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



 
                        THE PRESIDENT'S BUDGET:
                            FISCAL YEAR 2005
=======================================================================



                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

            HEARING HELD IN WASHINGTON, DC, FEBRUARY 3, 2004

                               __________

                           Serial No. 108-16

                               __________

           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, February 3, 2004.................     1
Statement of:
    Joshua B. Bolten, Director, Office of Management and Budget..     8
    N. Gregory Mankiw, Chairman, Council of Economic Advisers....    12
     Peter R. Orszag, Senior Fellow, the Brookings Institution...    74
Prepared statement and additional submissions of:
    Hon. Jim Nussle, a Representative in Congress from the State 
      of Iowa:
        Prepared statement.......................................     4
        Letter from CBO..........................................    40
    Mr. Bolten:
        Prepared statement.......................................    11
        Reponses to questions for the record.....................    67
    Mr. Mankiw...................................................    14
    Hon. Adam H. Putnam, a Representative in Congress from the 
      State of Florida...........................................    65
    Hon. Lois Capps, a Representative in Congress from the State 
      of California..............................................    66
    Mr. Orszag...................................................    76














                        THE PRESIDENT'S BUDGET: 
                            FISCAL YEAR 2005

                              ----------                              


                       TUESDAY, FEBRUARY 3, 2004

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 2:14 p.m., in room 
210, Cannon House Office Building, Hon. Jim Nussle (chairman of 
the committee) presiding.
    Members present: Representatives Nussle, Shays, Gutknecht, 
Thornberry, Toomey, Hastings, Schrock, Brown, Putnam, Wicker, 
Franks, Garrett, Barrett, Hensarling, Diaz-Balart, Crenshaw, 
Tancredo, Portman, Spratt, Moran, Baldwin, Moore, Capps, 
Thompson, Baird, Emanuel, DeLauro, Ford, Scott, Cooper, 
Edwards, Majette, and Davis.
    Chairman Nussle. The Budget Committee will come to order. 
This is a hearing on the President's budget for fiscal year 
2005.
    We are very pleased again today to have before us the 
Director of the Office of Management and Budget, Josh Bolten, 
and the Honorable Gregory Mankiw, who is the Chairman of the 
Council of Economic Advisers; and I understand it is your 
birthday today, so ``happy birthday.'' Do you need a CBO score 
to determine your age or anything like that before we start?
    Mr. Mankiw. I will ask Josh about that. He is in charge of 
all the numbers.
    Chairman Nussle. Up here on the Hill we believe CBO is in 
charge of all the numbers, just so you are clear about that.
    We also have another announcement that I am pleased to make 
and this is, right, there is obviously somebody for everybody 
in the world because the staff director for the minority side, 
Tom Kahn, is engaged to be married. So congratulations. There 
is somebody for everyone, as they say, knowing Tom as well as 
we all do.
    No, we are very pleased for you and we wish you the best of 
luck as you move forward. Congratulations.
    Now we have got all of the fun out of the way, we can get 
down to some of the things we came to talk about. And I know we 
are meeting today in an air of concern, as we should be, about 
the Federal budget deficit. We are all concerned, as we move 
forward from this point, with exactly how we are going to deal 
with it.
    But I do not want to get off on the subject of deficits 
just yet because, while we are all concerned about the Federal 
budget deficit today, we are not going to shy away from some of 
the other deficits that we have out there in the country.
    When President Bush took office, we believe he had a 
security deficit in this country--a homeland security, national 
security deficit. We also believe that there was an economic 
growth deficit. In fact, he inherited a recession we had to do 
something about. Certainly it manifested itself very 
dramatically in the years after President Bush took office.
    But before we talk about only the financial situation of 
the budget, we do, I believe, have to hearken back to how we 
got to this situation and the fact that there were deliberate 
choices made by this committee on both sides with votes that we 
are glad to advertise to reduce taxes, to increase defense 
spending, and to protect the homeland and to deal with national 
emergencies that have gotten us to this situation.
    So before we start talking about where we are today, we do 
need to remember that part of how we got to this situation was 
because of other deficits that needed to be taken care of first 
in order to protect this country and make sure that people were 
working again.
    The budget that the President has proposed is not going to 
meet everybody's likes or dislikes. There is always something 
in it for everybody and there is always something in it that 
people can disagree with. The choice of this committee, as we 
move forward, is to come together and to come up with a fiscal 
blueprint that addresses the needs of our economy, that 
addresses the needs of our national security and can do it in a 
fiscally responsible way to get us back on track.
    The President has laid out an agenda of strength, of growth 
and of opportunity for the future--strength of our Nation 
because we have to be strong if we are going to be free. We 
can't be free unless America is strong, so we have got to be 
free, and we want to be strong in order to preserve that.
    Secondly, America cannot provide the opportunities for our 
future if America's economy is not growing, creating jobs, 
providing opportunities for our kids in the future; and we knew 
that whether it was the Federal budget or the budget that 
families have to balance around their kitchen table every night 
in Iowa or across the country that you need a job in order to 
get that done. And while every economic indicator is pointing 
in the correct direction right now for economic growth, there 
are still too many people out there who, tonight, around their 
kitchen table with their spouse and their kids, are trying to 
figure out how to pay their bills, because they do not have a 
job.
    So we have to maintain a continued vigilance in making sure 
the economy grows. And we want to make sure that we do not 
raise taxes in the budget that we put forward, and so that will 
also be a hallmark.
    Finally, with regard to the budget, we need to, I believe, 
control spending. It is the one port in the storm that we can 
hold on to. It is the one thing we can control.
    Numbers will go up, numbers will come down. All sorts of 
things are outside the control of this committee, but there is 
one thing that we know for sure; and that is, we can, if we 
determine that it is important enough, control spending, not 
only in the 17 percent that the appropriators like to remind me 
is the portion that seems to always get the attention, but 
across the board in defense, in homeland.
    We shouldn't be wasting one penny; one dollar should not be 
wasted in those programs. And we know that there are 
opportunities out there to make sure that those dollars are 
being spent wisely.
    So we are going to look in every nook and cranny of the 
budget in order to make sure that we can find savings, ways 
that we can root out waste, fraud, and abuse; and we are going 
to continue to be vigilant in controlling spending because, for 
us, cutting deficit in half is an important goal. In fact, I am 
unaware of anybody who has got a better goal to meet right now.
    But we know that this long journey toward cutting deficit 
in half in 5 years--while a 5-year journey can start with the 
first step today, and that is by controlling spending in this 
budget. It doesn't matter what we are projecting for next year 
if we can't cannot get our job done this year.
    So this year's budget, as we look to the future, has got 
some work cut out for it. The President has proposed, as 
Director Bolten has identified in his budget, 65 programs that 
can be eliminated, another 63 that can be reduced. There are a 
number of suggestions that are good, that we should pay heed to 
on the discretionary as well as the mandatory side.
    But as we move forward, we have to also look at ourselves 
in the mirror. We have a transportation bill coming to the 
floor here. In fact, as I understand it, the Senate, the other 
body, just passed a bill the other day that has already gotten 
a veto warning from the President. If we cannot control the 
spending this year, 5 years is somewhat of an irrelevant goal. 
We have got to do what we can right now.
    So I think the proof will be in what we are able to do now, 
not just what this budget looks like 5 years from now.
    One other thing I wanted to mention, because it has come up 
and I want to put it into the record, there has been some 
discrepancy over numbers already on Medicare and a few other 
instances, and I just want to get this out. I have had an 
opportunity to communicate with the Congressional Budget 
Office. They have sent me back a letter indicating that while 
there might be all sorts of different predictions, 
prognostications, and projections for what the budget may look 
like in the future, the Congressional Budget Office has done 
its research, has done its work on the Medicare bill. It did it 
back when it passed.
    It has taken another fresh look at it, and in its operative 
sentence here--I will read it for you--it says, ``To date, we 
have not received any additional data or studies that would 
lead us to reconsider our conclusions. Therefore, CBO believes 
its estimate is sound and has no reason at present to revise 
it.'' Medicare is going to be scored by CBO and CBO numbers are 
going to be the ones that control determining the size of the 
Medicare bill.
    Does that mean that we are not going to have to provide 
oversight to Medicare? Absolutely not. We have got to provide 
oversight to Medicare just like we should for food stamps and 
other mandatory programs that are out there. We should push in 
our other committees that we serve an effort to ensure that are 
we, as authorizers or appropriators, provide the oversight on a 
regular basis. But at least, to start with, CBO is firm on the 
fact that we have good numbers to use.
    While it is interesting that there are other people making 
predictions, those numbers are probably wrong almost the date 
that they are put out. And we are going to have to provide 
constant vigilance to make sure that that program stays within 
its means and meets the needs of seniors the way we did this 
last year when we provided a voluntary drug benefit under 
Medicare for the first time ever.
    We have got a lot of work to do, and I know that this is 
going to be a lively discussion, as it almost always is. We 
have some important work to do that begins today. But again I 
believe that the most important thing we can do this year to 
set us on the right course is to make sure this budget provides 
that America is strong, that our economy continues to grow, and 
that we have very detailed provisions to control spending now--
not just 5 years from now, but today in this budget.
    With that, I would be happy to yield to my friend, Mr. 
Spratt, for any opening comments he would like to make.
    [The prepared statement of Mr. Nussle follows:]

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

    Good afternoon, and welcome to this Budget Committee hearing 
concerning the President's budget request for fiscal year 2005 
certainly one of the most important we'll have all year.
    Today I am pleased to welcome Josh Bolten, director of the 
administration's Office of Management and Budget, and Greg Mankiw, 
chairman of the President's Council of Economic Advisors.
    Yesterday, President Bush submitted his fiscal year 2005 budget to 
Congress. And in the usual flurry of quick judgements and half-
information, some of the basic points of the administration's request 
got lost. So let's review the priorities set by this request priorities 
I believe are supported by the vast majority of Americans, and the vast 
majority of this Congress.
    They are: One, protect our homeland; two, ensure that the United 
States has the world's most superior defense; three, keep our economy 
growing and creating jobs; and four, do all of this while at the same 
time ensuring that we're getting ourselves back on the path to fiscal 
restraint and reduced deficits.
    These without question are the most urgent priorities of this 
nation, and they will certainly be the top priorities of our 
congressional budget.
    But there is one thing I can pin down for you now, and that is that 
we're going to do whatever we can to ensure the continued growth of our 
economy and of jobs for Americans. And that means that raising taxes is 
not even an option. It's off the table. Period.
    The President has proposed making permanent the tax relief, and I 
can guarantee you that we will support that in our budget.
    Now to deficits.
    We all know how we got here, but let's review now so that we don't 
have to do yet another run through later in this hearing:
    We have large deficits because we deliberately responded to the 
extraordinary set of challenges of the past few years, including 9/11 
and its aftermath, the conflicts in Iraq and Afghanistan, and the 
economic recession. We did what we had to do, and that meant borrowing 
money in order to protect the country and strengthen the economy.
    How do we get ourselves back on track?
    We've already acted on and will continue to support the first piece 
of this puzzle, and that is promoting a robust economy and job 
creation.
    However, while growth is important, it is not the only answer. We 
must also get a hold of our out-of-control spending. As I just said, we 
simply cannot continue to spend like we have been without facing major 
consequences down the road.
    The President's budget sets a plan to cut our current deficit in 
half in 5 years. Is this doable? I'd say, with a little restraint, 
absolutely.
    I'm encouraged that the President's request continues the effort 
begun in the House of Representatives last year, when we came up with a 
list of about $110 billion in wasteful spending that could be reformed, 
cut or eliminated.
    Some of those savings initiatives were included in the President's 
budget, and I think that's certainly a step in the right direction to 
get our spending, and thus the deficits, under control.
    Now, would I like, and will I look at possibilities to reduce the 
deficits further, faster? Absolutely. But again, this is a pretty good 
start.
    So today, we'll begin this process of planning our budget by 
reviewing the President's request, and we'll continue by meeting with 
several of the President's cabinet secretaries over the next month to 
get a better idea of what is included in their budget requests.
    Again, my first impression of this budget is that it's going to be 
a good foundation for Congress as we plan our own budget. I am 
certainly interested, and eager to hear more.
    Now, before I wrap this up, I'd like to make a prediction one that 
I actually hope does not come true.
    Just last week, I sat here and once again listened to some of my 
colleagues over and again claim their grave concern about the deficits. 
And I truly hope that their concerns are sincere.
    But my prediction today is that their concern about the deficits 
might have a lot more to do with rhetoric than it does with their 
actual willingness to do anything about them.
    I can just about guarantee you that you will not hear these same 
critics telling us their plans for controlling spending, but for 
increasing spending. You will also hear, though likely in slightly 
masked terms calls not for us to spend less, but for the American 
taxpayers to spend more via tax increases to finance this continued 
overspending by the Federal Government.
    So again, that's my prediction, and I can only hope that it will be 
proven 1wrong.
    With that, I'll turn it over to Mr. Spratt for his opening 
statement, and then we'll hear from OMB Director Bolten.

