trying to build the 
capacity to be able to evaluate these kind of programs over 
longer horizons where it is actually relevant and important to 
Congress. How such information was deployed and the manner in 
which it was delivered are something we would need to work with 
you on.
    Mr. Spratt. Let me ask you about discretionary spending. 
Since you are going on the Financial Accounting Standards 
Board, if you had a corporation that knew it was going to 
sustain somewhere between $3 [billion]-$5 billion a month for 
an activity in which it was engaged for the forthcoming fiscal 
year, do you think it should be reflected in its projection as 
a contingent liability for the future?
    Mr. Holtz-Eakin. Yes.
    Mr. Spratt. We have that situation now with discretionary 
spending with the cost of deployment to the Persian Gulf. We 
have treated this as a mandatory thing but the chairman will 
tell you because he has been an advocate for trying to book 
every year some sort of actuarial equivalent to the amount we 
spend on emergencies, hurricanes and tornadoes, fires and 
droughts, and things like that, we know over a period of time 
what it is likely to be but we have not been able to sell the 
idea that some amount should be put in the budget as a 
realistic reflection of a likely cost.
    We have an even bigger example in the discretionary 
accounts this year in that we know there is a supplemental 
coming for the Persian Gulf and we know it is probably going to 
be over $25 billion, maybe as much as $50 billion, but it is 
not reflected even in the mid-session review. Do you think that 
is a problem?
    Mr. Holtz-Eakin. I think that to the extent there are 
expenditures that Congress can quantify, they ought to enter 
the budgetary calculations. It is literally above my pay grade 
to make decisions about whether we made a commitment on that 
but if we know we are going to spend money and we are going to 
spend it this year especially, certainly it ought to be 
reflected in budgetary decisions.
    Mr. Spratt. Thank you, sir.
    Chairman Nussle. Mr. Diaz-Balart. Mr. Cooper.
    Mr. Cooper. This is a very important hearing and I wish we 
had more members present. Of course it is a busy time and 
members were up late loading. I think another factor is the 
future has no lobbyists. As we focus on these vitally important 
long-term issues, there is a natural tendency of today's 
politicians to shortchange them.
    I also think it is very difficult for folks to grapple with 
the magnitude of the numbers we are talking about. I have come 
to admire Peter Fisher's statement, the Treasury Under 
Secretary, who said basically government is an insurance 
company that is at least $23 trillion in the hole with side 
businesses in defense and homeland security. That does more to 
encapsulate in one sentence the nature of government because so 
many folks back home don't even view Medicare and Social 
Security as government programs. That is their money and they 
would deny the government has much to do with that. We face a 
real problem both in analysis and of communication.
    I appreciated your statement. Yesterday we had a hearing on 
whether the Air Force should buy or lease aircraft tanker 
fleets, about $17 billion. I thought I understood you to say 
that it is the same outlay of government money, it should be 
scored virtually the same whether we buy or lease. the 
government is taking control of that property regardless of the 
legal formalities, correct?
    Mr. Holtz-Eakin. Yes and I commend to you a fine study on 
lease/purchase arrangements that CBO put out earlier this year.
    Mr. Cooper. On the aircraft decision?
    Mr. Holtz-Eakin. Not on the aircraft decision but on this 
kind of financial arrangement.
    Mr. Cooper. There are so many other issues to get into. A 
statement the chairman made in our last hearing worries me and 
I hope I am quoting him correctly. This was in USA Today. It 
says, ``Tax cuts do not cause deficits. You only borrow money 
in Washington for spending.'' Perhaps I got the chairman's 
statement wrong and if the chairman would like to amend or 
correct that, I would be delighted to give the chairman the 
benefit of the doubt. That is a statement that is hard for me 
to understand and I only have two degrees in economics. Can you 
understand or make sense of that?
    Mr. Holtz-Eakin. I think one can appeal to an accounting 
identity and one can appeal to a politician and one can appeal 
to economics. The accounting identity is this: If you hold 
spending fixed and cut taxes, the difference will be borrowed. 
That is the easiest way to make sense of the math.
    Mr. Cooper. But deficits are like a see-saw, aren't they, 
taxes on one side and spending on the other and to get balance, 
you have to focus on both sides of the see-saw, not just one 
side or the other?
    Mr. Holtz-Eakin. The spirit of my remarks was that over the 
long-term, you will have to finance your spending decisions in 
some way, so focusing on what you have committed in the way of 
spending is the appropriate first step. Figuring out how to 
finance it is certainly an important issue over the near term. 
If you are going out 1, 2, or 3 years, you want to look at both 
sides of that equation. I was focusing on the spending as I 
said because the nature of the hearing was really long-term 
issues.
    Mr. Cooper. Sometimes democracies inflate away the value of 
the currency too. They try to avoid financing deficits until it 
is almost too late and the value of the currency deteriorates.
    Mr. Holtz-Eakin. Despite Chairman Greenspan's ability to 
opine on fiscal policy, I am going to resist the temptation to 
opine on monetary policy. It would probably go on too long.
    Mr. Cooper. But that is also a possibility isn't it? Not 
everything in life is financed. Sometimes there are worse 
outcomes.
    Mr. Holtz-Eakin. There are different forms of financing. It 
is financed one way or another. Inflation taxes are taxes 
nonetheless.
    Mr. Cooper. You mentioned that the Medicare drug bill is 
not factored into your chart, the future of Medicare spending. 
Can you give us an idea of how the curves would change? The 
figure of $1 trillion was mentioned. I assume that would be a 
dramatic increase in the bandwidth of Medicare section on your 
chart?
    Mr. Holtz-Eakin. Yes. We haven't done the full 75 years. I 
wanted to put this in the testimony largely to point out the 
shortcoming in these 10 year budget windows and how longer term 
information is important. To the extent that a final bill is 
passed and details are available to actually do a long-term 
projection, that would be possible for us to undertake.
    Mr. Cooper. One of Peter Fisher's recommendations is that 
we have an accrual spending statement on every measure passed 
by Congress. We do not do that today. Do you think that would 
be a helpful policy improvement?
    Mr. Holtz-Eakin. It is one of the potential pieces of 
supplemental information that I think would be helpful. More 
supplementary information about long-lived programs I think is 
something Congress would benefit from. You are in a better 
position to decide than I. Whether it is an accrual statement, 
which as I said loses timing, or whether it is simply some 
information about the scale of the obligation and the rate at 
which it arrives depends on who is using the information and 
for what purpose.
    Mr. Cooper. Today's system of arbitrary sunsets and 
deadlines and we don't count things that are more than 10 years 
out, things like that, this current system is so arbitrary as 
to almost be meaningless because the last tax cut bill was 
either scored at $350 billion or at $1 trillion plus depending 
on whether you gave out year effects to the measure.
    I see my time has expired.
    Chairman Nussle. Since you have two degrees in economics, I 
was giving you the benefit of the doubt.
    Mr. Diaz-Balart.
    Mr. Diaz-Balart. I apologize for the noise problem before.
    Along the same line as Mr. Cooper's questions, given the 
importance of long-term Federal obligations and the effects on 
the economy, which are pretty obvious, would it not be 
appropriate to have the CBO submit not only the projected 
spending revenue effects of legislation we passed but also of 
the effect on the GDP which is a huge issue?
    Mr. Holtz-Eakin. Under current CBO procedures, under a 10-
year projection, for example, we do in fact include the impact 
on GDP. We develop a forecast for the economy which includes 
the current state of policy at any point in time and its 
implications for the future. We then layer on top of it the 
current law on both the outlay and tax side to get a projection 
of the future course of the Federal budget.
    Mr. Diaz-Balart. What would you suggest would be our next 
step in improving budget for long-term commitments?
    Mr. Holtz-Eakin. Quantitatively, the entitlements--shown in 
the picture to my left--produce the large known number. 
Information of some sort that informed Congress about decisions 
that altered that picture in one direction or another I think 
would be a very valuable step in the right direction.
    The vast array of other suggestions I had were designed to 
place commitments for which the scale is really unknown in the 
budget at least or supplementary information about them in the 
budget information so that they could be better understood and 
compared with existing programs.
    Mr. Diaz-Balart. As things get more and more complex, which 
tends to happen, is our budgeting process prepared to handle 
the increased complexity of budgeting for long-term 
commitments?
    Mr. Holtz-Eakin. It is a fair concern, I think. As someone 
who consumes these budgets, you are sure you appreciate the 
complexity. As I work with the CBO staff which I have nothing 
but praise for, I become painfully aware of the difficulty and 
the complexity in the many programs. I think there is a clear 
and important path toward using more and more kinds of 
budgetary information across a broader array of programs.
    The first step is, in fact, to not just launch into it but 
to make some point of recognition--supplementary information if 
you want to bring a formal point of order or some such device--
into the budget price. That would be the next step. Only after 
both the Congress and anyone who is providing this information 
have become comfortable with the procedures, after they have 
shown some stability and robustness in a variety of settings, 
do you want to incorporate them into the budget process in any 
real formal sense by which you might do allocations on the 
basis of them or something like that.
    Mr. Diaz-Balart. Thank you, Mr. Chairman.
    Chairman Nussle. Mr. Scott.
    Mr. Scott. Thank you, Mr. Chairman.
    Mr. Holtz-Eakin, sometimes it is nice to start off with the 
facts, then you can get to the excuses, the explanations, the 
allegations, the spin. This is the chart from February of the 
deficit year by year and shows the deficit under Johnson, 
Nixon, Ford and Carter, the deficit under Reagan and Bush. Let 
me ask you whether or not you agree that at the end of the 
Clinton administration not only had the deficit been eliminated 
but even taking into consideration Social Security, Medicare 
and keeping those in the so-called lockbox, there was an actual 
surplus. Is that accurate?
    Mr. Holtz-Eakin. I want to make sure I understood the 
chart. It is not the unified surpluses or deficits; it is in 
fact the budget.
    Mr. Scott. Right.
    Mr. Holtz-Eakin. There was a small on-budget surplus at 
that time.
    Mr. Scott. In February, the deficit estimate was about $500 
billion for next year. Is that right and since then it has gone 
up $150 billion since February, right?
    Mr. Holtz-Eakin. These are the OMB estimates of the on-
budget surplus?
    Mr. Scott. Right.
    Mr. Holtz-Eakin. I don't know the on-budget surplus off the 
top of my head.
    Mr. Scott. The question we would have to ask is looking at 
these numbers how bad it would have to get before we concluded 
that somebody doesn't know what they are doing. Let me show you 
the next tax cut. Does this tax cut chart accurately reflect 
the 20 percentile distribution of who got the tax cuts?
    Mr. Holtz-Eakin. I'd have to study this chart more 
carefully.
    Mr. Scott. After we passed the tax cuts, does this chart 
accurately reflect the jobs that have been created by 
administrations going back to Truman?
    Mr. Holtz-Eakin. That looks about right.
    Mr. Scott. Actually it is a little out of date again. It is 
not $2.5 million, it is not $3 million but the direction is 
pretty solid. That chart includes the Korean War, the Vietnam 
War, the hostages in Iran, the cold war, Somalia, Grenada as 
well as 9/11. The next chart is the interest on the national 
debt. The green bars show where the interest on the national 
debt was going. The red bars show the interest on the national 
debt after we got these tax cuts passed. The blue bar is the 
defense budget. Does the administration's budget in 2013 show 
the defense budget and the interest on the national debt as 
essentially the same?
    Mr. Holtz-Eakin. We don't have 10 year projections from the 
administration at this point.
    Mr. Scott. Did the CBO numbers for the 2013 budget show 
interest on the national debt and the defense budget 
essentially the same?
    Mr. Holtz-Eakin. I will have to check.
    Mr. Scott. The next chart is the Social Security challenge 
that shows the cash flow in Social Security chart that 2017 may 
have adjusted a year or so one way or the other but essentially 
shows the challenge we have in Social Security, in paying 
Social Security for the future?
    Mr. Holtz-Eakin. It is probably an accurate accounting of 
Social Security. An economist would suggest that is not really 
the challenge, that a unified deficit is a better measure of 
the economic resources one will require in the Federal budget. 
The trust fund represents a device within the Federal budget to 
keep account of Social Security but it is not an economic 
concept that has consequence.
    Mr. Scott. We are going to have to somewhere in the unified 
budget find the cash to pay the red. Did you agree with Mr. 
Spratt's comment that the present value of the Social Security 
problem is about one-third of the present value of the tax 
cuts?
    Mr. Holtz-Eakin. It is not a calculation I have done. 
Present values are useful when there is a firm commitment on 
the incoming side and the outgoing side. The degree to which 
there is malleability on both sides, both on the receipts and 
on the outlays, makes it less informative.
    Mr. Scott. Let me ask a direct question. Looking at the 
cash flow of the Social Security trust fund and the interest on 
the national debt going through the ceiling, how can you 
creditably say there is any intent to pay Social Security in 
the future?
    Mr. Holtz-Eakin. I would direct you back to this chart 
which I think is illustrative. it shows the commitment to spend 
under current programs and current law and then the question 
becomes how such commitments will be financed if they are to be 
met.
    Mr. Scott. I noticed your chart doesn't include interest on 
the national debt which we are showing as virtually equivalent 
to the defense budget.
    Mr. Holtz-Eakin. To show the interest on the debt, you 
would have to make a specific assumption about the timing of 
the financing and the amounts borrowed in different years. 
Since the point of this is to highlight that in the long-term, 
you have a commitment to pay for one way or another. It was 
clear to leave out the second decision, which is the timing of 
the financing on the tax side.
    Mr. Scott. Mr. Chairman, I would point out that the CBO 
budget shows interest on the national debt at about $500 
billion for 2013. As mentioned, somebody has to pay it so I 
appreciate it. My time has expired.
    Chairman Nussle. Thank the gentleman.
    Ms. Majette.
    Ms. Majette. Thank you, Mr. Chairman. Thank you, Mr. 
Director, for being here this morning.
    If you will indulge me, I am going to take us off the 
beaten path for a couple of minutes. I wondering the degree to 
which the CBO takes into account the reductions in cost in one 
program due to spending in another. Let me give you an example.
    We are currently in the process of reauthoriztaion of the 
Head Start Program. Studies have shown that students who 
complete the Head Start Program are five times less likely to 
go to jail or to prison than students who do not complete the 
Head Start Program and are not otherwise put at the starting 
line in terms of their education at the same place.
    When you look at the overall cost of Head Start, which is 
$6,500 per year per child, and currently we are only covering 
900,000 children, only one in five children at that figure, to 
what degree can you take into account reductions in the cost of 
incarceration and the effects that has on our country with 
respect to the cost of covering more students in the Head Start 
Program?
    For your information, I am a former State court judge and I 
know that in my county, in DeKalb County, it costs $52 a day at 
a minimum to feed and house an inmate each day. So you are 
looking at essentially $18 a day per child for Head Start 
versus a minimum of $52 a day in a jail.
    What would you say with respect to balancing that and how 
we might be able to use those kinds of analyses in dealing with 
this deficit problem?
    Mr. Holtz-Eakin. I certainly won't pretend to be an expert 
on incarceration. It is not something I want to learn about 
personally in any way. But as a matter of the way CBO does its 
business, for example, on a cost estimate, it does attempt to 
think comprehensively about the impacts of any proposal. For 
example, it is a straightforward part of doing our business in 
the Medicare area to look at ancillary impacts on Medicaid in 
order to get the overall impact of a proposal on the spending 
in the Federal budget.
    The initial question is does CBO think about these 
interactions? The answer is, yes, we do our very best to think 
about the way in which the proposal will affect the array of 
individuals and actors in the private sector and as well, their 
impact on the Federal budget.
    With respect to specific estimates on Head Start, I am not 
conversant with all the degrees to which we have brought in 
different kinds of behaviors. An important issue to point out 
is that in a 10-year budget window, it strikes me as unlikely 
that you would capture those kinds of feedbacks.
    Ms. Majette. In terms of that general kind of comparison, 
you are saying the CBO does take that into account?
    Mr. Holtz-Eakin. As a matter of routine business in all 
areas of our cost estimates.
    Ms. Majette. So if you are talking about medical coverage, 
it would make more sense to spend more money at the outset in 
terms of prevention and screenings than to wait until a later 
point in time when you have to spend more money for those 
higher costs that are ancillary to the failure to address it 
earlier on?
    Mr. Holtz-Eakin. Certainly, in thinking about issues in the 
health area, we have spent a tremendous amount of time and 
effort to look at the peer review literature and find out the 
degree to which for example, a disease management program can 
be shown to bring long run reductions in the overall cost of 
care for an individual. That kind of analysis is one of the 
reasons that CBO really devotes effort in its areas of study 
outside of just straight cost estimates. We do studies at CBO 
so that we are better informed about the nature of the impacts 
when it comes time to look at a budgetary issue narrowly 
defined. Certainly we have looked at those kinds of feedbacks 
as many in health as we can find.
    Ms. Majette. Thank you. I yield back the balance of my 
time.
    Chairman Nussle. Mr. Kind.
    Mr. Kind. Thank you, Mr. Chairman, and thank you, Mr. 
Holtz-Eakin, for your presence and testimony here today.
    As my friend from Tennessee, Mr. Cooper, indicated, this is 
an incredibly important hearing. It is one that forces us to 
look out into the future rather than just focusing on the next 
election which I think is incredibly important for us 
policymakers to do more of rather than less of as we make these 
decisions that are going to affect not only tomorrow but the 
next generation and the next after that.
    If anyone deserves a new chapter in the book of John F. 
Kennedy's ``Profiles in Courage,'' it is you because you are 
stepping into what seems to be the perfect fiscal storm of some 
huge challenges that we are going to be facing together as a 
Nation.
    Unprecedented budget deficits are exploding on the scene 
again. What is perhaps most disconcerting about it is there 
doesn't appear to be any plan on how we can reverse course to 
instill some budget discipline, bring things back into balance, 
because it is all happening at exactly the worse moment in our 
Nation's history, on the eve of close to 80 million of our so-
called baby boomers and their massive retirement, the 
demographic time bomb that many of us are aware of which is the 
800 pound gorilla in our deliberations every time we take up 
these policy issues.
    Unlike the deficits we faced during the 1980s and early 
1990s, we don't have the luxury of a decade like the 1990s 
again, the time to reverse course, bring things into balance, 
start reducing the publicly held national debt and preparing 
our country for what we know is going to start occurring in a 
few short years. That is very disappointing because as long as 
the policies are pursued and we see the red ink mounting, it is 
going to be awfully hard for future Congresses, and especially 
the next generation and the children of today to be able to 
take up these challenges themselves and to reverse course.
    As the father of two little boys myself, I am very 
concerned in the direction of fiscal policy and the long-term 
economic consequences that might bring.
    Looking at the 1990s, I think there were certain things the 
Congress along with the administration did well in order to 
instill some budgetary discipline, certain tools that were 
available to policymakers, certain restrictions on what you 
could and couldn't do, not the least of which was the PAYGO 
rule which expired unfortunately in 2000. The new 
administration and Congress had an opportunity of extending the 
PAYGO rule but passed on it. I think it was one of the most 
important mistakes made starting a new decade facing what we do 
today.
    I am wondering whether you have had an opportunity and you 
probably have given the scholar that you are, to study the 
history of certain budget disciplines, especially the PAYGO 
rule and if you have any opinions in regards to whether a 
certain type of fiscal tool is something that makes sense and 
something the Congress and the administration should seriously 
consider in order to start developing a plan on how we get out 
of the sea of red ink which is accumulating by the minute 
today.