    Mr. Spratt. Thank you, Mr. Chairman.
    Dr. Mankiw and Mr. Bolten, welcome, both of you. We look 
forward to both of your presentations today on this critically 
important matter.
    This is the last budget that President Bush will send us 
during this term of office, and it isn't exactly playing to 
rave reviews. The lead editorial in the Washington Post today, 
``The Bush administration's 2005 budget is a masterpiece of 
disingenuous blame-shifting, dishonest budgeting and 
irresponsible governing.'' If I had said that myself, the 
chairman would have gaveled me down. It is the lead editorial 
in the Washington Post today.
    The New York Times says, ``The President's budget is an 
exercise in election year cynicism.'' So let us take a look at 
the last 4 years that this particular budget completes.
    When the President came to office in January of 2001, he 
found a budget in surplus, in surplus by $236 billion in the 
year 2000 and by $127 billion in 2001, the year he took office. 
In 3 years, from 2001-04, this administration has moved this 
surplus to a deficit by almost $650 billion. Back out the 
surplus in Social Security and the on-budget deficit for this 
year is $675 billion.
    Now the numbers are getting so big it is hard to keep them 
in relation to something that we can call ``reality.''
    Let me put it in perspective in one way. In 1980-81, when 
President Reagan took office, the national debt was $711 
billion. The sum total of all the debt that the government owed 
to the public was $711.9 billion. You will incur in your budget 
this year almost that much debt, this year alone.
    Since 2001, you have added about $533 billion to the 
national debt. Over the next 5 years, you will stack another $2 
trillion on top of that.
    Let me offer another perspective just to show that 
balancing the budget is tough, but it is feasible. It has been 
done. Our claims might otherwise be empty, but in the 1990s we 
did it. From 1993 to the year 2000, every year for 8 straight 
years during the Clinton administration, the bottom line of the 
budget got better, as this chart clearly shows. It went from 
$290 billion the last year of the first President Bush's office 
to a surplus of $236 billion in the year 2000.
    Every year of this administration, the Bush administration, 
the bottom line of the budget has gotten worse and worse and 
worse to the point where this year we will have another record 
deficit, $521 billion. It is hard to put a pretty face on these 
figures.
    You say that you are reversing course in this budget for 
2005. But in effect what you are telling us is that we are 
going to let the deficit go up by almost 50 percent this year 
and then over the next 5 years that will leave us--we are going 
to bring it down by 50 percent.
    Now, this budget purports to do that, purports to cut the 
deficit in half over 5 years, but there are a lot of problems 
with that particular claim. For starters, this budget doesn't 
capture all the spending that is likely to occur by your own 
acknowledgment in fiscal year 2005. For example, it leaves out 
the cost of deploying 125,000 troops to Iraq and 12,000 troops 
to Afghanistan. We know what the cost is. We have done it 
before. We have got cost experience, but there is no estimate 
of what that cost will be here.
    Last year's budget, by the way, left out the same cost, and 
then after the budget was passed, you sent us two bills. You 
sent us the cost of the war in two installments, $80 billion in 
April, $87 billion in October, $167 billion in supplemental 
spending.
    The President told the country just 2 weeks ago in the 
State of the Union that he would send us a budget in 2 weeks, a 
budget that, quote, ``pays for the war.'' Those were his words. 
But this budget doesn't pay for the war.
    You acknowledged, Mr. Bolten, yesterday that the cost of 
the deployments to Afghanistan and Iraq could come to as much 
as $50 billion. You said that was a ceiling, but that they 
could rise to as much as $50 billion.
    I think both of you would agree that is a major omission, 
that is a big sum of money even for government work. And I have 
to tell you, it casts doubt on the claim that you can cut the 
deficit in half over the next 5 years.
    It makes us wary of other sleight-of-hand techniques in 
this budget: revenues that you claim for ANWR when you know 
that that idea has gone around the track many times and never 
crossed the finish line; co-pays and deductibles that veterans 
must pay for prescription drugs and for enrollment in a 
veterans hospital--been around before, never made it across the 
finish line. I could go down, again and again and list things 
which have been tried before and failed because the policy did 
not meet with our approval, and yet you are relying upon these 
revenues with the purported expectation that this year they 
will pass.
    In the absence of any surplus--it is gone; surplus that we 
thought was there in 2001 was overestimated to the tune of 
about $3.5 trillion. In any event, what is left of it has been 
written off to tax cuts and spending increases, but in the face 
of these deficits, now there is no surplus anymore.
    You venture to include $1.2 trillion in additional tax cuts 
over the next 10 years, but you include almost nothing for 
fixing the Alternative Minimum Tax, even though the Treasury 
Department itself has told us that unless we fix the 
Alternative Minimum Tax, which affects about 2 to 3 million tax 
filers today, by 2010 it will affect 20 to 30 million tax 
filers. We know politically it has to be done and yet you 
request $1.2 trillion in additional tax cuts and include 
nothing for fixing the Alternative Minimum Tax other than 
indexing the exempt amount.
    Easily, the additional costs there could be $600 billion; 
and when you adjust the $1.2 billion by that $600 billion, if 
you fix the AMT and you add interest to it, because if you have 
more deficits you have got more debt service to pay, it is 
clearly a $2 trillion item on top of the budget you are 
proposing. And what you offer as an antidote for that is 
spending restraints on one-seventh of the budget, nondefense, 
discretionary domestic spending.
    Oddly enough, when you do a budget, ordinarily you look for 
the spikes in the budget--what has been going up the fastest, 
what is costing the most--and you try to bear down on them. If 
you look at these accounts, the domestic discretionary spending 
accounts, and if you back out international affairs, which is 
included, and you back out homeland security, they have barely 
grown, maybe 2 percent over the last 2 fiscal years. So what 
you are proposing is that we now reduce the rate of growth to 0 
percent or maybe a half of 1 percent and that will solve the 
problem.
    You can understand, I hope, why we are skeptical.
    We will give you a fair hearing today, but we have to tell 
you we are deeply concerned about this deficit. We are deeply 
concerned about where your budget takes us, and we are very, 
very doubtful, very, very skeptical that it puts us on the 
track toward cutting the budget in half even if that were an 
acceptable goal. I would want a more ambitious goal.
    So we will have lots of questions to ask you today. What 
are the programs that you propose to eliminate? What are the 
tax cuts? Because we share with you the object--we believe that 
these budgets are simply intolerable and cannot last over time. 
I don't think the course that you are plotting is sustainable.
    And so today there will be lots of questions. We are 
concerned that this is not a feasible goal that you have laid 
out because of the conditions you have prescribed for it. I 
have more questions about it, and that is why I am just cutting 
my statement short to get to it.
    But thank you for coming. We look forward to putting these 
questions to you. We look forward to working with you, if 
possible to work out this very, very grave problem for our 
country.
    Chairman Nussle. Thank you, Mr. Spratt.
    Mr. Bolten welcome back to the committee, and we are 
pleased your entire statement will be in the record and we are 
pleased to receive your testimony.

 STATEMENT OF JOSHUA B. BOLTEN, DIRECTOR, OFFICE OF MANAGEMENT 
                           AND BUDGET

    Mr. Bolten. Thank you, Mr. Chairman and Mr. Spratt. It is a 
pleasure to be back before the committee.
    Mr. Chairman, I particularly commend you for your statement 
reminding us if we don't adequately protect the national 
security, the homeland security, nothing else matters. And I 
also appreciate your reminding us that we can begin the 
restraint of spending immediately. That is where the 
President's budget is headed, and that is why we have presented 
the budget we have.
    The President's budget continues to support and advance his 
three top priorities: winning the war on terror, protecting the 
homeland, and strengthening the economy. The President is 
committed to spending what is necessary to provide for our 
security and restraining spending elsewhere.
    Since September 11, 2001, more than three-quarters of the 
increase in the Federal Government's discretionary spending has 
been directly related to our response to the attacks, enhancing 
homeland security, and the war on terror. The President's 2005 
budget continues this spending trend: significant increases in 
essential funding for our security programs, combined with a 
dramatic reduction in the growth of discretionary spending 
unrelated to security. With your support in enacting this 
budget into law, we will be well on the path to cutting the 
deficit in half within 5 years.
    Mr. Chairman, we find it useful to divide spending in the 
budget in the discretionary portion of the budget in the way 
that Mr. Spratt just described, which is to distinguish between 
defense, the boxes on the left, homeland security in the 
middle--which, by the way, is not congruent with the Department 
of Homeland Security. About two-thirds of the Department of 
Homeland Security is in that middle box, but they do a fair 
amount of spending that is not homeland security related; and 
there are also a number of departments that do have important 
homeland security accounts, like Health and Human Services, 
Agriculture, the Justice Department have important accounts in 
that middle group. And then finally the category of nondefense, 
nonhomeland spending, which you see on the right.
    The President's 2005 budget, as you will see in the yellow 
bars, increases spending by 7 percent to support our men and 
women in uniform and transform our military. It increases 
homeland security spending by nearly 10 percent--that is the 
yellow bar in the middle--to strengthen our capabilities 
created to prevent future attacks. And it holds the rest of 
discretionary spending to half of 1 percent--that is the yellow 
bar on the right that you can barely see--less than half the 
rate of inflation, while continuing to increase funding for key 
priorities such as the President's No Child Left Behind 
initiative.
    The President's budget is built on the sensible premise 
that government spending should grow no faster than the average 
increase in American family incomes of approximately 4 percent. 
This budget proposes to hold the growth in total discretionary 
spending to 3.9 percent and again to reduce the growth in 
nondefense, nonhomeland spending to half of 1 percent, below 
the rate of inflation.
    In the last budget year of the previous administration, 
that is, 2001--those are the green bars on the chart--
discretionary spending unrelated to homeland security soared by 
15 percent. With the adoption of the President's first budget 
in 2002, that growth rate was reduced to 6 percent and 5 
percent the following year, then 4 percent and below 1 percent 
for the President's 2005 budget presentation. The President's 
budget builds on the pro-growth economic policies that have 
laid the foundation for the economic recovery now under way and 
for sustained economic growth and job creation in the years 
ahead.
    The tax cuts that you and the Congress enacted have been 
critical to strengthening the economy and creating jobs. 
Perhaps the best time in American history, these tax cuts 
deserve much credit for today's brightening economic picture, 
which includes nine consecutive quarters of positive growth, 
the highest quarterly growth in 20 years, an 8.2 percent annual 
rate in the third quarter of this past year, extraordinary 
productivity growth, continued strength in housing starts and 
retail sales and encouraging signs of renewed business 
investment. These indicators suggest that job growth, which is 
critical, but also typically lags in recovery, should continue 
to strengthen in the months ahead.
    The President will not be satisfied, however, until every 
American who wants a job can find a job. So this budget 
supports the President's six-point plan for economic and jobs 
growth including making permanent the tax relief that has 
fueled our economic recovery.
    The sustained growth that this budget supports will be good 
news for our budget picture as well. As the economy improves, 
Treasury revenues will as well.
    Mr. Chairman, like America itself, the Federal budget has 
faced extraordinary challenges in recent years. A stock market 
collapse that began in early 2000, a recession that was fully 
under way in early 2001, revelation of corporate scandals years 
in the making, and of course, the September 11 attacks and the 
ensuing war on terror. With Treasury receipts only beginning to 
reflect a recovering economy and major ongoing expenditures in 
Iraq, Afghanistan, and elsewhere in the war on terror, we still 
face a projected deficit of $521 billion in the 2004 fiscal 
year. That size deficit, at 4.5 percent of GDP, is not 
historically out of range. Deficits have been this large or 
larger in 6 of the last 25 years, including a peak of 6 percent 
in 1983.
    Under the circumstances that created it, today's deficit is 
certainly understandable. But that deficit is also undesirable 
and unwelcomed, and with the enactment of this budget, we will 
bring it down. With continuation of the President's economic 
growth policies and sound spending restraint reflected in the 
budget that we released yesterday, our projections show the 
deficit will be cut more than half over the next 5 years. You 
can see that on the chart--our projections on the chart that is 
on the screen now.
    The dramatic reduction begins in the fiscal year of this 
budget which, Mr. Chairman, you emphasized, 2005, for which we 
are projecting a deficit of $364 billion, roughly 3 percent of 
GDP, the rapid deficit reductions continue in subsequent years 
with our projections, showing the deficit falling to 1.6 
percent of GDP by 2009. This is not only well below half its 
current 4.5 percent level, it is also well below the 2.2 
percent average deficit during the last 40 years; and the black 
line that you see going across the middle of that chart is that 
2.2 percent average deficit over the last 40 years. It is, in 
our judgment, a reasonable and desirable goal over the next 5 
years to bring ourselves well below that 40-year average 
Federal deficit.
    This deficit reduction is the combined effect of economic 
growth and spending restraint. As the economy recovers, tax 
receipts as a percent of GDP rise to historical levels by the 
end of the budget window, while spending restraint keeps 
outlays flat or slightly declining as a share of GDP. The 
spending restraint reflected in this budget is not automatic, 
so we are also proposing new statutory budget enforcement 
mechanisms, establishing in law limits on both discretionary 
and mandatory spending and requiring that any increases in 
spending be paid for by spending offsets.
    We plan to transmit legislation to the Congress that has 
three elements:
    First, to reinstate caps on discretionary spending for 5 
years, through 2009; Second, a pay-as-you-go requirement 
limited to new mandatory spending. Any proposed increase in 
mandatory spending under our proposal would have to be offset 
by a reduction in mandatory spending; tax increases could not 
be used as an offset, and pay-go would not apply to tax 
legislation. Third, measure the long-term unfunded obligations 
of major entitlement programs and propose a 60-vote hurdle in 
the Senate for legislation that would expand these obligations.
    I know that many members of this committee on both sides of 
the aisle have expressed interest in these sorts of budget 
enforcement mechanisms, and I look forward to working with you 
to gain enactment of these proposals to restrain spending.
    Finally, the President is keeping his administration 
focused on what the American people care most about, results. 
The measurement of government's success is not how much we 
spend but rather how much we accomplish. This budget includes a 
scorecard that measures the progress agencies are making in 
achieving results so that the government continues to be more 
and more accountable to the taxpayers.
    Since President Bush took office, our Nation has confronted 
a cascading set of challenges. The President and Congress 
responded on all fronts--with tax relief to get the economy 
going, the largest reorganization of the Federal Government in 
50 years to create a new Department of Homeland Security, and 
the largest increase in the defense budget since the Reagan 
administration--to wage and win the war on terror. The 
President's 2005 budget builds on this record of 
accomplishment. With renewed economic growth and the Congress' 
cooperation in restraining spending and focusing it on our most 
critical priorities, we can accomplish the great goals the 
President has set for the country while dramatically improving 
our budget situation.
    I look forward to taking your questions.
    Chairman Nussle. Thank you, Director.
    [The prepared statement of Mr. Bolten follows:]

Prepared Statement of Joshua B. Bolten, Director, Office of Management 
                               and Budget

    Chairman Nussle, Ranking Member Spratt, and distinguished members 
of the committee, the President's 2005 budget, which was transmitted to 
the Congress yesterday, continues to support and advance three 
overriding national priorities: winning the war on terror, protecting 
the homeland, and strengthening the economy.
    The President is committed to spending what is necessary to provide 
for our security--and restraining spending elsewhere. Since September 
11, 2001, more than three-quarters of the increase in the Federal 
Government's discretionary spending has been directly related to our 
response to the attacks, enhanced homeland security, and the war on 
terror. The President's 2005 budget continues this spending trend: 
significant increases in essential funding for our security programs, 
combined with a dramatic reduction in the growth of discretionary 
spending unrelated to security. With Congress' help in enacting the 
budget we transmit today, we will be well on the path to cutting the 
deficit in half within 5 years.
    The President's budget:
     Increases defense spending by 7 percent to support our men 
and women in uniform and transform our military to ensure America has 
the best trained and best equipped armed forces in the world;
     Increases homeland security spending by nearly 10 percent 
to strengthen capabilities created to prevent future attacks; and
     Holds the rest of discretionary spending to half of 1 
percent growth--less than half the rate of inflation--while continuing 
to increase funding for key priorities such as the President's No Child 
Left Behind education reforms.
    The President's budget is built on the sensible premise that 
Government spending should grow no faster than the average increase in 
American family incomes of approximately 4 percent. This budget 
proposes to hold the growth in total discretionary spending to 3.9 
percent and, again, to reduce the growth in non-defense, non-homeland 
security spending to half of 1 percent, below the rate of inflation. In 
the last budget year of the previous administration (2001), 
discretionary spending unrelated to defense or homeland security soared 
by 15 percent. With the adoption of President Bush's first budget 
(2002), that growth rate was reduced to 6 percent; then 5 percent the 
following year; and 4 percent for the current fiscal year.
    The President's budget builds on the pro-growth economic policies 
that have laid the foundation for the economic recovery now underway, 
and for sustained economic growth and job creation in the years ahead.
    The tax cuts Congress passed and were signed into law have been 
critical to achieving the President's priority of strengthening the 
economy and creating jobs. Perhaps the best timed in American history, 
these tax cuts deserve much credit for today's brightening economic 
picture, which includes:
     Nine consecutive quarters of positive growth through the 
end of 2003;
     The highest quarterly growth in 20 years--an 8.2 percent 
annual rate in the third quarter of 2003; and the highest growth for 
any 6-month period in 20 years as well;
     Extraordinary productivity growth;
     Continued strength in housing starts and retail sales; and
     Encouraging signs of renewed business investment.
    These indicators suggest that job growth, which typically lags 
recovery, should continue to strengthen in the months ahead.
    The President will not be satisfied however until every American 
who wants a job can find a job. So this budget supports the President's 
six-point plan for economic and jobs growth, including making permanent 
the tax relief that has fueled our economic recovery.
    The sustained growth that this budget supports will be good news 
for our budget picture as well: As the economy improves, Treasury 
revenues will as well.
    Like America itself, the Federal budget has faced extraordinary 
challenges in recent years: a stock market collapse that began in early 
2000; a recession that was fully underway in early 2001; revelation of 
corporate scandals years in the making; and of course, the September 11 
attacks and ensuing war on terror.
    With Treasury receipts only beginning to reflect a recovering 
economy--and major ongoing expenditures in Iraq, Afghanistan, and 
elsewhere in the war on terror--we still face a projected $521 billion 
dollar deficit for the 2004 fiscal year. That size deficit, at 4.5 
percent of GDP, is not historically out of range. Deficits have been 
this large or larger in six of the last 25 years, including a peak of 6 
percent in 1983.
    Under the circumstances that created it, today's deficit is 
certainly understandable. But that deficit is also undesirable and 
unwelcome, and with Congress' help, we will bring it down. With 
continuation of the President's economic growth policies and sound 
spending restraint as reflected in the budget we are releasing today, 
our projections show the deficit will be cut by more than half over the 
next 5 years.
    This dramatic reduction begins in the fiscal year of this budget, 
2005, for which we are projecting a deficit of $364 billion, roughly 
3.0 percent of GDP. The rapid deficit reductions continue in subsequent 
years, with our projections showing the deficit falling to 1.6 percent 
of GDP by 2009. This is not only well below half its current 4.5 
percent level, it is also well below the 2.2 percent average deficit 
during the last 40 years.
    This deficit reduction is the combined effect of economic growth 
and spending restraint. As the economy recovers, tax receipts as a 
percentage of GDP rise to historical levels by the end of the budget 
window, while spending restraint keeps outlays flat or slightly 
declining as a share of GDP.
    The spending restraint reflected in this budget is not automatic. 
So we are also proposing new statutory budget enforcement mechanisms, 
establishing in law limits on both discretionary and mandatory 
spending, and requiring that any increases in spending be paid for by 
spending offsets. We plan to transmit legislation to the Congress that 
has three elements:
     Reinstate caps on discretionary spending for 5 years 
through 2009.
     A pay-as-you-go requirement limited to new mandatory 
spending. Any proposed increase in mandatory spending would have to be 
offset by a reduction in mandatory spending. Tax increases could not be 
used as an offset and pay-go would not apply to tax legislation.
     Measure the long-term unfunded obligations of major 
entitlement programs and propose a 60 vote hurdle in the Senate for 
legislation that would expand these obligations.
    I look forward to working with this committee to gain enactment of 
these proposals to restrain spending.
    Finally, the President is keeping his administration focused on 
what the American people care about--results. The measure of 
government's success is not how much we spend, but rather how much we 
accomplish. This budget includes a scorecard that measures the progress 
agencies are making in achieving results, so that the government 
continues to be accountable to the taxpayers.
    Since President Bush took office, our Nation has confronted a 
cascading set of challenges. The President and Congress responded on 
all fronts, with tax relief to get the economy going, the largest 
reorganization of the Federal Government in 50 years to create a new 
Department of Homeland Security, and the largest increases in the 
defense budget since the Reagan administration, to wage and win the war 
on terror. The President's 2005 budget builds on this record of 
accomplishment. With renewed economic growth and the Congress' 
cooperation in restraining spending and focusing it on our most 
critical priorities, we can accomplish the great goals the President 
has set for the country, while dramatically improving our budget 
situation.