    Mr. Holtz-Eakin. Opinions are a dangerous thing for CBO 
directors, but let me review briefly some things we have seen 
in the United States. In the early 1980s, we had deficits as a 
fraction of GDP of about 6 percent. I think it is fair to say 
there was a realization that structural deficits of that 
magnitude could not be sustained, and efforts were undertaken 
to address that.
    The first form of those efforts were Gramm-Rudman-Hollings 
deficit targets, which did not work and which were missed not 
once but twice, two different iterations. Then the discipline 
mechanisms changed to controlling spending in the form of 
discretionary caps and in terms of the PAYGO rules that you 
mentioned. Congress and the administration moved forward in 
that fashion.
    Then in the late 1990s, there was a great deal of attention 
paid to the scale of the on and off-budget surpluses, and that 
served implicitly as some sort of targeting device for fiscal 
policy in the United States.
    I would argue that in the absence of some sort of targeting 
device about which there is some consensus, mere rules will not 
be sufficient to achieve any such objective. You first have to 
identify an objective as a Congress in whatever fashion is best 
and then put in place rules that can support movements toward 
that fiscal policy target.
    Mr. Kind. One of the concerns I have is that the future of 
the country and economic growth, getting ourselves out of this 
budget mess is pretty much being bet on these large tax cuts 
stimulating economic activity and growing the revenue stream in 
the out years. It is a huge gamble that is occurring because if 
it doesn't occur, if we don't see the huge revenue increase 
that my friends on the other side claim will come from these 
big tax cuts and the extenders which we know are coming 
tomorrow, the next generation is going to be left holding the 
bag. That is going to be very difficult for them to wrestle 
with.
    The dynamic that occurred in the 1990s was really twofold. 
One is there was restraint on spending and we had a decline all 
8 years in the Clinton administration on spending as a 
percentage of GDP. That now is reversed and we are back up 
again.
    The other dynamic was that the urge for large, massive tax 
cuts in the 1990s was also blocked, so there was a spending 
part of it and there was a revenue part of the equation which 
enabled balance to occur and some short term surpluses to 
happen at the same time. It is something that doesn't exist 
today, that same type of balance on long-term fiscal outlook.
    Again, I thank you for your testimony today.
    Mr. Holtz-Eakin. Certainly.
    Chairman Nussle. Mr. Shays.
    Mr. Shays. Thank you for being here.
    I have had the pleasure of being on this committee for 10 
years. This is my 11th year and I had a bit of interruption but 
when I look at what we have done in spending over the last 
years, I would like to have you pull up chart 21, then we will 
go to 22, 23, 24, 25 and 26.
    Chart 21, we see Medicaid going up quite significantly 
under Republicans and Democrats. Medicare, chart 22, we see 
tremendous increases. Under Veterans Affairs, 23, we are seeing 
tremendous increases. Under Transportation, 24, you see 
spending going up. This is not spending that my colleagues on 
the other side of the aisle have voted against. They have 
thought we have not spent enough. Chart 25, Labor, HHS, 
educational appropriation. As much as we have increased 
spending in the last 5 years by 65 percent, it is still not 
enough for our colleagues on the other side of the aisle.
    Then go back to chart 8. I want you to look at chart 8 and 
tell me how you react to it. It is spending growth out of 
control, per capital real spending, excluding net interest. It 
is approaching almost $6,500 per capita and I want to know if 
these are the same numbers you are seeing as well?
    Mr. Holtz-Eakin. This is the total including entitlements, 
discretionary? We can check and make sure the numbers match.
    Mr. Shays. When you look at this chart, does this chart 
surprise you? Do you see it? Are you looking at it?
    Mr. Shays. We follow the numbers on a regular basis, as you 
know, and try to inform Congress about these matters.
    Mr. Shays. I look at trend lines and I am thinking the last 
2 years, that has almost gone up straight practically in 
comparison to what it did before.
    The irony to this in some ways is that in spite of the fact 
my colleagues on the other side of the aisle don't like the tax 
cut, they are not supporting repealing it. They had an 
opportunity to sign on to repeal it. That is the mess we are 
in.
    The only reason I mentioned the first part is to say that 
having seen the arguments, I don't know if it is a Democrat or 
Republican problem, I think it is a problem of Congress and 
even when I look at the chart showing the Presidents who were 
in power, Ronald Reagan most of the time had a Democratic 
Congress, so I just kind of think we are all part of this mess.
    Having said that, I want you to tell me when we look at 
spending because spending is where the problem is, is it the 
entitlements that concern you more or the discretionary 
spending?
    Mr. Holtz-Eakin. For the purpose of this hearing, which is 
about the long-term impacts, I think the entitlements are in 
fact the large knowable piece of the budget that one can take a 
look at and see the implications for the long-term.
    Our assumption in putting together estimates of the other 
spending is that discretionary spending ultimately rises as a 
constant fraction of GDP. It is very difficult for us to 
forecast and we did not attempt to predict the kinds of 
discretionary appropriations that Congress would make.
    Mr. Shays. So if entitlements are the key problem, would 
you be advocating to Congress that we do what we had done when 
we brought our bill out of committee before it was chopped 
apart by many on the other side of aisle when we tried to 
freeze discretionary spending for 1 year or at least hold it to 
a 1 percent increase? Do you think that was an advisable thing 
to do?
    Mr. Holtz-Eakin. My message to you is, that is a policy 
decision that the Congress will have to make. My point is 
simply that over the long-term, these spending commitments will 
have to be financed in one form or another. A rise to 28 
percent of GDP if financed by taxes in any given year would be 
a rate of taxation that is well above historical norms.
    Mr. Shays. I am not quite sure I understand your position 
that slowing the growth of entitlements or freezing them is not 
something you can comment to. Why can't you comment on that?
    Mr. Holtz-Eakin. Whether it is desirable or not, my 
testimony focuses on the cost not the benefits. It would lower 
the cost, no question. Whether it is desirable is an issue of 
the benefit of those outlays compared with the benefits of 
other Federal programs, and of the use of those funds in the 
private sector, and that is a policy decision.
    Mr. Shays. My time is up. I just would have to say to you I 
understand it is a policy decision but you don't seem to want 
to speak to the consequences of a policy decision.
    Mr. Holtz-Eakin. It would lower the overall claims on the 
private sector. That is the spirit of the message I am trying 
to convey today, which is in the end, there are finite 
resources.
    Mr. Shays. Why would there be a description of you as a 
profile in courage if you are basically not expressing opinions 
about these issues and providing warning signs and so on? Where 
does that profile in courage description apply to you?
    Mr. Holtz-Eakin. I am not the person who gave myself that 
label, but I would suggest that if one wanted a warning sign 
about the issues that Congress would face going forward, this 
particular set of current service spending demands is in fact a 
very pertinent piece of information that Congress ought to 
think about to decide how it will finance or choose not to 
finance them by reducing spending. That part is the call.
    Mr. Shays. What I am trying to get a handle on is that you 
had an opportunity to discuss with this committee whether or 
not you have greater concerns about entitlements or 
discretionary spending and you said that since this is a 
hearing about long-term expenditures, then you refer to your 
chart. Can't you be a bit more emphatic about what would 
concern you as an American and as someone who focuses on the 
budget? Should our concern be more on entitlements or should it 
be more on discretionary spending?
    Mr. Holtz-Eakin. There are a variety of answers, none of 
which will, I suspect, satisfy you.
    Mr. Shays. Your job is not to satisfy me but to educate me 
and to not be milk toast. I want to know some facts. What is 
the big concern?
    Mr. Holtz-Eakin. Fact: If you take a dollar from the 
private sector and devote it to entitlement or discretionary 
spending programs, you will either crowd out some private 
sector consumption or some private sector investment and the 
economic consequences will be identical.
    Mr. Shays. Which is more likely to occur based on your 
study of Congress? Entitlements will crowd out or 
discretionary?
    Mr. Holtz-Eakin. It is not possible to distinguish between 
them. They will be financed either in some composite way by 
taxes or by borrowing. Both will crowd out.
    Mr. Shays. Which is the biggest growth in the last 15 
years?
    Mr. Holtz-Eakin. If you look at the Federal budget even 
longer than that, we have switched from a budget that had a 
dominant character that was discretionary spending to now a 
budget that is denominated by entitlement spending. There is a 
lot more of the total budget devoted to the entitlement 
programs than to discretionary programs.
    Mr. Shays. If I had answered the question if I was sitting 
there, I would have said Congressman, the bottom line is the 
part of the budget that you guys don't vote on is the one that 
is growing the most and you had better get a handle on that 
part of the budget or we are in deep trouble. That to me may be 
not saying specifically but that is the kind of thing I would 
expect from my budget director.
    Thank you, Mr. Chairman.
    Chairman Nussle. Thank you.
    Are there other members who have an additional question? 
The reason I ask is, I have been told we will have votes around 
noon and we will have our typical series of votes. I think six 
or seven is what I am hearing.
    If there aren't any other questions for our budget 
director, I think it probably would be a good idea to move on 
to the second panel so that we can get that in before the 
votes.
    If there aren't any other questions, I appreciate your 
testimony today. It is a good start. We are going to have more 
we have to discuss obviously. There is a lot of interest in 
this.
    Thank you for your testimony. We will enjoy working with 
you on solving this.
    The next panel consists of the distinguished William G. 
Gale from the Brookings Institute, Tax Policy Center. He has 
been before our committee before. We welcome you back to the 
committee. Your entire written statement as you have presented 
it will be made a part of the record.
    During the time you have, you may summarize and give us the 
high points you feel we should know and then we can have a 
chance to ask you a few questions as well. Welcome back to the 
committee and we appreciate your attendance here today.

STATEMENT OF WILLIAM G. GALE, BROOKINGS INSTITUTION, TAX POLICY 
                             CENTER

    Mr. Gale. Thank you for having me testify this morning. It 
is always an honor to appear before this committee.