    Chairman Nussle. Welcome too, Chairman Mankiw. We are 
pleased to receive your testimony at this time. If you have a 
prepared statement, it will be made part of the record. You may 
summarize.

 STATEMENT OF N. GREGORY MANKIW, CHAIRMAN, COUNCIL OF ECONOMIC 
                            ADVISERS

    Mr. Mankiw. Thank you very much, Chairman Nussle, Ranking 
Member Spratt, and members of the committee. I appreciate the 
opportunity to testify on the administration's economic 
forecast as it relates to the budget for fiscal year 2005.
    The administration's economic forecast is a joint product 
of the Council of Economic Advisers, the Office of Management 
and Budget, and the Treasury. In developing it, the 
administration consciously adopts conservative economic 
assumptions that are close to the consensus of private-sector 
forecasters.
    The U.S. economy made notable progress in 2003. The 
recovery was still tenuous going into the year. On the one 
hand, powerful contractionary forces still lingered, the 
capital overhang, corporate scandals, and uncertainty about 
future economic and geopolitical conditions. On the other hand, 
economic stimulus was provided by expansionary monetary policy 
in the administration's 2001 tax cut and 2002 stimulus package.
    Over the course of 2003, the contractionary forces 
dissipated and the expansionary forces were augmented by the 
tax relief that the Congress passed and the President signed 
into law in May.
    The economy has gained considerable momentum over the past 
year. Real GDP increased at an annual rate of 6.1 percent in 
the second half of 2003, the strongest reading for any half-
year period in nearly 20 years. Growth in exports and in 
business equipment and software investment picked up sharply in 
the middle of 2003, and the labor market began to rebound. Core 
consumer inflation declined to its lowest level in decades.
    The administration forecasts continued economic recovery 
with real GDP growth well above its historical average and a 
further decline in the unemployment rate. Real GDP is projected 
to increase 4 percent during the four quarters of 2004. On a 
calendar-year-over-year basis, GDP is projected to increase 4.4 
percent this year. Much stimulus remains in the pipeline in the 
form of low marginal tax rates and refunds on 2003 tax 
liabilities. Tax refunds are expected to be higher than usual 
because although last year's tax cuts were retroactive to 
January, withholding changes generally were not. In addition, 
businesses can expense 50 percent of their equipment investment 
through the end of 2004. The lower tax rates, higher tax 
refunds, and investment expensing included in the Jobs and 
Growth Act are expected to reduce tax collections by $146 
billion in 2004, compared to $49 billion in 2003.
    The U.S. economy continues to display supply side 
characteristics favorable to long-term growth. Advances in 
productivity have been remarkable. We estimate the growth of 
the economy's long-run potential to be about 3.1 percent per 
year. During each of the next 4 years, real GDP is expected to 
grow faster than its long-run potential rate as the economy 
continues to recover. In particular, real GDP growth is 
projected to average 3.7 percent during the 4 years from 2003-
07. The administration projects in 2008 and 2009 real GDP will 
expand at its potential rate of 3.1 percent and the 
unemployment rate will stabilize at 5.1 percent.
    Let me conclude with a few remarks on the relationship 
between the budget deficit and the economy. It is true that 
large persistent deficits act as a drag on the economy. It is 
also true that higher tax rates alter incentives in a way that 
acts as a drag on the economy. In my view, concerns about the 
deficit should not be resolved with higher tax rates. Doing so 
would merely replace one drag on growth with another. Rather, 
the solution to long-run deficits is continued progrowth tax 
policy and spending restraint.
    The President's tax cuts were designed to encourage work, 
saving, and investment, the building blocks of economic growth. 
He has presented a budget with significant spending restraint. 
These proposals will position the U.S. economy for further 
strong growth in the years ahead.
    I thank you for the opportunity to testify. I look forward 
to your questions.
    Chairman Nussle. I thank you for your testimony.
    [The prepared statement of N. Gregory Mankiw follows:]

Prepared Statement of N. Gregory Mankiw, Chairman, Council of Economic 
                                Advisers

    Chairman Nussle, Ranking Member Spratt, and members of the 
Committee, thank you for the opportunity to testify on the 
administration's economic forecast as it relates to the President's 
budget for fiscal year 2005.
    As you know, the forecast is a key input into the budget process. 
The Council of Economic Advisers initiates a macroeconomic forecast 
twice a year, in the fall for the budget and the spring for the Mid-
Session Review. The forecast itself is a joint product of the Council, 
the Office of Management and Budget, and the Treasury-the 
administration's economic ``troika.'' The chief economists and staffs 
from the three agencies work closely together, and then I review the 
forecast carefully, together with the secretary of the Treasury and the 
Director of the Office of Management and Budget.
    In developing the forecast, the administration consciously adopts 
conservative economic assumptions that are close to the consensus of 
private-sector forecasters. This approach provides a prudent and 
cautious basis for the budget projections.
    The outlook for 2004 and beyond reflects the key role of the 
administration's policies in supporting the recovery and boosting job 
creation. The administration's policies are designed to enhance U.S. 
economic growth, not just maintain it.
                    2003: an economic turning point
    The U.S. economy made notable progress in 2003. The recovery was 
still tenuous going into the year. On the one hand, it was still 
struggling against powerful contractionary forces-the capital overhang, 
revelations about corporate scandals, and uncertainty about future 
economic and geopolitical conditions. On the other hand, it had the 
benefits of the stimulus from expansionary monetary policy and the 
administration's 2001 tax cut and 2002 stimulus package. Over the 
course of 2003, the contractionary forces dissipated and the 
expansionary forces were augmented by the Jobs and Growth Tax Relief 
Reconciliation Act (JGTRRA), which the President signed into law in 
May.
    The economy now appears to have moved into a full-fledged recovery. 
The economy has gained momentum over the past year, with annualized 
real GDP growth increasing from 2\1/2\ percent during the first half of 
2003 to 6.1 percent during the second half-the strongest GDP growth for 
any half-year period in nearly 20 years. GDP growth in 2003 was 
supported by robust gains in consumption, residential investment, and 
defense spending. Inventory investment declined over the first three 
quarters of last year but turned positive in the fourth quarter. Growth 
in business equipment and software investment and in exports picked up 
noticeably in the second half of the year. The labor market began to 
rebound in the final 5 months of 2003. Core consumer inflation declined 
to its lowest level in decades.
               gdp growth, productivity, and unemployment
    The administration forecasts that the economic recovery will 
strengthen further this year, with real GDP growth running well above 
its historical average of 3.3 percent since 1960 and the unemployment 
rate continuing to decline. The administration expects real GDP to 
increase 4.0 percent during the four quarters of 2004. This projection 
is close to that in the latest Blue Chip consensus economic forecast 
(as of January 10, 2004). This compares with GDP growth of 4.3 percent 
during the four quarters of 2003 and 2.8 percent during the four 
quarters of 2002. Measured on a calendar year-over-year basis, the 
administration projects GDP growth of 4.4 percent in 2004, compared 
with 3.1 percent in 2003 and 2.2 percent in 2002.
    In 2004, the composition of GDP growth is expected to shift away 
from household and government spending and toward business fixed 
investment and net exports. Evidence of emerging momentum in investment 
accumulated over the course of 2003: businesses began to hire, build 
inventories, and increase shipments of nondefense capital goods. In 
addition, expected faster growth among U.S. trading partners and the 
decline in the exchange value of the dollar make U.S. exporters well-
positioned for expansion.
    Much stimulus remains in the pipeline in the form of refunds on 
2003 tax liabilities this spring and the ongoing effects of the current 
low interest rates. The reduction in the tax withholding schedule 
included in the 2003 fiscal package (JGTRRA) only began in July 2003, 
and households are still adjusting to these lower tax rates. Moreover, 
tax refunds in the first half of 2004 are expected to be higher than 
usual: the tax cuts were retroactive to January 2003, but last year's 
withholding changes generally did not capture tax savings on income 
earned in the first half of the year. In addition, because of the 2002 
and 2003 tax cuts, businesses will be able to cut their tax liabilities 
by expensing 50 percent of their equipment investment (rather than 
depreciating the new capital) through the end of 2004. The lower tax 
rates, higher tax refunds, and investment expensing included in the 
Jobs and Growth Tax Relief Reconciliation Act are expected to reduce 
tax collections by $146 billion in 2004, up from $49 billion in 2003.
    The U.S. economy continues to display supply-side characteristics 
favorable to long-term growth. Advances in productivity have been 
remarkable, and inflation remains low and stable. We estimate the 
growth of the economy's potential GDP to be 3.1 percent per year.
    During each of the next 4 years, real GDP is expected to grow 
faster than its potential rate as the economy continues to recover. The 
administration forecasts that real GDP growth will average 3.7 percent 
at an annual rate during the 4 years from 2003 to 2007-again in line 
with the consensus of private-sector forecasters. Because this pace is 
somewhat above the assumed rate of increase in productive capacity, the 
unemployment rate is projected to decline over this period. In 2008 and 
2009, real GDP growth is projected to continue at its long-run 
potential rate of 3.1 percent, and the unemployment rate is projected 
to stabilize at 5.1 percent.
    The growth rate of the economy over longer time horizons is 
determined by its supply-side components, which include population, 
labor force participation, productivity, and the workweek. The 
administration expects nonfarm labor productivity to grow at a 2.1 
percent average annual pace over the forecast period, virtually the 
same as that recorded during the 43 years since the business-cycle peak 
in 1960. The projection is notably more conservative than the 4.4 
percent average annual rate of productivity growth since the output 
peak in the fourth quarter of 2000. After such an extraordinary surge, 
a period of more typical productivity growth is likely as firms shed 
their hesitancy to hire. In addition, the slower pace of productivity 
assumed in the forecast reflects the administration's view that in the 
absence of a good explanation for the recent acceleration, it is 
prudent to base the productivity forecast on longer-term averages.
    In addition to productivity, growth of the labor force is projected 
to contribute 1.0 percentage point per year to growth of potential 
output on average through 2009. Labor force growth results from growth 
in the working-age population and changes in the labor force 
participation rate. The Bureau of the Census projects that the working-
age population will grow at an average annual rate of 1.1 percent 
through 2009-roughly the same pace as during the years between 1990-
2003. The last year in which the labor force participation rate 
increased was 1997, so the long-term trend of rising participation 
appears to have come to an end. Since then, the participation rate has 
fallen at an average 0.2 percent annual pace-although some of the 
decline in 2001 and 2002 probably resulted from the recession-induced 
decline in job prospects. In 2003, the baby boom cohort was 39-57 years 
old, and over the next several years the boomers will be moving into 
older age brackets with lower participation rates. As a result, the 
labor force participation rate is projected to edge down an average of 
0.1 percent per year through 2009. The decline may be greater, however, 
after 2008, which is the year that the first baby boomers (those born 
in 1946) reach the Social Security early-retirement age of 62.
    In sum, potential real GDP is projected to grow at a 3.1 percent 
annual pace, slightly above the average 3.0 percent rate of real GDP 
growth since 1973 and slightly below the 3.3 percent average since 
1960. Actual real GDP growth during the 6-year forecast period is 
projected to be slightly higher, at 3.4 percent, because the civilian 
employment rate makes a transitory and small (0.2 percentage point) 
contribution to growth through 2007 as the unemployment rate falls. 
This contribution then ends as the unemployment rate stabilizes at 5.1 
percent.
                           consumer spending
    Consumer spending is expected to moderate this year after rising 
briskly in the second half of 2003. Real personal consumption 
expenditures increased at an average annual pace of 3.0 percent during 
the first half of 2003 and then accelerated to an annual rate of 4.7 
percent in the second half of the year.
    Wages and salaries increased moderately in the second half of 2003, 
bolstered by the emerging recovery in the labor market. Moreover, the 
personal tax cuts included in the 2003 fiscal package (JGTRRA) meant 
that U.S. households were able to keep substantially more of their 
earnings. The reduction in withholding and the advance rebates of the 
child tax credit added $37 billion to disposable income (not at an 
annual rate) in the second half of the year.
    Other factors also likely contributed to the strengthening of 
consumer spending over the course of 2003. The robust performance of 
equity markets and solid gains in home prices bolstered wealth. 
Household wealth (net financial resources plus the value of 
nonfinancial assets such as cars and homes) increased $2\1/4\ trillion 
during the first three quarters of 2003, and it probably rose 
substantially further in the fourth quarter given the solid increase in 
broad indexes of stock prices in the last few months of the year. 
Consumer sentiment was depressed early in the year by the prospect of 
war with Iraq. Sentiment jumped in April and May following the 
successful resolution of major combat operations and then was little 
changed until November, when it picked up noticeably. By the end of the 
year, household sentiment was somewhat higher than it had been at the 
end of 2002 and much higher than it was just prior to the war with 
Iraq.
    During 2003 as a whole, consumption grew somewhat faster than 
household after-tax income. Personal saving as a fraction of disposable 
personal income averaged 2.3 percent in 2002 and was slightly lower, at 
2.0 percent, in 2003.
    The likely behavior of personal saving in coming years is a key 
factor in the consumption outlook. In particular, the relative flatness 
of the personal saving rate over the past couple of years appears to be 
the result of offsetting forces. On the one hand, capital losses 
associated with the decline in the stock market from March 2000 to 
March 2003 probably tempered consumption (with some lag) and, in turn, 
caused the personal saving rate to increase. On the other hand, 
personal saving was likely depressed by the boost to consumption from 
low interest rates (both directly through the availability of low-
interest-rate loans on durable goods and indirectly through the funds 
made available by cash-out mortgage refinancings). As interest rates 
and incomes rise over the course of the next several years, the 
transitory forces boosting consumption growth should dissipate, and as 
a result, real consumption is expected to grow more slowly than real 
GDP.
    An increase in corporate contributions for defined-benefit pension 
plans may boost the saving rate in the near term from what it might be 
otherwise. The Pension Benefit Guarantee Corporation (PBGC) has 
estimated that corporate contributions to defined-benefit plans will 
increase sharply above 2003 levels. Indeed, rapid increases have 
already begun, according to separate data included in the Employment 
Cost Index. The contributions raise personal income (as it is measured 
in the National Income and Product Accounts), but because these funds 
are not placed in the hands of employees until retirement, they may 
have smaller effects on current-year consumption. As a result, they may 
increase the personal saving rate.
                         residential investment
    Real residential investment is expected to slow somewhat in 2004 
after a remarkably robust performance in 2003. During the four quarters 
of 2003, real residential investment grew at an average annual rate of 
more than 10 percent. Housing starts moved above the already high 2002 
level to an average of 1.8 million units in 2003, the largest number of 
starts since 1978. In addition, sales of both new and existing single-
family homes rose to record levels.
    Some of the strength in housing demand reflected the same gains in 
after-tax income and wealth that bolstered real consumer spending. The 
low levels of mortgage interest rates were another important driving 
force. The interest rate on new fixed-rate 30-year mortgages slipped 
from an average of 6\1/2\ percent in 2002 to an average of 53/4 percent 
in 2003. This level is the lowest in the 32 years for which comparable 
data are available. Indeed, according to data from the Michigan Survey 
Research Center, consumers' assessments of home-buying conditions 
remained very positive in 2003, largely because of low mortgage 
interest rates. As a result of the very favorable conditions in the 
housing sector, the U.S. home-ownership rate climbed to 68.2 percent in 
the third quarter of 2003-equal to its highest level on record.
                       business fixed investment
    Business investment in equipment and software picked up sharply in 
the second half of 2003 and the strength is expected to persist in 
2004. However, business investment in structures is forecast to gain 
only slightly over the year.
    Real business fixed investment-firms' outlays on equipment, 
software, and structures-posted a gain of 6.4 percent during the four 
quarters of 2003 after declines of 10.2 percent during the four 
quarters of 2001 and 2.8 percent during the four quarters of 2002. The 
acceleration during the year was noteworthy, with real investment 
rising at an annual rate of 9.8 percent in the second half compared 
with 3.1 percent in the first half of the year. The improvement from 
2002 to 2003, as well as the pickup over the course of 2003, largely 
reflected a strengthening in real purchases of equipment and software.
    Within the equipment and software category, the largest increases 
occurred for certain high-tech items. Real outlays for computers 
increased nearly 40 percent during the year, and real investment in 
software continued its solid upward trend, rising 12\1/2\ percent. 
Outlays for transportation equipment were held down by further large 
declines in purchases of aircraft during the year. Finally, real 
spending on equipment outside of the high-tech and transportation 
categories posted a solid gain over the course of 2003.
    The increased momentum in business purchases of capital goods in 
2003 likely reflects the impact of several factors. First, with capital 
overhangs probably behind them, firms were poised to take advantage of 
further declines in prices of high-tech goods stemming from continued 
technological advances. Second, striking gains in productivity and 
falling unit labor costs bolstered corporate profits. Third, the cost 
of capital was held down by a number of factors, including falling 
prices for high-tech capital goods, but also by low interest rates, 
rising stock prices, and the investment incentives introduced in the 
Job Creation and Worker Assistance Act of 2002 (JCWAA) and expanded in 
the 2003 fiscal package (JGTRRA).
    The administration expects the recovery in real business investment 
in equipment to strengthen further this year, reflecting the 
acceleration in output, continued low interest rates, and the 
investment incentives provided by the 2002 and 2003 tax cuts. Fixed 
investment in equipment tends to be related to the pace of growth in 
output (along with the cost of capital), and so the pickup in real GDP 
growth from 2.8 percent during the four quarters of 2002 to 4.3 percent 
during the four quarters of 2003 is projected to lead to an increase in 
investment during 2004.
    Growth in equipment investment in 2004 should be further boosted as 
firms pull forward spending in anticipation of the expiration of the 
period when businesses are able to expense (rather than depreciate) 50 
percent of the value of their equipment investment. The flip side of 
some investment being pulled forward into 2004 is that investment may 
grow more slowly in 2005. Even so, the pace of equipment investment in 
2005 is projected to be strong.
    Despite the emerging recovery in spending on equipment and 
software, business demand for structures remained soft in 2003. High 
overcapacity seems to have offset the impetus imparted by low interest 
rates and higher cash flow. In the office sector, vacancy rates rose 
substantially for the third consecutive year. Vacancy rates moved still 
higher in the industrial sector and now stand at extremely elevated 
levels. The good news is that the substantial declines in total 
spending on structures seem to have abated. Indeed, real investment in 
nonresidential structures dipped only about 1.3 percent over the four 
quarters of 2003, in contrast with a plunge of more than 25 percent 
during the preceding 2 years. Strength in oil and gas drilling and an 
increase in construction of general merchandise stores during the year 
have offset continued softness in some other sectors.
    The forces that shape the outlook for business structures-the 
growth of output and the cost of capital-are much the same as for 
business equipment. However, they operate with a longer lag because of 
the time it takes to plan and build these structures. Investment in 
business structures is projected to post a small gain during 2004.
                          business inventories
    Inventory investment is projected to make a noticeable positive 
contribution to GDP growth through the first half of 2004 and then stay 
at a level that keeps stocks in line with rising sales throughout 2004 
and 2005. This would continue a turnaround in stockbuilding that 
appears to have begun in September 2003 and was evidenced by the 
positive contribution of 0.6 percent by inventory investment to fourth-
quarter GDP growth. Businesses began 2003 with lean inventories 
following a massive liquidation in 2001 and little restocking during 
2002. Inventory investment was substantially negative over the first 
three quarters of 2003, as increases in production lagged those in 
final demand. The reasons for this slow response of production are 
unclear. Firms may have been surprised by the strength of final demand, 
or they may simply have been waiting for compelling evidence that a 
sustainable recovery was under way. The net decline in inventories 
during the first three quarters of 2003 left stocks in their leanest 
position relative to final sales of goods and structures in at least 50 
years. This lean position resulted, at least in part, from efficiencies 
generated by just-in-time inventory-management techniques.
                          government purchases
    Real Federal Government spending is expected to fall in the 2005 
and 2006 fiscal years, and remain fairly flat thereafter. The defense 
supplemental appropriations for fiscal year 2004, signed in November 
2003, allows for some further near-term growth in Federal Government 
purchases. Real Federal spending (consumption expenditures and gross 
investment) climbed 53/4 percent during the four quarters of 2003. The 
gain was led by a rise of 73/4 percent in real defense spending largely 
related to military operations in Iraq. Real nondefense spending rose 
about 2\1/2\ percent. This increase was less than one-third as large as 
the gain during the four quarters of 2002, when outlays were stepped up 
considerably for homeland security.
    Tax receipts of states and localities decelerated during the 
economic slowdown, while fiscal positions deteriorated as well from 
rising health care costs and increased demand for security-related 
spending. With many of these governments subject to balanced-budget 
rules, they have taken a variety of measures to address their fiscal 
imbalances, including drawing on accumulated reserves (so-called 
``rainy day funds''), raising taxes, and restraining spending. Real 
expenditures of state and local governments were little changed during 
the four quarters of 2003, in contrast with an average annual gain of 
around 3 percent over the preceding 5 years. With state and local 
governments still under pressure, their real expenditures are projected 
to increase slowly during the coming year. Eventually, their fiscal 
situations should be improved by increases in tax revenue resulting 
from the strengthening of the economy.
                          exports and imports
    Prospects for exports over the next 2 years look promising for the 
first time since the global slowdown began in 2000. Growth among the 
non-U.S. OECD countries is projected by the OECD Secretariat to rise to 
2.6 percent during the four quarters of 2004, up from a pace of 1.6 
percent during 2003. Growth is expected to rise further to 2.8 percent 
in 2005. The expected growth in foreign markets should support growth 
in U.S. exports. In addition, the effect will likely be augmented by a 
rise in the U.S. market share of world exports owing to the effects of 
the 23 percent decline in the value of the dollar against major 
currencies from its peak in early 2002 through the end of 2003. The 
effect of the recent dollar decline on exports will likely take a 
couple of years to be fully felt.
    Real imports are projected to increase along with domestic output, 
but the growth of real imports is likely to be slowed by the recent 
decline in the dollar's value relative to other currencies. On balance, 
real imports are projected to grow at about the same pace as GDP, on 
average, during the next 2 years. Nominal imports will increase faster 
than real imports because import prices will rise in reaction to the 
recent dollar decline. The current account deficit, which rose to about 
5 percent of GDP in the first three quarters of 2003, is projected to 
edge up in 2004 and decline thereafter.
    Overall, real net exports are expected to make a small positive 
contribution to real GDP growth during the next year and are likely to 
make a larger contribution thereafter. Over the next 6 years, the 
returns to foreign owners of U.S. capital are likely to grow faster 
than the returns to U.S. owners of foreign capital, a legacy of a long 
period of strong foreign investment in the United States during the 
past decade. As a result, real gross national product (GNP), which 
includes these net foreign returns to capital, is expected to grow 
slower than real gross domestic product (GDP).
                            the labor market
    Boosted by strong demand and income growth, the labor market in 
2004 and beyond is expected to build upon the favorable developments in 
the last 5 months of 2003. Nonfarm payroll employment fell an average 
of 50,000 workers per month in the first 7 months of 2003, before 
increasing 35,000 in August, 99,000 in September, and an average of 
48,000 per month in the fourth quarter. The strengthening was 
experienced in most sectors. Job gains in professional and business 
services stepped up appreciably from the modest upward pace seen 
earlier in the year. Construction employment began to expand in the 
second quarter after 2 years of modest job losses, and the quarterly 
averages of employment in the wholesale trade, transportation, and 
utilities industries turned up at the end of the year. The 
manufacturing sector continued to shed jobs through year-end, though 
the pace of decline slowed, and the factory workweek climbed more than 
0.5 hour, on balance, in the final 5 months of 2003.
    The unemployment rate increased in the first half of 2003, reaching 
a peak of 6.3 percent in June, before falling during the second half of 
the year. In the fourth quarter, the unemployment rate averaged 5.9 
percent, the same as it had been a year earlier. Because the labor 
force is constantly expanding, employment must be growing moderately 
just to keep the unemployment rate steady. For example, if the labor 
force is growing at the same rate as the population (about 1 percent 
per year), employment would have to rise 110,000 a month just to keep 
the unemployment rate stable, and larger job gains would be necessary 
(and are expected) to induce a downward trend in the unemployment rate.
    Looking ahead, temporary-help services employment-a leading 
indicator for the labor market-suggests substantial further employment 
growth in the future. Average growth in temporary-help services 
employment over a 6-month period has a striking positive correlation 
with growth in overall employment over the subsequent 6 months. 
Statistical analysis suggests that an increase of one job in temporary-
help services corresponds to a subsequent rise of seven jobs in overall 
employment. Employment in temporary-help services has expanded 194,000 
since last April, suggesting robust growth in overall employment this 
year. The unemployment rate is projected to fall to 5.5 percent by the 
fourth quarter of 2004-well below its average of 6.3 percent since 
1970.
                               inflation
    Core CPI inflation is expected to continue at a low level in 2004, 
and overall inflation is expected to be even lower as energy prices 
retreat further. Overall CPI inflation is projected to fall to 1.4 
percent during the four quarters of 2004-close to the past year's pace 
of core inflation. With the unemployment rate expected to average 5.6 
percent for the year as a whole (above the estimated 5.1 percent 
midpoint of the range of unemployment rates consistent with stable 
inflation) the level of slack-although less than in 2003-is still 
projected to hold down inflation during 2004. Also keeping inflation in 
check is the recent rapid pace of-and solid near-term prospects for-
productivity growth. Offsetting this effect is the somewhat higher pace 
of import-price inflation (resulting from the recent dollar decline) 
and the quicker pace of GDP growth. Over the next 5 years, CPI 
inflation is expected to edge up, eventually flattening out at 2.5 
percent, a level that is identical to the consensus private-sector 
forecast.
    The path of inflation as measured by the GDP price index is 
similar, but a bit lower throughout the projection period. Inflation as 
measured by the GDP price index is projected to fall to 1.2 percent 
during the four quarters of 2004, the same as the 1.2 percent pace of 
the core GDP price index during the four quarters of 2003. GDP price 
inflation is projected to increase slowly thereafter-roughly parallel 
to the rise in CPI inflation.
    The wedge between the CPI and the GDP measures of inflation has 
important implications for the Federal budget and budget projections. A 
larger wedge reduces the Federal budget surplus because cost-of-living 
adjustments for Social Security and other indexed programs rise with 
the CPI, whereas Federal revenue tends to increase with the GDP price 
index. For a given level of nominal income, increases in the CPI also 
cut Federal revenue because they raise income tax brackets and affect 
other inflation-indexed features of the tax code. Of the two indexes, 
the CPI tends to increase faster in part because it measures the price 
of a fixed market basket. In contrast, the GDP price index increases 
less rapidly than the CPI because it reflects the choices of households 
and businesses to shift their purchases away from items with increasing 
relative prices and toward items with decreasing relative prices. In 
addition, the GDP price index includes investment goods, such as 
computers, whose relative prices have been falling rapidly. Computers, 
in particular, receive a much larger weight in the GDP price index (0.8 
percent) than in the CPI (0.2 percent).
    During the 8 years ended in 2002, the wedge between inflation in 
the CPI-U-RS (a version of the CPI designed to be consistent with 
current methods) and the rate of change in the GDP price index averaged 
0.5 percentage point per year. With the core CPI and the core GDP price 
index both increasing at about a 1\1/4\ percent pace during the past 
year, inertia suggests that the near-term wedge will be only about 0.2 
percentage point in 2004. The wedge is expected to widen eventually to 
its recent mean of 0.5 percent by 2009.
                           financial markets
    Stock prices skidded early in the year, but rallied in March and 
have been on a solid uptrend since then. During the 12 months of 2003, 
the Wilshire 5000 index-a broad measure of stock prices-rose 29 
percent. An increase of this magnitude has not been seen in any year 
since 1997. High-tech stocks did even better; for example, the Nasdaq 
index, which is heavily weighted toward high-tech industry, rose 50 
percent during 2003. Nearly two-thirds of the rise in broad measures of 
stock prices occurred after the President signed the 2003 tax cut 
(JGTRRA) in late May; the Act reduced marginal tax rates on dividends 
and capital gains and thus likely contributed to the robust performance 
of stock prices.
    Following a large decline in 2001, and a smaller one in 2002, the 
interest rate on 91-day Treasury bills fell an additional 29 basis 
points in 2003 and ended the year at 0.9 percent. These reductions 
reflected the Federal Reserve's efforts to stimulate the economy, 
leaving real short-term rates (that is, nominal rates less expected 
inflation) slightly negative. Following market-based expectations of 
interest rates (derived from rates on Euro dollar futures), the 
administration does not expect real rates this low to persist once the 
recovery becomes firmly established, and nominal Treasury bill rates 
are projected to increase gradually. Long-term interest rates fell 
sharply last spring and then rebounded in the summer. For the year as a 
whole, long-term Treasury rates were about unchanged, but corporate 
interest rates dropped a bit as the spread over Treasury rates 
narrowed. The administration projects that the yield on 10-year 
Treasury notes, which averaged 4.3 percent in December 2003, will edge 
up gradually next year, consistent with the path of short-term Treasury 
rates.
    The gradual increase in the interest rate on 91-day Treasury bills 
is projected to continue through 2009. The rate is expected to reach 
4.4 percent by 2009, at which date the real interest rate on 91-day 
Treasury bills will be close to its historical average. The projected 
path of the interest rate on 10-year Treasury notes is consistent with 
that on short-term Treasury rates. By 2008, this yield is projected to 
be 5.8 percent, 3.3 percentage points above expected CPI inflation-a 
typical real rate by historical standards. By 2009, the projected term 
premium (the difference between the 10-year interest rate and the 91-
day rate) of 1.4 percentage points is in line with its historical 
average.
                       the composition of income
    A primary purpose of the administration's economic forecast is to 
estimate future government revenue, which requires a projection of the 
components of taxable income. The administration's income-side 
projection is based on the historical stability of the long-run labor 
and capital shares of gross domestic income (equal to GDP less a 
statistical discrepancy). During the first three quarters of 2003, the 
labor share of gross domestic income (GDI) was on the low side of its 
historical average. From this jump-off point, it is projected to rise 
to its long-run average and then remain at this level over the forecast 
period. (The income share projections are consistent with data 
available through December 2, 2003. They exclude any effects of the 
later comprehensive revision to the National Income and Product 
Accounts.) The labor share consists of wages and salaries, which are 
taxable, employer contributions for employee pension and insurance 
funds (that is, fringe benefits), which are not taxable, and employer 
contributions for government social insurance. The administration 
forecasts that the wage and salary share of compensation will decline 
while employer contributions for employee pension and insurance funds 
grow faster than wages. This pattern has generally been in evidence 
since 1960 except for a few years in the late 1990s. During the next 5 
years, the fastest growing components of employer contributions for 
employee pension and insurance funds are expected to be employer-paid 
health insurance and contributions for defined-benefit pension plans.
    The capital share (the complement of the labor share) of GDI is 
expected to fall before leveling off at its historical average. Within 
the capital share, a near-term decline in depreciation (an echo of the 
decline in short-lived investment during 2001 and 2002) helps boost 
corporate economic profits, which in the third quarter of 2003 were 
noticeably above their post-1973 average of about 8 percent of GDI. The 
share of corporate economic profits in GDI is projected to be bolstered 
in 2004 by the strong recent productivity growth together with stable 
gains in hourly compensation, and an expected decline in depreciation.
    From 2005 forward, the profit share is expected to slowly decline 
back to its historical average of about 8 percent. The projected 
pattern of book profits (known in the national income accounts as 
``profits before tax'') reflects the 30 percent expensing provisions of 
the Job Creation and Worker Assistance Act of 2002 and the 50 percent 
expensing provisions of the Jobs and Growth Tax Relief Reconciliation 
Act of 2003. These expensing provisions reduce taxable profits from the 
third quarter of 2001 through the fourth quarter of 2004. The 
expiration of the expensing provisions increases book profits 
thereafter, however, because those investment goods expensed during the 
3-year expensing window will have less remaining value to depreciate 
thereafter. The share of other taxable income (the sum of rent, 
dividends, proprietors' income, and personal interest income) is 
projected to fall, mainly because of the delayed effects of past 
declines in long-term interest rates, which reduce personal interest 
income during the projection period.
            conclusion: the importance of spending restraint
    Let me conclude with a few remarks on the relationship between the 
budget deficit and the economy. It is true that, according to most 
economic models, large, persistent deficits act as a drag on the 
economy. It is true as well that, according to most models, higher tax 
rates alter incentives in a way that also acts as a drag on the 
economy. In my view, concerns about the deficit should not be resolved 
with higher tax rates. Doing so would merely replace one drag on growth 
with another. Rather, the solution to long-run deficits is continued 
pro-growth tax policy and spending restraint. The President's tax cuts 
were designed to encourage work, saving, and investment-the building 
blocks of growth-and he has presented a budget with significant 
spending restraint. These proposals will ensure that the current 
economic recovery continues and position the U.S. economy for further 
strong growth in the years ahead.
    Thank you for the opportunity to testify. I look forward to your 
questions.