    It is also an honor to appear immediately following Doug 
Holtz-Eakin, my friend and former co-author who I think is 
doing a fabulous job at CBO.
    I would like to make five main points in my testimony. 
Before I do that, let me just say that any emphasis on long-
term budget issues is welcome and I especially appreciate the 
committee's attention to that matter.
    The first main point is the conventional wisdom is 
accurate. The United States does face a long-term budget 
deficit in the coming decades and a big part of that is that 
Social Security, Medicare and Medicaid will expand as you have 
just heard in the previous session.
    There is uncertainty about the precise level of the fiscal 
gap or the long-term shortfall but there is little uncertainty 
that it will actually be there. Almost every study suggests 
that under a huge variety of assumptions, we will see a long-
term fiscal gap.
    The second point is that one can overemphasize the role of 
Social Security, Medicare and Medicaid in the long-term fiscal 
gap. There is another big part of the problem and that is the 
potential tax cuts on the horizon that would occur if we remove 
the sunsets in the existing tax code. If all the sunsets were 
removed, revenue would fall by 2.4 percent of GDP as in 2013. 
If in addition to that, we actually fixed the alternative 
minimum tax so only 3 percent of taxpayers stayed on it, which 
is about the current level, revenues would fall by 2.7 percent 
of GDP.
    One of the problems with getting the public to focus on the 
long-term budget issue is when we look at tax cuts or spending 
programs, we talk about 10 year numbers. So a Medicare 
prescription drug benefit is $400-some billion. The tax cut was 
$350 billion. When we talk about Social Security and Medicare 
financing problems, we talk about 75 year shortfalls. So 
numbers in Social Security and Medicare are very big but they 
look bigger relative to the tax cuts than they would if we 
reported the numbers on an equivalent basis.
    For example, the 75-year shortfall in Social Security could 
be fixed with an immediate and permanent cut in spending and 
raise in taxes of $75 billion, .7 of 1 percent of GDP. That is 
about 40 percent of the tax cuts due to legislation in the last 
couple of years.
    When we talk about Social Security being a big huge 
problem, it is important to realize if you think about it in 
the same accounting frame as you think about other taxes and 
spending programs, it is a manageable problem and Congress is 
making decisions every year that are at least as big if they 
are made permanent as fixing the Social Security shortfall 
would be.
    For example, the 2.7 percent of GDP loss in tax revenue 
that comes from extending the sunsets or removing the sunsets 
and fixing the AMT is almost four times as large as the Social 
Security deficit if both of them were tracked in a similar 
metric. It is larger than the permanent debt in Social 
Security. And over the next 75 years, if the tax cuts are 
extended, they would cost more in revenues than it would take 
to fix the Medicare trust fund and the Social Security trust 
fund over the next 75 years.
    So the main message here is that the decisions that you 
make on an everyday basis about current tax cuts, current 
spending bills, can have very large long-term implications if 
they are made permanent, and that, therefore, when we talk 
about Social Security and Medicare as the real fiscal danger, 
we should also add extending the tax cuts as a real fiscal 
danger, because it is the same order of magnitude.
    Alright, the third point I want to make is there is no 
hidden pot of gold waiting for us in terms of tax deferred 
retirement accounts. There have been a bunch of recent media 
activity about research by Stanford University professor, 
Michael Boskin. The press reports and some aspects of Boskin's 
paper suggest that future revenues from tax deferred savings 
plans are left out of the long-term budget calculations and 
that they are large enough to eliminate most or all of the 
fiscal gap. These suggestions are inaccurate. In fact, the 
underlying fiscal gap calculation already includes almost all 
of the revenues that are in Boskin's number and, as a result, 
adjusting the estimates to take account of Boskin's projection 
generates almost no change in the budget outlook. Nor are we 
likely to see $12 trillion in net present revenues. The right 
number is probably closer to $1 trillion, and could well be 
negative.
    There has been one useful aspect of the sound and fury 
about this report, though, and that is, when the report came 
out, a number of people said, well, this justifies further tax 
cuts now. And the logic of that is that the long-term fiscal 
situation should have an impact on current policy. Then when it 
came out that the $12 trillion really isn't there, then 
obviously it doesn't justify current tax cuts now. But the 
logic still holds; the long-term fiscal situation should have 
an influence on what we do or what you do now. And so I think 
that is an important lesson to take from that. But I think it 
is also obvious now, from looking at the data, that there is no 
hidden extra revenue out there waiting for us.
    Point four, the economic effects of persistent budget 
deficits are gradual, but they are debilitating nonetheless. I 
believe the chairman asked in the first session is there sort 
of a flex point; is there a point at which deficits become 
overwhelming. The short answer is no. Deficits are not like 
earthquakes. An earthquake happens, a building falls down, 
anyone can walk by and say that earthquake caused that building 
to fall down. Deficits aren't like that; the effects of 
deficits are much more gradual, they are more insidious. If you 
like animal analogies, you should think of deficits as termites 
in the woodwork, sort of gnawing away at the capital stock over 
the long-term; they aren't the wolf at the door threatening an 
immediate emergency. So think of long-term gradual declines in 
economic performance due to budget deficits.
    And the reason that occurs is that the real problem created 
by budget deficits is that they reduce national saving, which 
in turn reduces the assets owned by Americans and therefore 
reduces future national income. These effects can be sizeable, 
especially in the long-term. Conventional estimates that I have 
developed based on a model that was originally written by the 
Chair of the Council of Economic Advisors, Gregory Mankiw, 
shows that just the decline in the fiscal status since January 
2001 will reduce real GDP in 2012 by 1 percent and will reduce 
national income in that year by about $2300 per household. That 
is just due to the fiscal deterioration. Now, these effects 
will persist over time, that is, they will gradually get bigger 
and bigger, so they are long-term costs that the country will 
have to bear.
    Much of the debate about the deficit focuses on interest 
rates. I think this is a little bit of a side show. The deficit 
affects national saving regardless of whether it affects 
interest rates. I do think there is evidence that deficits 
affect interest rates, though, and we can talk about that if 
you are interested. Nor does it matter if the deficit is 
financed by capital inflows from overseas. If capital comes in 
from other countries, that just means that the amount that we 
produce in this country doesn't change. But because we borrowed 
more from others, our claims on that production fall, and, 
therefore, our future national income still falls.
    Alright, the last point, the fifth point I want to make is 
that the fiscal problems that the country faces are unlike any 
other that we have faced in the past. We will likely have to 
find a new way to deal with them. The notion that Federal 
spending can be held to a post-war norm of 19 percent of GDP I 
think seems virtually impossible to maintain without either 
severely cutting the major entitlement programs or completely 
eliminating the rest of the government.
    Basically, the short answer is you can't get there with 
spending cuts alone, although cuts in wasteful, fraudulent, or 
abusive spending, of course, are always welcome. In future 
years, the charts that were up over here showed that spending 
on Social Security, Medicare, and Medicaid alone will exceed 19 
percent of GDP, which has been the post-war average for all of 
government.
    So I think it was the CBO director who said you do not face 
an easy task. I certainly agree with that. The one point to 
add, though, is that just because spending is bigger than taxes 
doesn't mean that spending is too high; it could mean that 
spending is providing the benefits that the American public 
wants and, therefore, we need to raise taxes. In any case, that 
is your decision. But the unpleasant implication of all of 
these findings that a long-term resolution of these issues will 
either have to destroy the role of the Federal government in 
American society or it will have to anticipate significant 
increases in tax revenues as a share of the economy.
    Thank you very much.
    [The prepared statement of Mr. Gale follows:]

   Prepared Statement of William G. Gale, Brookings Institution, Tax 
                             Policy Center

    Chairman Nussle, Mr. Spratt, and members of the committee, thank 
you for inviting me to testify today. It is always an honor to appear 
before this committee. My testimony focuses on five main points.
    First, the conventional wisdom is accurate: The United States faces 
substantial projected fiscal deficits in the coming decades. A big part 
of the reason why is that increasing life spans, the retirement of the 
baby boom generation, and changes in health care technology will 
generate persistent increases in spending on Social Security, Medicare, 
and Medicaid that far outstrip the rate of growth of the economy.
    Second, there is another big part of the problem: namely, the 
sunsets that are in the tax code. If all of those sunsets were removed, 
revenue would fall by 2.4 percent of GDP on a permanent basis. If, in 
addition, the alternative minimum tax is reduced so that only 3 percent 
of taxpayers stayed on it--about the current level--revenues would fall 
by about 2.7 percent of GDP.
    These prospective revenue losses are huge. They are more than three 
times as large as the 75-year actuarial deficit in Social Security, 
expressed as a share of GDP. They exceed the 75-year actuarial deficit 
in the Social Security and Medicare Trust Funds. They are larger than 
the permanent deficit in Social Security.
    These facts imply that the aggressive tax-cutting agenda that the 
administration has pursued the last few years deserves equal billing 
with Social Security and Medicare as ``the real fiscal danger.'' They 
also imply that the decisions you make about extending the tax cuts, 
about removing the sunsets, have long-term fiscal implications that are 
greater than those that arise from fixing the entire Social Security 
problem.
    Third, there is no hidden pot of gold waiting for us in future 
revenue from tax-deferred retirement accounts. Recent press reports 
have grossly overstated the impact of research undertaken by Stanford 
University professor, Michael Boskin. The press reports and some 
aspects of Boskin's paper suggest that future revenues from tax-
deferred saving plans are (i) omitted in fiscal gap calculations, (ii) 
large enough to eliminate most or all of the fiscal gap, and (iii) 
likely to raise $12 trillion in revenues through 2040.
    These suggestions are flawed. In fact, the underlying fiscal gap 
calculations already contain almost all of the projected revenues. As a 
result, adjusting the conventional estimates for the difference between 
Boskin's projections and the projections that are built in to the 
fiscal gap estimates has trivial effects on the estimated long-term 
fiscal gap and on estimated future budget deficits. Nor are we ever 
likely to see $12 trillion in net revenues from tax-deferred retirement 
accounts. After adjusting Boskin's estimates for reasonable parameter 
values, an error in the computer code, and proper treatment of interest 
payments, the revenue effect will be either close to zero or possibly 
negative.
    Fourth, the economic effects of persistent budget deficits are 
gradual but they are debilitating nonetheless. The real problem created 
by budget deficits is that they reduce national saving, which in turn 
reduces the assets owned by Americans and hence reduces future national 
income. These effects can be sizable, especially in the long-term. 
Conventional estimates, based on models developed by the CEA Chair 
Gregory Mankiw, indicate that the decline in the fiscal outlook since 
January 2001 has reduced GDP by at least 1 percent in 2012 and national 
income per household by $2,300 in 2012. These effects will persist over 
time. To put it differently, controlling the deficit is a pro-growth 
policy.
    Much of the public debate focuses on how deficits affect interest 
rates. The impact on interest rates can be an important channel through 
which deficits matter. But the debate about interest rates is--or 
should be--considered a sideshow. Persistent deficits reduce national 
saving and therefore hurt the economy even if they do not affect 
interest rates. regardless of whether interest rates rise. Nor does it 
matter if the deficit is completely financed by capital inflows. For 
example, even if capital flows in to offset the deficit, that only 
implies that domestic production does not fall. But since Americans 
would own fewer claims on that production, since they borrowed from 
abroad, their income would still fall.
    Fifth, the fiscal problems the country faces are unlike any other 
the country has faced in their origin and nature. We will likely have 
to find a new way of dealing with them. The notion that Federal 
spending can be held to its post-World War II norm of about 18 or 19 
percent of GDP seems virtually impossible to maintain without severely 
cutting the major entitlement programs or eliminating the rest of 
government. In future years, spending on Social Security, Medicare, and 
Medicaid alone is anticipated to exceed 19 percent of GDP. The 
unpleasant implication is that a long-term resolution of these issues 
that does not destroy the role of the Federal government in American 
society will have to include significant increases in tax revenues as a 
share of the economy.
    The comments above are documented and elaborated in several recent 
papers, which are attached to the submitted testimony. The papers 
include:
    Alan J. Auerbach, William G. Gale, and Peter R. Orszag. 
``Reassessing the Fiscal Gap: Why Tax-Deferred Saving Will Not Solve 
the Problem.'' Tax Notes. July 28, 2003. Forthcoming. Available 
athttp://www.brookings.edu/views/papers/orszag/20030714.htm.
    William G. Gale and Peter R. Orszag. ``Fiscal Policy and Economic 
Growth: A Simple Framework.'' Tax Notes. February 3, 2003. Available at 
http://www.taxpolicycenter.org/ research/author.cfm?PubID=1000450.
    William G. Gale and Peter R. Orszag. ``The Real Fiscal Danger.'' 
Tax Notes. April 21, 2003.
    Available at http://www.brook.edu/views/articles/gale/20030421.htm.
    William G. Gale and Peter R. Orszag. ``Sunsets in the Tax Code.'' 
Tax Notes. June 9, 2003.
    Available at http://www.brook.edu/views/articles/gale/20030609.htm.

    Note.--Arjay and Frances Fearing Miller Chair and Deputy Director, 
Economic Studies Program, Brookings Institution; and Co-Director, Tax 
Policy Center. Much of this testimony is based on collaborative work 
with Alan Auerbach and Peter Orszag. All errors and omissions are my 
own responsibility and should not be attributed to any other individual 
or organization.

    Chairman Nussle. Mr. Spratt.
    Mr. Spratt. Thank you, Mr. Chairman.
    Mr. Gale, I have to leave to go testify at another hearing, 
and I simply wanted to thank you for coming and put one 
question to you, which is the overarching question of this 
hearing. Given what you have just laid out, given what we know 
about long-term costs, about the effects of tax cuts, as well, 
what should we do with respect to the budget to at least ensure 
awareness that decisions like big tax cuts or big entitlement 
increases are reflected in our decision making? Or should we go 
even further and formally factor into the budget its 
compilation and its presentation, some kind of accrual of these 
known expenses in the out years, including the big tax 
reductions as well as big entitlement programs?
    Mr. Gale. I have gone full circle on what the right sort of 
budget rule set of responses are. Two years ago if you had 
asked me, I would have laid out a very detailed, complete set 
of rules that I thought would solve every imaginable problem. 
And then over the past 2 years those rules would have fallen by 
the wayside. I think there are two problems. One is that 
government finances are complicated. There is just not a simple 
way to summarize the activities of the Federal government, 
which is a fifth of the entire economy. And the second issue is 
that rules can be broken. And so we want a rule that is simple 
enough to understand, but strong enough to resist maneuvers to 
evade the rules. It is very difficult to come up with a single 
set of rules, I think, that solves all those problems.
    So what I think currently, and I hope that my thinking will 
continue to evolve on these issues as I learn more, is that we 
need different information for different purposes. It is very 
unlikely that one single budget is going to provide everybody's 
answers to every question. For example, we need the cash flow 
budget simply to keep track of what the government is actually 
spending and what the government is actually bringing in. We 
need the CBO baseline to mark what are actually legislative 
changes and what are not changes. But neither of those provides 
an accurate picture of the financial status of the Federal 
government, so we need a variety of supplemental budgets as 
well, including budgets that project out, for example, the 
elimination of expiring tax provisions. For reasons that are 
unknown to me, the budget assumes that temporary spending 
provisions are extended, but temporary tax provisions are 
allowed to expire. It would make more sense to make those 
things consistent, and, given past history, it makes more sense 
to assume the budget score, the revenue score, that temporary 
provisions are either treated as permanent or, if they are 
treated as temporary, then they need 60 votes or something in 
the Senate, maybe in the House 60 percent, to overcome an 
extension of that provision.
    So I think there are a variety of particular rules that 
would help, and there are a variety of particular budget 
presentations that would help, but there is no silver bullet 
other than eternal vigilance by Congress.
    Mr. Spratt. Thank you very much.
    Chairman Nussle. Thank you.
    I just have a few questions. First is does the tax burden 
by the Federal government, State government, local government, 
does tax burden affect the economy?
    Mr. Gale. The short answer is yes. The broader question is 
does the burden of government affect the economy, and the 
answer is yes, as well as saying that the benefits of 
government affect the economy too.
    Chairman Nussle. Yes. Well, let me ask. Does the tax burden 
affect GDP?
    Mr. Gale. Sure. Both the level of taxes and the composition 
and the incentives created by taxes have effects, both positive 
and negative, on GDP.
    Chairman Nussle. As part of GDP, will it affect component 
parts such as employment?
    Mr. Gale. Certainly.
    Chairman Nussle. Productivity?
    Mr. Gale. Absolutely.
    Chairman Nussle. Does increasing the tax burden have an 
effect on GDP?
    Mr. Gale. Absolutely.
    Chairman Nussle. Unemployment?
    Mr. Gale. Or employment.
    Chairman Nussle. Or employment.
    Mr. Gale. Again, both the level and the composition of 
taxes will affect the economy. Something that raises revenues, 
but does it in a way that closes loopholes, will probably have 
an overall beneficial effect on the economy. Something that 
cuts revenues, but does it by increasing loopholes, will 
probably have a negative effect on the economy. So both the 
level and the structure of the tax system matter.
    Chairman Nussle. Does reducing taxes have an effect on the 
economy?
    Mr. Gale. Absolutely.
    Chairman Nussle. I understand you are looking at me kind of 
like why are you asking me these simple questions, but you 
might be considered an adverse witness when it comes to some of 
those basic concepts about what taxes do to the economy. So, 
before we talk about how much the government has to do and what 
our obligations are, and anything else, I mean, the bottom line 
is that the government can impact the economy in either a 
negative way or a positive way depending on the size of the tax 
burden.
    Mr. Gale. Right. Not just the size, but also the 
incentives. So, for example, the 2001 tax cut did a couple 
things. Think of it broadly as cutting marginal tax rates and 
increasing the budget deficit. Increasing the budget deficit 
reduces national saving and reduces future national income. 
Cutting marginal tax rates generally will help increase, to 
some extent, labor supply, saving, entrepreneurship, etc. The 
net effect of the tax cut is the sum of the generally positive 
incentive effects and the generally negative budget deficit 
national saving effects. And so estimates have suggested that, 
at least over the long run, the budget deficit effects outweigh 
the incentive effects, so you get a small negative impact.
    Chairman Nussle. Long run?
    Mr. Gale. Long run.
    Chairman Nussle. Right. If nothing is done.
    Mr. Gale. If the tax cut is implemented as legislated.
    Chairman Nussle. But if nothing is done, long run.
    Mr. Gale. No, no. If you implement the tax cut and let it 
go forward and extend it, you know, remove the sunsets, 
estimates suggest that that alone will reduce long-term GDP 
growth.
    Chairman Nussle. That alone, absent any other activities.
    Mr. Gale. Right.
    Chairman Nussle. Right. OK.
    Mr. Gale. Right.
    Chairman Nussle. But if there are other activities, such as 
maybe contracting the size of the government, contracting the 
obligations on the spending side, that could also have an 
impact in the same way.
    Mr. Gale. Oh, that is true, but contracting the government 
would have that effect regardless of whether you had the tax 
cut or not.
    Chairman Nussle. Wouldn't interest rates also have a pretty 
dramatic impact on that? I mean, obviously interest rates being 
low now is a far better situation for a borrower than if they 
were high.
    Mr. Gale. It is true for a borrower it is better. For 
someone who is getting interest income and living off it, it is 
not so good to have low interest rates.
    Chairman Nussle. Right. But they may also be investing in 
other vehicles other than just a bond that tracks to the 
interest rates. So, I mean, I understand what you are saying. I 
think this is pretty basic, but there are some who don't 
believe it at all.