    Chairman Nussle. We have a number of members who are here 
today and others that are coming back. I am going to try to 
limit my questions to the time limit, and I am going to ask 
other members to do the same to respect other members' 
questions. So let me get into this quickly.
    As I understand it, from my years on the Budget Committee 
in service in Congress, there are three ways that we can tackle 
the problem we have got. We can raise taxes, we can cut 
spending, or we can grow the economy. And unless I am missing 
something here, the President is not picking No. 1. He is 
basically saying, we are not going to raise taxes at this time 
in our economic situation, and we don't believe that that is 
the right recipe in order to fix the deficit.
    Is that your understanding, there are no tax increases in 
this budget?
    Mr. Bolten. Mr. Chairman, that is correct. We have some 
loophole closers in there, but in general there are no tax 
increases contemplated in this budget. And, in fact, what we 
are proposing is to extend the tax cuts that you have enacted 
precisely because the most important thing we can do to restore 
our budget picture to health is to keep strong economic growth 
going, and the most important element in doing that is 
sustaining the tax cuts that you have enacted.
    Chairman Nussle. Let me get into the second one, and that 
is spending restraint. It is a fairly austere budget. It is 
interesting to me that we will hear complaints that we don't 
get to balance soon enough, or we don't cut the deficit soon 
enough, or it isn't realistic because Congress won't get it 
done. What do we expect the President to do? He has got to 
propose something.
    He has given us a blueprint to work from. It is austere. 
Can we do better? We might be able to do better than that. But 
the way I see it right now--and this is what I would like to 
ask--is, where do you see the potholes--no pun intended, maybe 
pun intended--spending concerns that the administration, 
looking at the congressional playing field, the way it sets up 
right now? And I guess, maybe more specifically, what are your 
concerns about the transportation bill and about the energy 
bill and about the appropriations process that you see laid 
before you?
    Mr. Bolten. Mr. Chairman, you have just highlighted our 
principal short-term anxieties about what might happen to our 
budget picture over the course of this early legislative 
season. They are first and foremost with the appropriations 
process, but we are just beginning that now with our budget 
presentation. We look forward to working with you, with the 
leadership, and with the Appropriations leadership in making 
sure that we keep that appropriations process well contained 
within proper limits, as I believe we did this past year.
    But the immediate challenges include, notably, the highway 
bill which you just mentioned. We are carrying in our budget a 
proposal for a 6-year highway bill that contemplates spending 
$256 billion over 6 years. That is a 21 percent increase over 
the last 6-year highway bill. So there is a substantial 
increase built in there. There are proposals now in gestation 
on both sides of the Capitol which go substantially above that. 
Either this morning or late yesterday, a letter came forward 
from Secretary Mineta and Secretary Snow indicating the 
principles within which the administration proposes to live and 
the principles that led us to our number of $256 billion, and 
added that if legislation were presented to the President that 
departed from those principles, his senior advisors would 
recommend that he veto the bill.
    Chairman Nussle. What were those principles?
    Mr. Bolten. Mr. Chairman, the principles were three:
    First, that transportation infrastructure spending should 
not rely on an increase in the gas tax or other Federal taxes;
    Second, that transportation infrastructure spending should 
not be funded through bonding or other mechanisms that conceal 
the true cost to Federal taxpayers; and
    Third, that highway spending should be financed from the 
Highway Trust Fund, not the General Fund of the Treasury.
    Chairman Nussle. If those are the three principles, is the 
word ``veto'' tucked into that letter somewhere?
    Mr. Bolten. The penultimate paragraph of the two 
Secretaries' letter says that if a surface transportation 
reauthorization bill that breached any of these three 
principles were presented to the President, his senior advisors 
would recommend that he veto the bill.
    Chairman Nussle. Well, we have got a test then, and it is 
probably going to come up before the budget, and we will just 
have to see how it all shakes out.
    But this is what we are talking about. There is a lot of 
chest-beating right now about spending, mostly from Members of 
Congress on both sides. And the President has been very clear; 
he said no tax increase has to come out of the trust fund, and 
no bond proposal to try to figure out a way to get around the 
first two principles. And we will just have to see how Congress 
reacts, because it is interesting to me, I have always thought 
this--it has always been interesting to me that the President 
gets blamed or given credit for the budget situation. The 
Democrats love to give President Clinton the credit for 
balancing the budget. It isn't any more true than it is now.
    Congress, says Article I of the Constitution, we are 
responsible for the purse strings, and if we put a bill on the 
President's desk that violates those principles, we are asking 
for a veto. And it is more spending than in the budget, so if 
you are concerned about the deficit, you have got an 
opportunity right now. And I have got just as many projects as 
everybody else does that we think are vitally important to my 
district and State. We all do and we will all advocate for 
them.
    But we have an opportunity to put our chest-beating where 
our mouth has been and our budgets have been and our proposals 
have been with the first bill out of the blocks, even probably 
before a budget gets passed. I would suggest to you that that 
will be a very good test to determine not only who is 
responsible, but whether or not we are going to get our arms 
around this deficit and whether or not we are going to be able 
to get on a glide path to cut it in half in 5 years.
    I have tons of other questions, but I wanted to get that on 
the record and find out where you were coming from, and I 
appreciate your testimony in that regard.
    Mr. Spratt.
    Mr. Spratt. Mr. Chairman, you mentioned the fact that there 
are no tax increases in the budget. There is something called 
the Alternative Minimum Tax, which the Treasury Department has 
said will increase taxes to a higher rate for up to 30 million 
tax filers by 2010. I said earlier there is no mention of that 
problem here.
    As you propose $1.2 trillion in additional tax cuts, you 
offer nothing except for indexing the exempt amount of the AMT 
as a correction. We all know it is coming, and it is in fact a 
tax increase for middle-income American, the AMT, if you leave 
it on the books in its present form.
    I said earlier that the President had included in his State 
of the Union message a statement that he would send us a budget 
in 2 weeks and that budget would pay for the war. This budget 
doesn't pay for the war.
    Would you tell us why it doesn't pay for the war and why 
the President made that statement if the budget was to be sent 
to us in this form?
    Mr. Bolten. Mr. Spratt, I believe the President's statement 
in the State of the Union was referring generally to the war on 
terror, and at the time that we presented this budget, we 
acknowledged that in addition to the proposals that you see on 
the table enclosed in this budget, we have expressly said--and 
it is contained in the document that you have received--we have 
expressly said that we will need supplemental funding in----
    Mr. Spratt How much? Can you give us an approximation?
    Mr. Bolten. Well, one of the reasons why there is not a 
specific number in here is that it is impossible to know how 
much we will need for the war in Iraq and Afghanistan.
    Mr. Spratt. But that happened last year, you know, and 
within months we had an $80 billion supplemental on our desk, 
in a few months we had an $87 billion supplemental on our desk. 
We now have 3 years of cost experience in those theaters. 
Surely we can extrapolate what the likely cost is going to be 
in 2005.
    Mr. Bolten. Well, Mr. Spratt perhaps you are able to 
extrapolate exactly what the security situation is going to be 
in Iraq and Afghanistan, but I think most of our defense 
experts are unable to say that.
    Here is what I did say yesterday if I may----
    Mr. Spratt. I think as the Budget Director you should at 
least have some approximation because it is a big number and it 
determines whether or not you can fulfill the pledge that you 
have solemnly made to cut the budget deficit in half in 5 
years. $50 billion is a big number.
    Mr. Bolten. I agree completely, and that is why I used a 
number in my remarks at a press conference yesterday that you 
cited.
    If I could lay out what I actually did say, the number--the 
amount that we will need to spend for the war in Iraq and 
Afghanistan is not knowable at this time, first. Second, it is 
common practice, and in fact, it is far preferable practice 
that we handle emergencies, war spending, through supplementals 
so they don't end up folded into the base, which means that it 
is very hard to get that funding out once the war ends.
    What I did say, as well, is that our current spending path 
suggests that we will be spending in 2004 outlays less than $50 
billion to keep our troops on the ground supplied in Iraq and 
Afghanistan. If you want to assume that the level of our 
commitment in 2005 is going to be as robust as it has been in 
2004, then you will have to add into our deficit number for 
2005 something below that $50 billion figure. My own 
expectation is that our need will be less, but we do not know.
    The reason why I used that particular figure was for those 
who want to assume our commitment is going to need to remain as 
large, my hope and expectation is that it will be lower, but we 
want to be sure that we are forthright in indicating that we 
are going to need that spending in 2005, and you need to add 
that into your deficit calculation.
    Mr. Spratt. I understand. I have got one minute under the 
rules.
    OK, I will take a few minutes.
    When you mentioned the deficit, you did say it is 
undesirable and you did say it is unwelcome. I don't find a lot 
of moral fervor in those words, and it seems to me that in the 
budget here you are making a choice. You know that there is no 
more surplus, and therefore, $1.2 trillion in additional tax 
cuts has to go straight to the bottom line and has to increase 
the deficit, pro tanto, by that amount, $1.2 trillion. So in 
effect you are saying that tax cuts trump the deficit, tax cuts 
in my estimation--this administration's estimation--are more 
important than the deficit itself.
    Mr. Bolten. What we are saying, Mr. Spratt, is that 
economic growth is a priority here because it is flagging 
economic growth that brought us into the deficit situation we 
now face. It is recovering economic growth that will bring us 
out.
    Mr. Spratt. And you are not worried that $521 billion 
deficits and $2 trillion in additional debt over the next 5 
years could indeed run up interest rates, could cause, you 
know, foreigners not to want to hold all of the denominated 
assets? There are all kinds of economic perils that deficits 
can impose upon the economy.
    Mr. Bolten. No question about it, and Dr. Mankiw--I will 
let him say a word in just a second--specifically mentioned 
that in his testimony.
    We do need to be concerned about that. So far, we have not 
seen those effects in the economy. We continue to have 
historically low interest rates right now in the economy, but 
it does need to be a matter of concern, which is why we have 
proposed a budget that we believe credibly puts us on a path 
toward bringing that deficit well below its 40-year average 
over the next 5-year period.
    Mr. Spratt. Dr. Mankiw, if you don't attain that goal and 
we have deficits of this magnitude indefinitely into the 
future, aren't you worried about the impact on the economy, 
interest rates, growth?
    Mr. Mankiw. I think the reason that deficits are 
undesirable, as Mr. Bolten said, is that they do tend to 
raise--put pressure on interest rates. There is a wide range of 
views among professional economists about how large that effect 
is. But I think certainly the consensus among professional 
economists is there is some upward pressure on interest rates 
there, and that is one reason why we want to get the deficit 
down, because it is bad for growth to run large persistent 
deficits; and that is precisely why the President has proposed 
a budget to reduce the budget deficit in half over the next 5 
years.
    It is also true that high tax rates put downward pressure 
on economic growth. So the win-win situation is we have neither 
the burden of deficits nor the burden of high tax rates through 
spending restraint.
    Mr. Spratt. It is my understanding that tax revenues this 
year will be 15.8 percent of our gross domestic product, and 
that is their lowest level as a percentage of GDP since 1950.
    Mr. Mankiw. Tax revenues are down in part because the 
economy is down, in part for technical reasons involving the 
stock market and capital gains collections and other sort of 
economic factors associated with the end of the high-tech 
bubble.
    Mr. Spratt. Let me ask one other question on a different 
topic; then I will turn it over to the others.
    The President also said in his State of the Union speech 
that his budget would include and the administration would 
support health care tax credits, and those would include 
refundable tax credits because otherwise they wouldn't be of 
any value to lower-income citizens who don't happen to have 
health care and don't have incomes that are significantly 
taxable.
    When we look through your budget to see how much was 
provided for that, we found that there was $65 billion included 
as an expenditure, which a refundable item would be, an outlay; 
however, it was footnoted, and the footnote indicated that this 
proposal for refundable health care tax credits to help 
Americans who don't have health insurance obtain it through the 
tax code, this idea would be implemented only if the total cost 
of it were its offset.
    You didn't propose offsets. Instead, you say in the budget 
documents, we are ready to work with Congress to identify $65 
billion in spending offsets, which I think you will agree in 
this kind of budget would be a Herculean task.
    So is this a proposal that you will put this up if we can 
find $65 billion to make room for it in the budget?
    Mr. Bolten. Mr. Spratt, that proposal is fully up before 
you. It has been up before you in the past few years. It has 
been on the President's agenda for some time.
    Mr. Spratt. But the budget documents say it is contingent 
on our identifying $65 billion in offset spending cuts.
    Mr. Bolten. Right. And we do have $35 billion in mandatory 
spending offsets that could be applied to this purpose, but we 
want to be sure it is consistent with the proposal that we have 
made for budget enforcement reform that we fully offset any 
increase in mandatory spending, as this would be; and what we 
are indicating is that we are prepared to work with you, once 
the legislation is taken up, to ensure that we do have adequate 
offsets for it.
    It is not a 1-year proposal, as you know. This is over the 
full budget----
    Mr. Spratt. Over a 5-year period of time, I guess. Where 
does the $35 billion come from? That will be my last question. 
The offsets you have identified, what are they?
    Mr. Bolten. A large portion of it comes from Medicaid 
savings, that is, the intergovernmental transfer proposal, and 
several others that are listed in the budget.
    Mr. Spratt. Aren't you taking from one poor person to help 
another?
    Mr. Bolten. I don't think so, Mr. Spratt, if you are 
talking about the intergovernmental transfers proposal.
    Mr. Spratt. No. I am simply saying you are taking it out of 
Medicaid, which helps poor people.
    Mr. Bolten. No. In that proposal what we are doing is 
taking money away from the Medicaid program that States 
themselves are taking away from the Medicaid program in a way 
that we think is not at all supportive of Medicaid. It is 
basically a mechanism that States have used over time to help 
their own budgets, that is totally unrelated to Medicaid and 
not proper for the Federal Government to be paying.
    Mr. Spratt. We will talk about it another time. Thank you.
    Chairman Nussle. Mr. Gutknecht.
    Mr. Gutknecht. Thank you, Mr. Chairman.
    And thank you for coming up here to visit with us today. I 
must confess I haven't had enough time to really go through the 
details of what the President has put before us, but I am 
struck at how much things have changed. I have been on the 
Budget Committee long enough that I remember where we were on 
September 11, 2001. We were preparing to have a Budget 
Committee meeting to talk about how we could keep from dipping 
into the Social Security Trust Fund. We don't even talk about 
that anymore; that is how far we have come.
    The other thing, I am struck, in listening to Mr. Spratt, 
with how both sides seem now to be defending turf that we were 
formerly completely unfamiliar with. On one hand, they are 
concerned about the Alternate Minimum Tax, which was put in in 
previous years to tax the rich, and yet at the same time they 
want to eliminate the tax cuts which might benefit the rich. 
There is a certain amount of inconsistency on both sides.
    But I do agree that the issue here we really need to 
concentrate on is economic growth because the one thing that we 
saw through the last 6 years is that if we could keep the 
economy growing here in this country, it helps cover a world of 
sins by this Congress.
    And I want to come back to something, Mr. Mankiw, that you 
said, because I don't think you answered completely, because I 
think it is important. I have said before--I believe this--we 
have a lot of theories around here. I tend to subscribe to your 
theory that if you want stronger economic growth, you have to 
allow Americans to keep and spend more of their own money; and 
the reason I believe that is because they can spend that money 
far more efficiently than we can spend it on their behalf, 
which is the real argument for reducing the scope and size of 
the Federal Government. But I want to come back to a point, and 
we are going to argue about how much the government should 
spend and how much it should grow and how much of the GDP it 
should consume.
    But one of the other points that I have made before is that 
government will be paid for. We can argue economic theory, but 
this is a fact: Government will be paid for. It will either be 
paid for now by current taxpayers or it will be paid for in the 
future by taxpayers, with interest. Our children will pay for 
that government, with interest.
    I want to come back to that question because I think it is 
important. If we continue to borrow upwards of $400 billion a 
year from our grandchildren, how much impact does that have on 
economic growth? And if we allow the government to grow, if the 
Federal Government continues to grow at two or three times the 
rate of the private sector, what does that do for economic 
growth in both the short and the long term?
    Mr. Mankiw. Most economists believe that tax cuts of the 
sort that the Congress passed and the President signed into law 
are good for economic growth both in the short run and the long 
run.
    In the short run, such tax cuts have important demand side 
of results, you put more money in people's pockets, they spend 
them, firms start hiring more workers to produce the goods that 
people are buying.
    In the long run, it has important supply-side effects by 
encouraging people to work, encouraging people to start 
businesses, encouraging savings, investment, and capital 
accumulation, which are the backbones of productivity growth 
which leads to higher real wages and higher living standards.
    But as you pointed out, the government faces a budget 
restraint. What that means is that tax cuts and spending 
restraint have to go hand and in hand. You really can't do one 
without the other. So it makes perfect sense, when the 
President talks about making the tax cuts permanent, that he 
also talks about spending restraint, because only through 
spending restraint is it possible to make the tax cuts 
permanent, and that is precisely why the President has proposed 
this progrowth tax policy and progrowth budget.
    Mr. Gutknecht. So you don't think that there is a 
consequence, in the next 2 to 3 years, of these big deficits? 
You think the Federal Reserve is going to keep interest rates 
low forever?
    Mr. Mankiw. I am not going to comment on Fed policy, 
although we do have an interest rate forecast in part of the 
administration forecast. That forecast is for rising interest 
rates as the economy recovers. It is very normal in a cyclical 
recovery for interest rates to rise as the economy recovers, 
and that is certainly what we are expecting, as well as most 
private-sector forecasters.
    Most economic textbooks will tell you the appropriate time 
to run a budget deficit is in times of war and recession, and 
we have experienced both. And I think the deficits we are 
seeing now, while not desirable, are a very understandable 
response to this series of economic and political forces that 
we have been experiencing.
    On the other hand, large persistent deficits are not 
desirable and do impede economic growth, and that is precisely 
why this budget includes shrinking budget deficits over time.
    Mr. Gutknecht. Thank you.
    Chairman Nussle. Mr. Moran.
    Mr. Moran. Thank you, Mr. Chairman.
    In his State of the Union address, President Bush told us, 
and I quote, ``In 2 weeks I will send you a budget that funds 
the war, protects the homeland, and meets important domestic 
needs by limiting the growth in discretionary spending to less 
than 4 percent.'' But yesterday, 2 weeks later, the President 
sent us a budget that does not fund the war in Iraq or the war 
on terrorism in Afghanistan or anywhere else.
    The DOD press release, the Department of Defense press 
release on the budget, states that with respect to incremental 
costs for operations in Iraq, Afghanistan, and the global war 
on terrorism, we have yet to determine the scope of those 
operations.
    Well, you know, Chairman Nussle said very clearly to the 
witnesses for the Department of Defense that when you submit 
your budget for 2005, you have got to include the war on--the 
war in Iraq and estimates of any other military conflicts. Now, 
to say, in quotes, ``a budget that funds the war,'' that was 
clear, could not have been clearer, and yet the Department of 
Defense and the Office of Management and Budget--you, Mr. 
Bolten--have decided you are going to ignore the President's 
statement.
    Now, I think it is appropriate for you to explain why you 
chose to ignore the President's very clear statement, and I 
know your answer is going to be something about, we don't know 
when we are going to hand over power in Iraq. The fact is that 
you said yesterday that we are funding the war in Iraq and 
Afghanistan at a rate of $50 billion.
    Now, if you put $50 billion in there, would that not be 
more accurate than to put zero? Is there any chance that we 
will spend zero on the war in Iraq and Afghanistan in the 
fiscal year 2005, Mr. Bolten?
    Mr. Bolten. Mr. Moran, the budget document that you have in 
front of us expressly says that we will need supplemental 
funding in 2005 for our ongoing operations in Iraq and 
Afghanistan. That is the actual incremental cost of keeping the 
troops on the ground. So we have been completely forthright in 
this document.
    Mr. Moran. Mr. Bolten, I am sorry and I know what is in the 
budget, but I am not asking you what you have said in the 
budget. I am asking for an explanation, because we have a 
budget here that you are telling us is not complete, that you 
are telling us you are going to make offsets, for example.
    We need to have some idea. Where are you going to get those 
offsets when you decide to actually ask us for the cost of the 
war in Iraq? The President now says, we are told, he is going 
to wait until after the election to hit us with that 
supplemental.
    But that means this whole budget resolution process is 
something of a sham. We know it is not accurate. We know we are 
going to have to take money from other programs. We know we 
have to fund the war in Iraq. We knew when we got the budget 
resolution last year that there was no money for Iraq, and yet 
there would have to be. We have now spent $166 billion we have 
allocated for the war in Iraq, and those numbers are above our 
budget resolution. And it is one of the reasons why when the 
President said he was going to hold it at 4 percent, total 
spending went up by about 12\1/2\ percent, about 3 times what 
the President said it was going to be; discretionary spending, 
about 8 percent.
    That takes credibility out of our budget resolution 
process. It makes us in the Congress look bad, and yet there is 
nothing we can do about it if you are not going to be 
straightforward with us. Some of this is a lecture, but it is a 
lecture I am sure that the chairman would like to make if he 
wasn't in the position he is in. But I would like to know, get 
some idea where you expect us to get the money to pay for the 
war in Iraq, which you know is going to necessarily have to be 
funded after the election.
    Mr. Bolten. I have had an opportunity to discuss this with 
the chairman. It was not quite in the same vein as the 
conversation that you and I are having right now, but what I 
did say yesterday, and I repeat today, is that the right way to 
do this kind of funding is through supplemental funding. We 
only have two choices in our current system, and maybe we ought 
to talk about how else we might do it. We could put the 
additional funding for a war, for which at this time we do not 
know the costs, and put that into the regular budget, run the 
risk that it becomes part of the baseline and increases defense 
funding inappropriately out into the future; or when we know 
the numbers, when we have a better handle on them, we can 
handle that incremental funding, and that is all we ask for in 
the supplementals is incremental funding.
    We can ask for that through supplementals. Given those two 
choices, the correct path is to do the latter. And when we come 
forward with a budget, we are going to need to do the latter. I 
also set some limits on what I think the actual request is 
going to be because I identified for Mr. Spratt and I 
identified for the press yesterday the amount we believe we are 
spending now in Iraq and in Afghanistan.
    Out over the course of the coming year, we expect that 
amount, the actual outlays to be less than $50 billion. If you 
choose to believe that our commitment in Iraq and Afghanistan 
is going to need to remain as robust in 2005 as it has been in 
2004, then that is the number you should expect to add to the 
deficit. My own hope is it will be less and probably 
substantially less.
    Mr. Moran. Zero is not an accurate number.
    Chairman Nussle. If I could, I do share the gentleman's 
frustration. I think many of us do, for the very reason your 
last point or question and that is we know it is not going to 
be zero. The challenge that we have is that we hope it is not 
going to be 50 either. And trying to come up with a number in 
between is a challenge, particularly when we don't want to feed 
it into the base of defense spending that, as a result, grows 
and compounds every year thereafter.
    And I would ask if I could, as a followup to the 
distinguished gentleman from Virginia, is there a way, or would 
you be willing to work with us to try and answer this question 
as we move the budget resolution forward, because we believe 
that honest budgeting--we know it is not zero and hope it is 
not 50, but we are afraid to put in 30 if it is really 40. I 
mean, that is the challenge we have got, or afraid to put in 10 
if it is 20. Coming up with a way to answer this question so it 
is clear within the budget and it is clear within the stated 
goal of reducing the deficit over time is something we need to 
work with you in order to accomplish.
    Mr. Bolten. It is a challenge and you have identified 
exactly the problem. If we put in too large a number and we end 
up having that money in the base, then we run the risk of 
inflating the defense budget entirely inappropriately and 
expanding our deficit in ways that all the members of this 
committee would be concerned about. If we put in too low a 
number, then we would be accused of trying to hide the true 
costs of the war and underfunding the actual needs of our 
troops. There is a real challenge to these emergency situations 
and that is what this is. This is a war. There is a real 
challenge to budgeting for them. I would be happy to work with 
the committee.
    Right now, our only available option that makes any sense 
is to notify the committee, as we have done very forthrightly 
in this budget, that we intend to come forward with a 
supplemental when the numbers are clear and at a time when the 
Defense Department needs the money.
    Chairman Nussle. I thank the gentleman.
    Mr. Thornberry.
    Mr. Thornberry. Thank you, Mr. Chairman. Dr. Mankiw, I want 
to get back to this point that Mr. Gutknecht asked about and 
you referred to at the end of your statement, because I do 
think it is a very fundamental issue when you look at budgets 
as to the economic effect of taxes or borrowing. I have saved 
an article from last fall written by Robert Samuelson. This 
copy happened to be in the WashingtonPost.com, and it is 
entitled ``The Deficit Chicken Hawks.'' He points out in the 
beginning that a variety of Republicans and Democrats are 
talking about deficits and the problems that they create, and 
then he goes on to say that almost everything you think you 
know about budget deficits is wrong or misleading and talks 
about their effect on the economy and the effect on tax rates.
    But the key is this paragraph, which I want to read, and I 
want to see whether you agree with Samuelson's opinion. He 
says, and I quote, ``but the big gest misconception about 
deficits is that by themselves, they threaten the economy's 
long-term vitality. Not true. The real threat is rising 
government spending. The reason is simple. Government spending 
must be paid for by either taxes or borrowing. If spending 
rises too high, economic growth may suffer from either steeper 
taxes or heftier deficits. Spending is the real culprit.''
    Now is that your view and the administration's view that 
either taxes or spending create?
    Mr. Mankiw. I absolutely do agree with that. One of the 
things that no economist that I know of disagrees with is the 
idea that the government faces a budget constraint. What that 
means is that every time you increase spending, you are 
increasing taxes, if not immediately, then sometime down the 
road, and that is the sense as I said earlier the policy of 
cutting taxes and restraining spending go hand in hand. 
Permanent tax cut is only feasible if it is with spending 
restraint. That is why the President has put forward the 