    The other thing I wanted to ask, because it came up before, 
when government reduces your taxes, just take yourself 
personally, what happens? I mean, let me lead you in the 
direction and you tell me if I am wrong. Don't you keep more 
money? Assuming you don't change, you haven't reduced your 
salary. Let us assume Brookings keeps paying you a similar 
amount, maybe they even give you an increase. But the bottom 
line is that if I don't take as much from you, you get to keep 
a little bit more, right?
    Mr. Gale. That is correct.
    Chairman Nussle. So there is more money in your pocket, 
right?
    Mr. Gale. Right.
    Chairman Nussle. Did the government borrow money in order 
for you to keep more of your money?
    Mr. Gale. Essentially, yes.
    Chairman Nussle. How did that happen? Did I borrow money 
and then give it to you so you could keep it in your pocket?
    Mr. Gale. No.
    Chairman Nussle. No. You got that from Brookings. Now, let 
me get to the other part.
    Mr. Gale. OK.
    Chairman Nussle. Did I borrow money to spend? Yes. Did I 
borrow money because there wasn't enough revenue? Yes. Did I 
borrow money because we had more obligations on the spending 
side? Yes. But I didn't borrow any money so that you would be 
able to keep more money from Brookings.
    Mr. Gale. I think Doug Holtz-Eakin's answer about the 
accounting is the one I am going to give.
    Chairman Nussle. No, no, no. I want your answer.
    Mr. Gale. Well, I am going to give you the same answer, 
which is that the deficit is the difference between taxes and 
spending.
    Chairman Nussle. Oh, I understand that.
    Mr. Gale. If you reduce taxes, the deficit goes up.
    Chairman Nussle. I understand that.
    Mr. Gale. It is sort of like asking which side of the 
scissor does the cutting. You know, it is just an accounting 
identity.
    Chairman Nussle. That is true in Washington, what side of 
the scissor does the cutting. I am talking about you now, and I 
am talking about any other taxpayer. Let me finish. I will give 
you an opportunity. Let me finish.
    Mr. Gale. OK.
    Chairman Nussle. If Brookings pays you the same amount of 
money and I reduce the amount of money you are sending to me, 
how did you get that money, was it borrowed from the 
government? No. It was given to you by the Brookings Institute 
for the value of the occupation, the value of the services that 
you provided to Brookings. Isn't that correct?
    Mr. Gale. In some literal sense, yes; in any realistic 
economic sense, no.
    Chairman Nussle. Who did you get your money from?
    Mr. Gale. The value of thinking about this as an economic 
perspective is that it forces you to add up all the various 
parts, and you can look at the effect on me directly, the tax 
cut will have a direct effect on my after-tax income, but it 
will also have effects that ripple through the economy that 
then affect the prices that I pay for things, and the interest 
rate that I pay to borrow, and the burdens that are placed on 
my children, etc. So, I mean, it is almost like at the level at 
which your statement was right, I could say, well, no, 
Brookings doesn't pay me, the payroll company pays me, because 
they are the one that send the check. Alright? But in an 
economic sense the government is reducing its revenue, but 
holds its spending constant, it is therefore borrowing more 
and, therefore, the money that is coming to me is being 
financed by the increase in borrowing.
    Chairman Nussle. I understand what you are saying, and this 
is, I suppose, and the way you are answering it particularly as 
an economist, a chicken or egg kind of a theory, what comes 
first. But from my perspective what comes first is you in your 
job. I mean, I don't get to take any money from you at all, 
period, if you don't have a job, do I?
    Mr. Gale. That is correct.
    Chairman Nussle. Well, that is, I guess, the point, is that 
what comes first to me, and why I said in Mr. Cooper, with his 
two degrees from wherever he got them from in the economist, 
and that is great, I respect that greatly, I respect your 
degrees, but my point is in the economic model that starts this 
whole thing going, if you don't get a job so that you can make 
money, so that I can take some of it to come out here and 
complete the rest of the transaction, it doesn't work.
    Mr. Gale. It is fair enough to say that ultimately the 
issue is the economy and that the right debate to have is what 
is the best way to have a healthy economy.
    Chairman Nussle. Thank you.
    Mr. Scott. Sorry to take so much time.
    Mr. Scott. No problem.
    Thank you, Mr. Gale. I had a little problem, as you did, 
trying to follow the logic. Let me ask you another question. 
Did Federal government borrowing increase as a direct result of 
the tax cuts?
    Mr. Gale. Absolutely.
    Mr. Scott. Thank you.
    I put back up the chart that I started off with to respond 
to my friend from Connecticut who was blaming this side of the 
isle for spending increases and projections. I just want to 
remind everyone that on that chart Democrats voted against the 
red and for the green. Democrats voted for the green and 
against the red. So that was our plan. The green is the 
Democratic plan; the red is the Republican plan.
    Chairman Nussle. Would the gentleman yield on that? Can I 
just ask a basic question?
    Mr. Scott. Yes..
    Chairman Nussle. We will check the record, but have you 
voted for any appropriation bills yet this year?
    Mr. Scott. I have voted for appropriations. I have proposed 
spending. But the fact that those who voted for the red part of 
the budget does not disqualify me from participating in helping 
to the priorities of the government. But I remind you that when 
we were in control and President Clinton was providing the 
leadership, you look at the chart, the green.
    Mr. Schrock. Would the gentleman yield?
    Mr. Scott. I will yield.
    Mr. Schrock. And I appreciate it, because I realize there 
are more Republicans in this room, so we are not looking to 
gang up here.
    Chairman Nussle. He can take us all on, trust me.
    Mr. Schrock. I know that. But I wanted to give the 
impression that he couldn't. But when I look at the Reagan-Bush 
years, I do remember the Democrats were in control during some 
of those times, and they were Democrat budgets, and the 
deficits were going up. And I kind of look at the Clinton years 
with Republicans and say, you know, we kind of were the ones 
encouraging that we get our country balanced again. So I kind 
of then say maybe we are both kind of mixed up in it. So I 
wasn't putting all the blame on the Democrats.
    Mr. Scott. Well, let me just say that, if you look at the 
budgets, the overwhelming number of votes on the red came from 
the Republican side. And when the Clinton administration was 
controlling the budget, essentially it was the Clinton budget. 
The first 2 years he had a Democratic Congress; the next 2 
years he had the veto trillion dollar tax cut several times, in 
fact, vetoed those tax cuts in the face of a threat to close 
down the government. The government was shut down, he vetoed 
them again.
    Mr. Schrock. He vetoed our spending budgets.
    Mr. Scott. He vetoed your budgets. He vetoed your tax cuts. 
You went in with a trillion dollar tax cut; he said no; you 
closed down the government and he vetoed it anyway.
    And then the difference in the red under Bush II is that 
you passed the trillion dollar tax cut and he actually signed 
it. Look what happened.
    Mr. Schrock. Would the gentleman yield one more time? And 
then I will not interrupt him again.
    Mr. Scott. I will yield.
    Mr. Schrock. We had a shutdown in December; they were on 
four appropriations budgets. They weren't on any tax bill, they 
were on appropriations. And the president vetoed them because 
he said we weren't spending enough. And the only way that we 
were able to get an agreement was that we spent more.
    Mr. Scott. I think if you look at the Clinton years, 
President Clinton controlled the budget process and you got 
green. As soon as Bush could sign some of the budgets, you got 
red.
    And let me get to some other questions I had.
    Mr. Gale, you are familiar with what happened after the tax 
cuts were enacted: the job situation collapsed. And I think we 
had a little trouble following the actual projections.
    This is a chart showing the Joint Committee on Taxation 
projection of what happens if you pass the 2003 tax cut, that 
you have a little short-term spike in jobs, but long-term the 
best you can hope for is that you come out even. Most of the 
projections and models show that you can end up worse than you 
started as a direct result of passing the tax cut. Is that 
right?
    Mr. Gale. That is right.
    Mr. Scott. Now, some tax cuts are better than others in 
terms of stimulating the economy. Based on the ones we had, 
passage of the 2003 tax cut was a long-term job killer, is that 
right?
    Mr. Gale. That is certainly what the JCT study found in its 
analysis of dynamic scoring.
    Mr. Scott. And that has a Republican majority.
    Now, we heard from the previous speaker the Medicare next 
10 years, second 10 years, going at a trillion dollars; 
interest in the national debt $500 billion a year; we have got 
obvious sunsets that are going to be removed; ATM fixes and 
whatnot will be hundreds of billions of dollars; and we saw the 
Social Security trust fund with a massive shortfall. Is there 
any credible expectation that we can pay Social Security in the 
future without a fundamental change in direction?
    Mr. Gale. Something has to give. We can dispute the basic 
long-term figures about how big each of these components are, 
how big the total is, but it is evident that we are on a path 
right now that is unsustainable. How that gets resolved is up 
to you all, obviously, but something has to give, yes.
    Mr. Scott. Unsustainable means you can't continue 
increasing the interest on the national debt and cutting taxes 
the way the taxes have been cut. With those lines going the way 
they are going, you can't credibly expect to be able to pay 
Social Security and Medicare in the future without a 
fundamental change in direction.
    Mr. Gale. That is right. Either you will have to impose 
very large cuts in the entitlement programs or essentially 
eliminate the rest of government, the discretionary side, or 
raise tax revenues by a significant amount. But there is no 
other way out. It is possible conceptually that we could grow 
out of the problem, but no one has any idea how to stimulate 
the incredibly massive amount of growth that we would need to 
actually grow out.
    Mr. Scott. Well, let us get a couple of number on the 
table. The on-budget deficit this year is about $600 billion, 
is that right?
    Mr. Gale. The on-budget.
    Mr. Scott. On-budget deficit.
    Mr. Gale. I think, roughly speaking, that is right, yes.
    Mr. Scott. What we get from the individual income tax every 
year is about $800 billion.
    Mr. Gale. That sounds right. It might be a little more.
    Mr. Scott. I have been told $790 billion.
    Mr. Gale. OK, a little less.
    Mr. Scott. About $800 billion. So that is how far out of 
balance we are.
    Mr. Gale. Right.
    Mr. Scott. That wasn't a question, Mr. Chairman, that was a 
statement. I appreciate the witness.
    Mr. Gale. Just briefly, the long-term fiscal imbalance that 
I have estimated and that other people have estimated is 
roughly 7 percent of GDP. That is about a third of Federal 
spending. So basically you either need to cut spending by a 
third or raise taxes by a third to bring the situation back 
into long-term balance.
    Now, again, the exact number is subject to debate, but 
whether it is a fifth or a third or a half, it is a monstrous 
adjustment in the public sector.
    Chairman Nussle. Thank you.
    Mr. Shays.
    Mr. Shays. The scary thing is when the chairman was asking 
questions about taxes in your income, I actually understood 
him. And I know the point he was making; I thought he made it 
brilliantly, frankly. Would you advocate increasing taxes equal 
to the deficit?
    Mr. Gale. Currently? Which deficit, the current deficit or 
the long-term deficit?
    Mr. Shays. No, no, the short-term. Next year. The deficit 
is whatever it is going to be, $450 billion, $500 billion. 
Should we increase taxes $500 billion to eliminate the deficit?
    Mr. Gale. Let me answer that in two parts, alright? And I 
will take your ``Profiles in Courage'' challenge here.
    Mr. Shays. I mean, isn't the simple answer obviously not?
    Mr. Gale. No. The simple answer is not obviously not.
    Mr. Shays. OK.
    Mr. Gale. The deficits that matter for the long-term status 
of the economy are the long-term budget deficits. If we had a 
deficit of $450 billion this year, and then we had surpluses as 
far as the eye could see, no one would care about this year's 
deficit. So it is not this year's deficit that is the long run 
threat. The long run threat, again, is the termites in the 
woodwork gnawing away gradually at the economic infrastructure. 
That is the deficit problem that needs the most attention. And 
that is the deficit problem that could be fixed with a 
significant increase in the long-term share of taxes as part of 
the economy, that is, by long-term tax increases, and I think 
that that is an issue that has to be on the table.
    The current deficit actually helps stimulate the economy in 
the short run for the same reason it hurts in the long run. 
There is a difference between stimulus and growth. Stimulus is 
like drinking a can of Coke, it gives you a big sugar and 
caffeine rush, and you can get more out of your existing body; 
you can get more energy out of your existing body. Growth is 
strengthening your muscles and bones, and building a better 
body. OK? So the short-term deficits right now are sort of No-
Doze for the economy, if you will, but, as you know, if you 
take No-Doze long enough, you are in pretty bad shape.
    And so I don't know that we have to eliminate the short-
term deficit this year. I wouldn't particularly advocate that. 
I would suggest that it is not a wise idea to continue digging 
the hole deeper.
    Mr. Shays. So the real issue is how quickly does the 
economy grow. And the reason why you wouldn't increase taxes a 
lot this year, as you know, it would have a tremendously 
harmful effect on the economy. And what you know as an 
economist is that even if we did not have a tax cut, we would 
still have a deficit of $275 billion, with no tax cut. I mean, 
that is a fact, true?
    Mr. Gale. I think that is right, yes.
    Mr. Shays. So your lesson to me is this economy better 
grow, or else we are going to have a big problem; and there you 
and I agree. And so then the next issue is you would be saying 
to us that what we have done is not going to encourage growth; 
and if you are right, then we have got a big problem. And time 
will tell whether we are encouraging growth, and that is the 
issue that I am interested in right now.
    Mr. Gale. Well, time will tell, that is true. On the other 
hand, after a great brouhaha about introducing dynamic scoring, 
the JTC finally did dynamic scoring and showed that the ``Jobs 
and Growth Act'' will have a negative effect on jobs and growth 
in the long run, and the reason is the way you stimulate the 
economy in the short run is very different from the way you 
make the economy grow in the long run. In the short run, with 
the huge amounts of excess capacity and businesses not wanting 
to invest because there is no aggregate demand out there, the 
way you get the economy stimulated is to boost aggregate 
demand; and one way to do that is to run budget deficits. In 
the long run, you need to increase the capacity of the economy, 
and that is where the negative effects of budget deficits come 
in, because they sap capital from the private sector. So in the 
long run sustained deficits are going to hurt the economy, and 
that is why we need to raise taxes, in the long run, to reduce 
the negative effect on the capital stock.
    Mr. Shays. Yes, but in the long run, as we have looked at 
our charts and as you have seen, it is the rising spending 
burden.
    Mr. Gale. Well, again, this is the two sides of the 
scissors. Just to say that spending is bigger than taxes 
doesn't mean that spending is too high.
    Mr. Shays. May I finish my point?
    Mr. Gale. Certainly.
    Mr. Shays. And then you make your point. You interrupted me 
and I wasn't able to make my point.
    Mr. Gale. Sorry.
    Mr. Shays. And my point was very simply that you are so 
focused on the taxes, and I am intrigued with why, when you 
look at the per capita spending of Americans going up to almost 
$6,500, why you don't think that will have a negative impact on 
the growth of our economy. And when you see Medicare, Medicaid, 
and Social Security growing at the rates they are going to 
grow, that scares the heck out of me, and you haven't counseled 
us at all on finding ways to slow the growth of them; you have 
solely focused on taxes. And I would have a lot easier time 
accepting your argument if the entitlements were part of your 
message, and I am curious why they aren't.
    Mr. Gale. I certainly did not mean to imply that 
entitlements are not part of the issue. I think the first thing 
I said was the conventional wisdom is accurate: the United 
States faces substantial projected fiscal deficits in the 
coming decades. A big part of the reason why is that increasing 
life spans, retirement of the baby boom, and changes in health 
care technology will generate persistent increases in spending 
on Social Security and Medicare.
    Mr. Shays. And then the rest of your whole dialogue has 
totally been on taxes. The whole dialogue.
    Mr. Gale. Well, the effort here is to provide value added. 
I think you have already heard endless times that Social 
Security, Medicare, and Medicaid are part of the problem. One 
of my points was to say that the tax issues that we discuss 
everyday are very large relative to the long-term issues that 
we always talk about.
    Mr. Shays. I just conclude by saying, Mr. Chairman, that I 
don't really think we heard that even from the previous 
speaker, at least in the response to questions.
    But I am not going to argue with your basic point, that 
there has to be some limit to the amount of tax cuts you can 
have, but in the same way there is some limit to the amount of 
tax increases you can have as well. And I thank you, I think 
you have been a very interesting witness. Thank you very much.
    Mr. Gale. OK, thanks.
    Chairman Nussle. Mr. Diaz-Balart.
    Mr. Diaz-Balart. Thank you, Mr. Chairman.
    You obviously are concerned about deficits, as I am. Would 
it be a fair statement that if I had a proposal to increase, I 
don't know, the long-term deficit by a trillion dollars, you 
wouldn't be really keen on that, right? I mean, I should 
probably not file that legislation?
    Mr. Gale. Again, it depends on what you are doing with the 
money. Deficits, per se, are not good or bad. Let me take that 
back. Policies that create deficits, per se, are not good or 
bad; they have two sets of effects. One is their direct effect 
on the economy and the second is that their indirect effect via 
increasing the budget deficit.
    Mr. Diaz-Balart. I understand that. But you just spent a 
long time now talking about, and I, frankly, in some ways agree 
with you, concern about the deficits. So now is there a caveat 
as to the deficit not being bad?
    Mr. Gale. No, no, no, no.
    Mr. Diaz-Balart. Alright. My question is, if I had a bill 
that increased the deficit by a trillion dollars, or let us say 
it is less, let us say it is $500 billion, to increase the 
deficit, you don't think that would be a really good idea.
    Mr. Gale. I would say that aspect of the bill would have 
negative long-term economic repercussions, but the overall 
effect of the bill would depend on the direct effect, which you 
haven't told me about, plus the indirect effect.
    Mr. Diaz-Balart. Of course. You have been focusing on the 
deficit, and I think we need to focus on the deficit, and I 
think the majority party is clearly focusing on the deficit. 
One of my concerns is that the minority, and they have the 
right to do so, their proposals increase the deficit by almost 
$900 billion. And if we are concerned by the deficit, which, by 
the way, you don't have to be, but if we are concerned about 
the deficit, as I am, I think clearly an increase of almost a 
trillion dollars a long-term in the deficit is problematic, and 
I think no ifs, ands, or buts, whether we do good things to 
increase the deficit by another trillion dollars. I am not 
talking about the deficit that you are concerned about, I am 
talking about that plus another trillion dollars. I think we 
could all agree that that would be problematic.
    But one of the things that you mentioned a little while 
ago, which I thought that I agree with you, was your concern 
about obviously cutting waste whenever you can. And so I 
imagine that you would support cutting waste whenever that is 
possible. You mentioned that, is that correct? I want to make 
sure I am not putting words in your mouth.
    Mr. Gale. I do support cutting waste, yes.
    Mr. Diaz-Balart. Mr. Chairman, so do I, which is why I am 
always kind of in awe as to why, when our colleagues in the 
minority party, we didn't get one vote--not one vote to cut 
just 1 percent in waste, fraud, and abuse. Not one vote to cut 
waste, fraud, and abuse from members of this committee or on 
the floor from our dear friends on the Democrat side, when we 
know that waste, fraud, and abuse is rampant.
    Let me just also ask you another question.
    Could we put up chart 3? Do we have that? If not, we won't 
put it up, of course.
    Without the tax cuts, we would have another 1.8 million 
people unemployed. 1.8 million people unemployed. Forget about 
theories now. Can you tell those 1.8 million people that their 
jobs are not important and, therefore, we should have not done 
that stimulus package that the President and the Congress 
passed? Do you think if you were one of those 1.8 million 
people and we couldn't be talking about whether your salary was 
paid for by, in theory, if you were one of those, do you think 
it would be OK to just say we shouldn't have done it? Can you 
look at those American hard working people and tell them that 
the policies were not worth it because their jobs are not that 
important?