spending-restrained budget in front of you.
    Mr. Thornberry. Perhaps we ought to keep our eye on the 
ball, at least in the opinion of this economist that the real 
threat is spending levels rather than spending deficits. Mr. 
Bolten, I want to ask you specifically on the subject of taxes, 
my understanding is that some of the reductions in taxes which 
we have passed in previous years are set to expire at the end 
of this calendar year. I would like to know what those tax cuts 
that are set to expire, how many people are affected, if you 
have those numbers, and how they would be affected if they 
expire in taxes and those areas are allowed to go back up?
    Mr. Bolten. There are three specific provisions that expire 
at the end of this year. They are the child credit--these are 
tax cuts, the child credit that expands the credit to $1,000 
per child. There is marriage penalty relief and they are the 
expansion of the 10 percent bracket. I don't have the exact 
numbers for you. We would be glad to provide them for the 
record. Maybe one of my colleagues could help me out with 
something, but those provisions apply to nearly every taxpayer. 
Certainly, your average family in America, these are the tax 
cuts that are important to them. And they make a huge 
difference in the tax bill that the average American family 
faces, because child credit, the marriage penalty and the 
expansion of the 10 percent bracket hits right at the heart of 
where the tax code hits average American families.
    Mr. Thornberry. I would appreciate it, if not now, to know 
how many or what percentage of the taxpayers are affected by 
each one and how much their tax bill will go up if these tax 
cuts are allowed to expire.
    Mr. Bolten. We can break that down, Mr. Thornberry, but I 
would say that almost every taxpayer in America is affected by 
at least one of these provisions.
    Chairman Nussle. Ms. Baldwin.
    Ms. Baldwin. Thank you, Mr. Chairman, Ranking Member 
Spratt. One of the best ways to appraise this budget is whether 
it conveys to the American people that this President 
understands the problems they are facing and attempts to 
confront those problems head on. Mr. Bolten, today, I would 
like to take a little opportunity to look at how this budget 
will affect my constituents. And it seems to me that the 
President's priorities are more tax cuts, and that those tax 
cuts continue to benefit the most affluent Americans over 
middle and lower income Americans, and one of the immediate 
issues of jobs, health care and education.
    And parenthetically, these are the three chief issues that 
my constituents raised to me when we get a chance to meet and 
share. This budget makes most of the provisions of Bush's 2001, 
2002 and 2003 tax cuts permanent, and at a projected cost of 
1.1--sorry, 131.6 billion over 5 years, but at a cost of $936.3 
billion over 10 years or $2.2 trillion when one includes 
interest on the debt.
    But it also proposes a series of new tax-favored savings 
account, the lifetime savings account and a new tax-favored 
retirement savings account. And in both of these cases, 
programs appear affordable in the short-term, 5-year picture. 
But when fully mature, these are projected to cost up to $50 
billion per year. These tax initiatives, all of them combined, 
will certainly drive us deeper and deeper into debt and will 
disproportionately, as I mentioned earlier, enrich the very 
most affluent in this country.
    In so doing, this will squeeze out our immediate hope in 
doing some meaningful things to address some our constituents's 
top challenges, jobs, education and health care. The effect of 
extending the tax cuts that previously had been passed and due 
to expire, remains very similar to the original packages before 
us. The top 1 percent of households will receive on average a 
$58,000 tax break, but yet the average middle income family 
will receive a tax break of around $655.
    So this commitment of just under $1 trillion over 10 years, 
only 47 percent or $440 billion will go to the top 5 percent of 
households. And that is a larger share than the entire 90 
percent--bottom 90 percent gets when combined. I think that the 
new savings plans would similarly benefit the very wealthy. The 
lifetime savings account, when fully up and running, according 
to some estimates, would provide the top 5 percent of the 
population with 50 percent of the tax benefits. The top 10 
percent would secure two-thirds of the tax benefits. And 
believe it or not, the retirement savings accounts are supposed 
to be even more skewed in terms of who receives the tax 
benefits. And I don't have time to go into some of the reasons 
why these appear so skewed in the outyears, but if you look at 
even current law, the Treasury Department says only 4 percent 
of those currently eligible to contribute to IRAs are able to 
actually max out and 5 percent of those participating in 401Ks 
are able to actually contribute to the minimum. These are the 
people who are going to receive the real benefit of these new 
proposals.
    But bringing it back home, the average family of 4 in my 
district will not get a lot of these benefits from these 
trillion dollar commitments that we are making over the next 10 
years, aside from additional interest payment on rapidly-
expanding debt. And yet, families in my district are still 
struggling with recent job losses and significant increase in 
health insurance costs. And it appears from this budget, 
reacting to these are simply not a priority. If you will, do 
you dispute the outyear, 10-year estimates, 2009-14 on the tax-
cut extensions that I just mentioned and also the fully 
implemented savings programs?
    Mr. Bolten. Ms. Baldwin, I don't actually have the numbers 
at hand on the LSAs, RSAs. I am going to ask Dr. Mankiw to say 
something on that. With respect to the extension of the tax 
programs, I think your numbers sound about in the range that we 
have estimated, and I think those were roughly the numbers that 
we were carrying in the budget tables at the back of our 
proposal. If I may take--Mr. Chairman, if I may go over Ms. 
Baldwin's time for several minutes because she raised some 
issues. Can I ask for one chart to be put up on the screen 
about the tax cuts, because you expressed some concern about 
the tax cuts being skewed to the rich.
    One of the things that happens with our tax code and has 
happened increasingly over time is that wealthy people have 
paid a larger and larger percentage of the total income tax. 
So, therefore, if you cut taxes, wealthy people tend to get 
more of the tax cut. But the net effect of the tax cuts that 
this Congress passed, and the previous tax cuts that the 
previous Congress passed, has been to make the tax code more 
progressive, and that is demonstrated in this chart.
    And let me take one example which is the top 5 percent. 
Those are the top 5 percent of income earners in this country. 
Those are people making more than $135,000 a year. And I think 
most of us would accept that is someone in a pretty high income 
range. Before the tax cuts, if you took out all of the tax 
cuts, the income tax cuts that you all adopted, those people 
were paying 50 percent of the total tax revenue in this 
country. The top 5 percent would have been paying 50 percent of 
the total tax revenue. After the tax cuts, that same group is 
paying 53 percent of the total tax revenue in this country. The 
result of the tax cuts that you all enacted has been to make 
the tax code more progressive rather than less.
    And I think that is the kind of relief that the tax cuts 
have made. More importantly than arguing sort of in the rear 
view mirror about who is benefitting more than who because 
there is a lot of benefit to go around in these tax cuts, the 
important part of the tax cuts is that they benefit the 
economy. Jobs is No. 1, I imagine, in your district. People 
care most about jobs. And where the jobs are coming from is 
especially in the small businesses of America.
    Those small businesses typically, especially the subchapter 
S corporations, pay the top income tax rate. They flow through 
their income and pay the top income tax rate. So when you talk 
about a tax cut benefitting the rich, a lot of the people 
getting that tax cut are the businesses. They are getting it 
through their business to create jobs. It is the small 
businesses in districts all over America that are really 
creating jobs. When they get that tax money, they are able to 
plan, they are able to invest and use that money to create 
jobs.
    If you care about jobs going forward, the worst thing we 
can do for those folks is threaten them with a tax increase. 
That will choke off the economic recovery that we are now 
seeing and cause those people to draw in on their investment 
and fail to create the jobs that I think are the most important 
things on your mind and the President's mind as well. Let me 
ask Dr. Mankiw to say a word about the LSAs and RSAs.
    Mr. Mankiw. Let me just say a word about the broader 
economic impacts of tax provisions aimed at increasing private 
saving. Private saving is now a low by historical standards, 
and that is a concern for many economists, and it is concerned 
both at the micro level that people may not be saving enough, 
but it is also concerned at the macro level, because one of the 
things we learn in basic macroeconomic courses is that saving 
provides the funds available for investment in the economy, new 
factories, new equipment, new housing. Investment in turn leads 
to capital accumulation.
    Capital accumulation in turn leads to productivity growth. 
And it is growth in productivity that allows rising incomes, 
rising real wages and rising living standards for American 
families. In thinking about the LSA RSA proposal, it is 
important to think about this not only in terms of its 
immediate effects, but the fact that this is going to provide 
incentives to save, which in turn is going to provide the 
foundation for longer term economic growth.
    Chairman Nussle. Mr. Toomey.
    Mr. Toomey. Thank you, Mr. Chairman. First thing I wanted 
to just touch on for Dr. Mankiw, to just follow up on a 
discussion we had earlier, you described two different aspects 
or two different ways in which the tax cuts affect the economy 
for the better. One was the demand side, the sort of immediate 
impact of people having more cash and they spend it; and the 
other is the supply side effect of creating greater incentives 
to work and save and invest. It strikes me that over time, the 
bigger impact of the two is the supply side effect, the fact 
that as long as we keep lower marginal tax rates, as long as we 
maintain lower capital gains rate, as long as we keep the pro-
growth policy in effect, we get year after year after year 
ongoing permanent increased incentives and therefore greater 
economic impact.
    So as you weigh the two, the greater economic value comes 
from maintaining the lower tax rate regime versus the short-
term demand side impact. Do you agree with that or would you 
characterize it differently?
    Mr. Mankiw. I agree with 90 percent of what you said. Most 
economists would say that the demand side effects would 
predominate in the short run over the period of 6 months or a 
year when you have unused capacity, and the idea is to increase 
demand. People put that capacity back to use. But over time as 
the economy goes back toward full employment, supply side 
effects will predominate, and both the supply side effects of 
lower marginal tax rates, meaning increased incentive to work 
also means increased incentives for capital accumulation in 
saving which is--which leads to productivity and growth in the 
long run.
    Mr. Toomey. I want to follow up briefly on the comments 
from my colleague from Texas, which I think were exactly to the 
point about the real measure of the burden the government 
imposes on the economy. I have long believed that it is best 
measured by the total level of spending and the way in which we 
finance that spending is of secondary importance to the total 
amount for a variety of reasons. I am very glad we established 
that once again here today. I think we need to emphasize and 
keep our eye on the ball. The problem is spending. That is what 
generates the big deficits and that is what represents the 
misallocation of capital. In terms of getting that under 
control, there are several things we have attempted.
    In the past, we have had a practice perhaps not always 
observed, but at least occasionally observed when there was a 
supplemental appropriation bill introduced, at least the 
nondefense parts would often be offset or at least there would 
be an attempt to offset it. I myself offered amendments in 
recent years to try to offset the nondefense portion of 
supplemental appropriation bills. Yet we have not been able to 
do that. And if my recollection is correct, the administration 
has not requested off sets. Is that the policy of the 
administration now or in the future, if we do have additional 
supplemental requests outside of the defense arena to those new 
spending measures that would above and beyond this budget?
    Mr. Bolten. Mr. Toomey, we don't have a policy of when we 
will or not seek offsets. Something as large as a war 
supplemental, there really isn't a reasonable prospect of doing 
that. When we see the prospect and see the prospect of actual 
enactment, we would like to work with you to see to it that any 
additional spending, for whatever the supplemental may be, that 
we can offset it because we are concerned about the same things 
you are: that those supplemental expenditures do tend to 
undermine the integrity of the whole budget process.
    Mr. Toomey. When you have a war, it is just not feasible, 
and I have not advocated that we attempt to offset that kind of 
magnitude. But as you recall, we did have more modest size and 
non-war related supplementals, including about $1 billion for 
FEMA recently, where I think we could have off set that. And if 
we can get that situation where it is manageable, I hope you 
will work with us and establish that discipline in finding 
those offsets.
    Second thing I wanted to observe, I am glad to see that the 
President is proposing a very, very modest, certainly by recent 
historical standards, a very modest increase in nondefense, 
nonhomeland security discretionary spending. I hope we can hold 
it to even less than that, but certainly that is movement in 
the right direction. My concern is that only amounts about one-
sixth of the total budget here, and two-thirds of the total 
budget is mandatory spending. We have recently, in recent 
years, increased that dramatically, a farm bill, this new 
prescription drug bill which is, of course, an enormous 
increase. Isn't there something we could be doing now on the 
mandatory side to try to get this under control, especially 
since mandatory spending has been growing at a more rapid rate 
in recent years and it already represents two-thirds of the 
budget?
    Mr. Bolten. There is a great deal we can do on the 
mandatory side. The chairman and you have long both been 
advocates to control that portion of the spending, which is 
that much more difficult to control. We have proposals in our 
budget to reduce some mandatory spending. I alluded to one in 
my exchange just now with Mr. Spratt on Medicaid, but there are 
a lot of other areas where I think we can work on holding those 
expenditures down. And institutionally, I think a very 
important move we can make is to adopt the kind of budget 
enforcement legislation that the administration is intending to 
put forward that would set limits on mandatory spending. If you 
want to propose to increase mandatory spending under this 
proposal, you have to propose at the same time to cut mandatory 
spending.
    Chairman Nussle. Mr. Moore.
    Mr. Moore. Thank you, Mr. Chairman. We have a $7.1 trillion 
debt, national debt in our country right now. We have a $521 
billion deficit projected for this year. We are spending almost 
a billion a day on what I call the debt tax, the interest on 
the national debt. That is the only tax that can never be 
repealed. And we are here talking today about what we are going 
to do this year and how we are going to try and cut that in 
half over the next 5 years, and I am very, very concerned about 
the future of our country.
    I spoke to a high school class 2 weeks ago. And I said to 
the senior class why should you be concerned about the national 
debt. One girl raised her hand and said because we are going to 
have to pay it off. Good luck to them and good luck to our 
grandkids, because we are going to saddle them with a debt that 
I don't think they can ever pay off, especially when it comes 
to the baby boomers starting to retire and that kicks in as 
well. So we have some major problems here, and I think this 
budget submission does not deal with reality of the situation 
we are facing right now. And I want to be as respectful as I 
can here, but I am very, very concerned here.
    And I think we as Republicans and Democrats need to come 
together and put aside partisan politics and say we have a 
problem in this Nation and we have to do something for the 
future of our kids and our grandkids and our country to make 
sure that we solve this problem. The chairman talks about how 
we want to stay strong and free, and I want that and I think 
both people on both sides of the aisle want that for our 
country. But a country can't be free, strong, and broke, and 
that is where we are headed right now if we don't turn things 
around. When it comes to supporting our national defense, when 
it comes to supporting our homeland security, I think you are 
going to have 95 percent of people in this Congress agreeing 
with that.
    And we will support our troops. I voted for the use of 
force resolution. And I voted for the $87 billion supplemental 
and I will support our troops, but I don't like it--and with 
all due respect, when people come in here and say, well, we are 
not going to tell you how much it is going to cost because we 
don't know; even businesses make advised and informed judgments 
and projections and estimates. And you could give us a 
projection or estimate about a supplemental. If it is wrong, it 
is wrong but it is better than a zero estimate. And that is 
what we had last year. I am concerned about where we are going.
    Again, I think we need to work together and put aside 
partisan politics and do what is right for our country. You 
talk about the worst thing we can do right now to small 
business--and I want to protect small business and I don't want 
any tax increases. I voted for the President's tax cuts 2 years 
ago when we were in surplus mode. I voted against it last year 
when we were in deficit mode and supported a smaller tax cut 
that was paid for because I thought it was the fiscally 
responsible thing to do.
    What we need to do now, you talk about the worst thing that 
could happen is a tax increase for businesses. I think maybe 
worst than that would be what Alan Greenspan expects to talk 
about in the next 30, 45 or 60 days, and that is, the danger of 
interest rates going up when this economy starts chugging 
again. And you remember the late 1970s. We had interest rates 
of 14, 16, 17 percent and that would be absolutely devastating 
for business, real estate, consumer borrowing for everybody in 
this country as far as I am concerned, except for people who 
want to get a large return on their investment.
    We cannot afford as a Nation and people are not seeing that 
right now, and I think because we have the lowest interest 
rates in this country we have had in 40 years. If we don't get 
a handle on this, I fear we could be in for rough sledding 
ahead, and we owe it to our country to do much better than 
that.
    The thing that gets me the most about this job is the 
ungodly partisanship up here. I am not being partisan when I 
say that because both sides do it, but we need to stop that and 
start working together for our country. And I guess I would ask 
you again, I suppose you can't do it today, but please come 
back to us as soon as possible with some estimate as to what 
this continuing conflict in Iraq is going to cost, just an 
estimate so we can plan. I don't expect it to be built in the 
base.
    I understand the reason for that, but you could at least 
give us an estimate between zero and 50 billion of what it is 
going to cost. And I would ask you to do that and submit it 
back in writing as soon as possible. Thank you.
    Chairman Nussle. Mr. Hastings.
    Mr. Hastings. Thank you, Mr. Chairman, and I thank the two 
of you for coming and testifying today. I have to remark with 
my friend from Kansas, and I know and I understand the 
compassion he is speaking with in trying to get this resolved 
and I have been on this Budget Committee--this is my 4th year 
now, and I remember 9/11 also when we were supposed to meet 
here and talk about getting into the Social Security trust fund 
and how difficult that was. But what Mr. Gutknecht didn't say 
when he referred to that was that times have changed.
    September 11 changed a whole lot and that is representative 
of the need for this country as represented with the increase 
in homeland security spending of 10 percent, and defense, 7 
percent, and trying to keep a cap on other spending because the 
economy hasn't grown. But the reason I mention to my friend 
from Kansas' remarks on that, we have the responsibility in 
this committee to build a budget. I would hope--we are the 
majority party and we will have a budget. I would hope that we 
will have an alternative so we can debate the alternative. We 
didn't have that the last time. And without an alternative this 
becomes a whole lot of political gamemanship.
    So I am with my friend from Kansas. I hope we don't do 
that. But it seems to me we ought to at least acknowledge there 
hasn't been a budget that we can debate between the two of us. 
I want to talk about a couple of issues in my district that 
hasn't been touched about, but I want to give kudos to OMB, 
particularly in regard to the commitment that your predecessor 
made at OMB and you have made at OMB regarding the clean up of 
the most environmentally contaminated sites in this country, 
and that is the nuclear sites at Hanford and Savannah River and 
other places in the country.
    The administration made a commitment two years ago to 
accelerate that clean up that will save billions of dollars in 
the outyears. I want to congratulate you for keeping that 
commitment. I just wanted to say you have kind of a proviso in 
there to have at least some discussion on the reclassification 
issue. I want to let you know that this member is talking to 
both the Department and my State to see that that gets done as 
quickly as possible. And if you want to comment on that, that 
would be fine.
    Mr. Bolten. Thank you for your comment, and I thank Mr. 
Moore for the tenor of his remarks.
    Mr. Baird. Would my colleague from Washington yield for 
just one moment?
    Mr. Hastings. I have a short period of time and I want get 
my questions----
    Mr. Baird. We did have a budget last year, an alternative.
    Mr. Hastings. Again, dealing with the Northwest, and you 
had some language and some issues there with the power 
authorities and specifically with BPA and specifically on page 
196, you said that the administration might consider proposing 
legislation regarding Bonneville Power. I understand that this 
is something that the administration is considering. Now is it 
true that you are just considering this? Is that an accurate 
statement?
    Mr. Bolten. That is correct, Mr. Hastings, and we would be 
very open to working with you on whatever plans we have.
    Mr. Hastings. That is something we work with on a 
bipartisan basis in the northwest, and we look forward to 
working with you as that consideration comes forward.
    Mr. Bolten. Mr. Hastings, we are aware of your interest and 
know what a strong advocate you have been for Bonneville and 
for all of the folks in that region. And we will certainly be 
consulting with you closely before we come out with any 
proposal.
    Mr. Hastings. I appreciate that, because BPA has tried some 
innovative things and that was the direction as a matter of 
fact that this committee and OMB had given them in the past. 
One last question here in my last minute. To get on the larger 
scale again, Mr. Toomey talked about the mandatory spending. I 
am glad you are going after the mandatory spending, because 
that is two-thirds of the budget. Would you care to comment on 
the 65 programs that you are seeking to eliminate just briefly. 
I want to save a minute.
    Mr. Bolten. Just briefly, Mr. Hastings, we do have a number 
of terminations proposed in this budget. There are 65 of them. 
They total $4.9 billion savings over the 2004 enacted levels. 
In addition to that, we have 63 major programs with major 
reductions in them. The total savings on that is about $8.0 
billion savings over the 2004 level.
    So there is quite a bit in this budget--quite a bit of belt 
tightening. This is not good news all around. There will be 
plenty of complaints from probably almost every member 
concerned about something we are proposing to either terminate 
or ratchet down. We will be ready to work with each of the 
members as we go through the process going forward. But 
something we do recognize is that when we have these demands of 
defense and homeland security, we do need to tighten the belt 
elsewhere. I think we are doing it in a responsible way, making 
sure that the real priorities of this country continue to be 
met.
    Mr. Hastings. Real quickly, Mr. Chairman, if I may. My 
remarks regarding a budget was a budget proposal alternative 
submitted in this committee. That has not happened in 4 years 
in this committee. That is all I was saying.
    Chairman Nussle. Mrs. Capps.
    Mrs. Capps. Thank you, Mr. Chairman and Ranking Member 
Spratt. I would like to turn our attention--Mr. Bolten, and 
welcome, Dr. Mankiw as well--to Medicare as a part of our 
budget. It has been widely reported in the press and it was 
revealed in the President's budget that the administration has 
a much higher cost estimate for the recently passed Medicare 
legislation, projecting a 10-year cost of $534 billion, a $139 
billion increase over CBO's estimate. Now in a letter from the 
CBO to Chairman Nussle dated yesterday, CBO explained the 
differences, including a $46 billion higher payment for private 
plans. Can you confirm that the administration estimates that 
private plans will receive increases of $46 billion under 
Medicare legislation?
    Mr. Bolten. No, I can't, Mrs. Capps. The actuaries have a 
large number of differences. I don't have any reason to 
disbelieve the number, but it is a very complicated area.
    Mrs. Capps. Yesterday, HHS officials briefed staff stating 
that the administration's estimate for payments to private 
plans is $46 billion. And in a letter to Chairman Nussle dated 
yesterday as well, CBO stated, and I quote, ``Both estimates 
assume that many of the participants in Medicare Advantage, 
which are the private plans as they are called now, are in 
areas where the payments to MA plans and beneficiaries through 
premium rebates would exceed what it would cost if those 
beneficiaries were in the fee-for-service sector. Most of the 
additional participants in the administration's estimate are in 
relatively low cost, low density areas where the payments to MA 
plans and beneficiaries would be substantially higher than the 
cost of those beneficiaries in the fee-for-service sector.''
    In other words, it would cost more to make these payments 
to private plans than it would to keep seniors in traditional 
Medicare. And my question is why should we pay private plans so 
much taxpayer money to provide services that would be cheaper 
in traditional fee-for-service plans--in a traditional Medicare 
fee for service?
    Mr. Bolten. I have to leave it to the actuaries who have 
done the briefing to provide you with the actual numbers. But 
stepping back to the principle involved, which I think is what 
you are asking about the Medicare bill that you all enacted 
last year adopts the very sound principle that that system 
overall will be better off if there is competition and choice 
in the system so that seniors who want to--only those seniors 
who want to, can move into a private plan that has a very 
strong history of providing both superior service, of providing 
more innovative service and ultimately doing it at lower cost.
    Within the budget window that the actuaries are talking 
about, there is an anticipation----
    Mrs. Capps. I would like to state for the record, according 
to Medicare Payment Advisory Commission, MedPAC, Medicare 
already pays private plans 19 percent more than what it would 
cost to serve those same seniors in the Medicare fee for 
service plan. And based on data from HHS's own actuaries, the 
average annual growth in Medicare spending from 1999 to 2002 
was 6.4 percent as compared to 10 percent for private health 
insurance. This is the evidence that we have. And even when you 
scrub the numbers to make sure they only compare benefits 
covered by both Medicare and private plans, Medicare growth was 
still lower at 6.2 percent compared to 8.7 percent for private 
plans.
    And you may say that private health plans are better at 
controlling costs, but all the concrete evidence is against 
you. MedPAC, the foremost resource on Medicare financing, 
clearly says that private plans cost taxpayers more than 
traditional Medicare. And even the data from your HHS supports 
this conclusion.
    On top of that, the fact is that they cost the taxpayer 
more and private plans are also less reliable than traditional 
Medicare. Across the country, even when they get increased 
payments, the private plans keep cutting benefits, raising 
cost-sharing and getting up and leaving our loved ones in the 
lunch. I strongly urge that the administration rethink this 
policy like our seniors are doing as they are receiving this 
bill and the language that it has been couched in. And I think 
we should go back and do away with this failed privatization 
experiment. I have left you a few seconds to comment on these 
strongly-held convictions and the data that I bring from my 
constituents in my district.
    Mr. Bolten. I understand the convictions. There is a 
philosophical divide here that I think was resolved in the 
Medicare bill that you all adopted and that is, do you trust 
the government to be dictating what seniors----
    Mrs. Capps. How do you respond the statistics that I have 
given to you from MedPAC?
    Mr. Bolten. I don't have any basis to dispute the 
statistics of what is happening now in the short run. In the 
long run, I have every confidence that the private sector is 
going to be able to provide----
    Mrs. Capps. Based on what? Based on what?
    Mr. Bolten. Based on 200-some years of history in this 
country with a system in which the most innovation comes not 
from the government, the most efficiency comes not from the 
government, the most quality of care comes not from the 
government but from innovation in the private sector. And I 
think that was effectively litigated and resolved in the bill 
that you all adopted.
    Mrs. Capps. I yield back.
    Chairman Nussle. Just because you referred to it, I think 
it is my duty, since the letter was to me, to ask that it be 
made part of the record. I ask unanimous consent that the 
letter from CBO be made part of the record and I believe and I 
hope it has been distributed.
    Mrs. Capps. Thank you very much.
    [The information referred to follows:]