    Mr. Gale. I would say two things. One is I don't know where 
the 1.8 million number comes from. The numbers I have seen in 
the calculations I have done are substantially smaller than 
that.
    Mr. Diaz-Balart. Can you tell those people that have gotten 
their jobs that their jobs are not important?
    Mr. Gale. Let me finish.
    Mr. Diaz-Balart. If you would answer my question. I would 
like you to answer my question.
    Mr. Gale. Yes. I am trying.
    Mr. Diaz-Balart. My question is can you tell them that 
their jobs are not important and that we shouldn't have done 
that.
    Chairman Nussle. Let us let the witness answer.
    Mr. Gale. What I would tell them is their job is important, 
and that we could have gotten those jobs in a much less 
expensive, less regressive manner than the tax cuts that we 
passed the last 3 years. Every study of the short-term effects, 
stimulus effects, suggests that tax cuts that were aimed lower 
in the income distribution and aid that had gone to the States 
would have provided bang for the buck, that is, jobs per dollar 
cost, that is substantially larger than large-scale tax cuts 
for high income households. And, you know, you can look at 
virtually any of the major consulting firms that are out there, 
any of the logic of the major macro economic models will tell 
you that. So it is not a matter of anyone being opposed to 1.8 
million people getting jobs; it is a matter of the fact that 
the way we got those 1.8 million jobs imposes unnecessary 
burdens on my children, all of our children, and imposes or 
creates a distribution of after-tax income that I think a lot 
of people don't think is fair.
    Mr. Diaz-Balart. And thank you again for your testimony. My 
final point is that what I have learned, I have a sister-in-law 
who is an economist, and she has always told me that they can 
pretty much confuse relatively simple issues. What we have 
heard today is that deficits are a huge problem, and yet when 
the minority wants to increase the deficit by a trillion 
dollars, $900 billion, to be correct, $890 billion, it looks 
like the problem is not the deficit, it is who proposes the 
deficit. And then when we hear that jobs are important, but if 
a Republican proposal created the jobs, that seems to be a 
problem. As far as I am concerned, there is 1.8 million people 
that have jobs that wouldn't have it. I cannot look at those 
people in the face and tell them their jobs are not important.
    Mr. Scott. Mr. Chairman. Mr. Chairman.
    Chairman Nussle. The gentleman from Virginia.
    Mr. Scott. Would the gentleman yield?
    Mr. Diaz-Balart. With pleasure.
    Chairman Nussle. He doesn't have the time.
    Mr. Scott. Could I make a comment just very briefly?
    Chairman Nussle. If you do it briefly. Then I need to 
recognize Mr. Hensarling.
    Mr. Scott. Thank you. I would point out that this chart 
ends at 2003, and perhaps the witness could explain what would 
happen in a few years and who would be explaining what to who 
if this chart went out to, say, 2013, payroll jobs with and 
without the tax cuts.
    Mr. Gale. Sure. This comes back to the stimulus being the 
can of Coke; you get your sugar rush and you feel like you have 
more energy, but then it wears off and you feel more tired. The 
same thing will happen with these tax cuts; and this is even 
according to the Joint Committee on Taxation dynamic analysis, 
it is according to the Congressional Budget Office's analysis 
of the President's budget and so on. What you get in these tax 
cuts is short-run Keynesian stimuli, which then turn into long-
run drags on the economy. And the benefits of the short-run 
Keynesian stimuli are certainly there, but the point, the 
relevant critique, is that the same benefits could have been 
obtained in a less expensive, less regressive manner, and with 
lower long-term costs in terms of the feedback effects on the 
capital stock. So ultimately there are going to be fewer jobs, 
according to CBO, 10 years out because of these tax cuts.
    Chairman Nussle. Mr. Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman.
    Well, Dr. Gale, I think I have good news: I appear to be 
the last questioner of the day. Unfortunately, I missed a 
portion of your testimony, but if I read it correctly, you 
claim that tax relief is the real fiscal danger, if I read that 
correctly in your testimony.
    My review of economic history shows that in the 1980s, when 
we had significant tax relief, that we promoted real economic 
growth of 3.2 percent between 1981 and 1989, and tax revenues 
grew. During the 1960s we had significant tax relief and real 
economic growth averaged 5 percent for 7 years and tax revenues 
grew. During the 1920s we had significant tax relief and real 
economic growth averaged 4.7 percent and tax revenues grew. I 
have seen these statistics in a wide variety of economic tests, 
so my two-part question is, No. 1, do you doubt the validity of 
these facts and, if you do, do you assume that there is no 
relation to the burden of taxation and economic growth?
    Mr. Gale. I certainly do not assume that there is no 
relation between economic growth and tax policy. If I did 
assume that, about half of what I do I would no longer do.
    Let me just comment briefly on this. Think about tax cuts 
as having two sets of effects: there is the direct effect on 
the economy of the incentives that are provided and there is 
the indirect effect on the budget deficit. OK? So the direct 
effect, let us call that positive. It may not be, but let us 
call it positive. The indirect effect on the budget deficit is 
definitely negative.
    Mr. Hensarling. Well, I am sure, but since I have a limited 
amount of time, are you agreeing, then, with the facts that I 
have posited?
    Mr. Gale. No.
    Mr. Hensarling. OK, please continue.
    Mr. Gale. I am disagreeing with the interpretation of the 
facts. OK? Everyone can look up economic growth rates by 
decade. I am not disputing the data.
    Mr. Hensarling. So you are disputing the cause and effect.
    Mr. Gale. Yes.
    Mr. Hensarling. You will admit there was significant tax 
relief and that economic growth grew significantly afterwards, 
you are just debating the nexus, is that correct?
    Mr. Gale. Economic growth continued afterwards. In the 
1960s, for example, the growth rate in the 2 years before the 
tax cut was just as high as the growth rate in the years after 
the tax cut. In the 1980s, if you look at the 1980s in 
historical perspective, we did not get that much growth 
relative to other decades, it is just we had such a bad 
recession at the beginning that it felt like we did.
    Mr. Hensarling. OK. Well, as I understand it, then, you 
doubt the nexus or you doubt my interpretation of the economic 
data, but you admit some nexus between tax relief and economic 
growth.
    If I could, let me move on, since you stated that tax 
relief is the real fiscal danger.
    Mr. Gale. I think I said it deserved equal billing as the 
real fiscal danger.
    Mr. Hensarling. OK, I am sorry, I missed a portion of your 
testimony. Equal billing to what?
    Mr. Gale. With Social Security and Medicare.
    Mr. Hensarling. With Social Security and Medicare.
    We passed in the House a $350 billion economic growth 
package over 10 years, and that is contrasted with a $28.3 
trillion--trillion with a ``T,''--budget. And if I am doing my 
math correctly, $350 billion to $28.3 trillion is approximately 
1.2 percent. If we round off, doesn't that seem to suggest that 
when it comes to deficits, that 99 percent of the real fiscal 
danger is on the spending side, and not the tax relief side, 
which you have already admitted may have some connection to 
positive economic growth?
    Mr. Gale. The short answer is no. This gets back to the 
whole problem with the Federal budget in the way we account for 
various programs. The three tax cuts that have been passed 
since 2001, if they are made permanent, as the President, the 
Vice President, all the economic advisors, and all the 
congressional leaders of the Republican party in both Houses 
have suggested they want, would cost 2.3 percent of GDP in 
revenues.
    Mr. Hensarling. Forgive me for interrupting.
    Mr. Gale. The Social Security trust fund is a third of 
that.
    Mr. Hensarling. I understood your short answer was no, that 
you disagree that 99 percent of the spending is the problem. In 
the remaining time I have, since these hearings do deal with 
waste, fraud, and abuse, this committee has heard testimony 
before that HUD has spent almost 10 percent of their budget in 
payments to people who don't qualify for the program. 
Approximately 25 percent of the people who have their student 
loans under the Department of Education forgiven for disability 
actually hold full-time jobs. Approximately 10 percent of food 
stamps are issued to people who don't qualify. Approximately 30 
percent of the people who receive the earned income tax credit 
do not qualify. Might that suggest, if we are scratching the 
surface, that if we routinely are wasting 10, 20, and 30 
percent of the taxpayers' money in these government programs, 
is it not possible that waste, fraud, and abuse in Federal 
spending also represents a real fiscal danger?
    Mr. Gale. I think qualitatively the answer is yes. In terms 
of the dollar magnitudes, the answer is probably no. Ten 
percent of food stamps is a pretty small number compared to 
Social Security, Medicare, and Medicaid spending. But having 
said that, I would encourage you to root out waste, fraud, and 
abuse both on the spending side and the tax side. The tax 
evasion numbers I think are equally substantial, and all of 
that is obviously appropriate jurisdiction of government 
policy.
    Chairman Nussle. I thank the gentleman. We will be having 
that hearing in the near future on taxes and our tax code. 
Today was to talk a little bit more about the long-term 
obligations, as opposed to the tax side. But you do make a good 
point, at least in my opinion.
    Mr. Gale. Thank you very much.
    Chairman Nussle. I thank the gentleman.
    We will be having that hearing in the near future on taxes 
and the tax code. Today was to talk a little bit more about the 
long-term obligations as opposed to the tax side. You do make a 
good point, at least in my opinion, on the tax code and the 
need for reform and loophole closing. I think many of us would 
agree with that.
    This has been spirited. We appreciate it. You are a good 
sport, you always have been. We appreciate that and we 
appreciate your testimony before the committee again today.
    Mr. Gale. Thank you very much.
    Chairman Nussle. Thank you.
    If there is no other business to come before the committee, 
we will stand in adjournment.
    [Whereupon, at 12:25 p.m., the committee was adjourned, to 
reconvene at the call of the Chair.]