                              5Congressional Budget Office,
                                              Washington, DC 20515,
February 2, 2004.
    Dear Mr. Chairman: CBO's baseline budgetary projections released in 
the Budget and Economic Outlook include $395 billion in outlays over 
2004-13 for the Medicare Prescription Drug, Improvement, and 
Modernization Act of 2003 (Public Law 108-173). That amount is 
identical to CBO's scoring of the bill when passed. In contrast, the 
administration estimates that additional outlays resulting from that 
act will total $534 billion over the 2004-13 period.
    Of course, a complete comparison of the overall budgetary impact of 
the legislation must also consider the effect on revenues. CBO 
estimates that the revenue effects of the legislation are largely 
offsetting. The legislation reduces revenues by providing qualified 
taxpayers with health savings accounts. At the same time, it increases 
revenues, CBO estimates, as businesses reduce expenditures on 
nontaxable health benefits and increase them on taxable wages. The 
administration has not released its estimated effects of the 
legislation on revenues. Those estimates could certainly differ from 
CBO's.
    Because the new prescription drug program represents a major 
departure from what currently exists, there is a great deal of 
uncertainty about its budgetary impact and a wide range of possible 
outcomes. CBO's estimate was the result of extensive analyses of the 
pharmaceutical drug market, the Medicare program, and the likely 
responses of potential enrollees. To date, we have not received any 
additional data or studies that would lead us to reconsider our 
conclusions. Therefore, CBO believes its estimate is sound, and has no 
reason, at present, to revise it.
    CBO has consulted with the administration to identify the major 
factors that account for the differences between the two estimates. 
Although such a comparison is complicated and we do not have complete 
detail on the key attributes, it appears that the difference derives 
from of differing assumptions or estimates in a number of areas. 
Attached is a sununary of those major differences. We will continue to 
work with the administration to understand the differences in more 
detail.
    I hope this information is helpful to you. The CBO staff contact 
for this analysis is Tom Bradley, who can be reached at 226-9010.
            Sincerely,
                                       Douglas Holtz-Eakin,
                                                          Director.

Comparison of CBO and Administration Estimates of the Effect of H.R. 1 
                           on Direct Spending
    Note: CBO estimates that the revenue effects of II.R. 1 total less 
than $0.5 billion over 10 years. CBO presently has no specific 
information on the administration's estimate of the revenue e/fects of 
H. R--1.

    The administration's estimate of $534 billion in outlays through 
2013 is $139 billion higher than CBO's $395 billion estimate. Almost 
all of that difference is attributable to our estimates of the Part D 
drug benefit and the Medicare Advantage program.
   part d drug benefit: the administration's estimate is about $100 
                        billion higher (2004-13)
    Basic benefits account for about $32 billion (about 7 percent 
higher than CBO estimate).
    The administration assumes a higher participation rate (94 percent 
of all Medicare enrollees, compared to CBO's assumption of 87 percent 
participation).
    Both agencies exclude about 5 percent who would be subject to 
secondary payer rules. The administration assumes that 94 percentage 
points out of the remaining 95 percent will participate.
    CBO excludes Medicare enrollees who decline Part B--we assume those 
beneficiaries generally will not participate because they have already 
showed that they will turn down a benefit with a 75 percent subsidy. 
CBO also excludes some beneficiaries who have generous prescription 
drug coverage through the Federal Employees Health Benefits program and 
other Federal programs.
    The administration estimates per-capita costs that are about 4 
percent higher throughout the 2006-13 period than CBO estimates.
    The differences in the number of participants and the per-capita 
costs each account for about half of the $32 billion difference in the 
cost of the basic benefit.
    The administration's low-income subsidy is about S47 billion higher 
(a 24 percent difference.)
    The administration assumes higher participation (13-15 percent 
higher than CBO after the third year of the program). CBO estimated 
participation in the low-income subsidy based on experience with 
participation of Medicare beneficiaries in the Medicaid, QMB, and SLMB 
programs.
    The administration assumes full participation immediately; CBO 
ramps up over 3 years.
    The administration's per-capita cost is higher than CBO's-initially 
7 percent to 10 percent higher, with the difference shrinking to 4 
percent by 2013.
    Savings in the Medicaid program account for about $18 billion of 
the difference. Medicaid savings will occur because creation of the 
Medicare drug benefit will end Medicaid's responsibility for providing 
prescription drugs to individuals who are eligible for both programs. 
However, those savings will be offset, in part, by additional Medicaid 
costs for newly enrolled people. CBO estimates that H.R. 1 will reduce 
Federal Medicaid spending by $141 billion over the 2004-13 period, 
compared to administration's estimate of $123 billion.
    CBO's estimate of net savings is higher largely because of 
differences in baseline projections for Medicaid spending on waiver 
programs to provide limited drug coverage to low-income Medicare 
beneficiaries who do not otherwise qualify for Medicaid. CBO's baseline 
projection of Federal Medicaid spending for those waiver programs was 
$18 billion higher than administration's baseline projection.
medicare advantage: the administration's estimate is $32 billion higher 
                     ($46 billion vs. $14 billion)
    The administration assumes much higher participation (32 percent of 
Medicare beneficiaries enrolled in Medicare Advantage (MA) plans vs. 
CBO's estimate of 9 percent\1\).
---------------------------------------------------------------------------
    \1\ CBO's estimate of 9 percent participation in MA plans does not 
include the effect on participation of payments to plans from the 
stabilization fund. The estimate assumed the stabilization funds would 
be spent, but CBO did not estimate the number of participants who would 
enroll in plans as a result of those expenditures.
---------------------------------------------------------------------------
    Both estimates assume that many of the participants in MA plans are 
in areas where the payments to MA plans and beneficiaries (through 
premium rebates) would exceed what it would cost if those beneficiaries 
were in the fee-for-service (FFS) sector. Most of the additional 
participants in administration's estimate are in relatively low cost, 
low density areas where the payments to MA plans and beneficiaries 
would be substantially higher than the cost of those beneficiaries in 
the FFS sector.

    Chairman Nussle. Mr. Schrock.
    Mr. Schrock. Thank you, Mr. Chairman, Mr. Bolten, Dr. 
Mankiw, thank you for enduring us again. I want to ask you a 
question. According to your testimony, the current deficit is 
4.5 percent of the GDP. What is the high est percentage of GDP 
that the deficit has ever increased? I think for relation 
purposes, it would be good to know that.
    Mr. Bolten. In the last 25 years, the highest has been 6 
percent of GDP in 1983 during the Reagan administration. In 
World War II, it probably spiked above 30 percent. So in all-
out wartime, it got much higher. But in modern times, the 
highest was 1983 at 6 percent of GDP.
    Mr. Schrock. One of the President's goals is to cut the 
deficit in the next 5 years, and I wish we could do it quicker 
and do you think it is doable? Do you think we could do it 
quicker? And if so, what is the path you take to get us there?
    Mr. Bolten. The chart that I had up on the screen showed 
that we do get there more quickly than 5 years of cutting the 
deficit in half as a percentage of GDP. It looks like on the 
numbers that we have--let me take the one with the green bars, 
you will see that on the current numbers, it looks like we just 
barely make it in 2006. The members have been correct in 
pointing out that especially in 2005, and maybe even in 2006, 
we will need to add in money for war in Iraq and Afghanistan.
    So that may be an unrealistic expectation to say we will 
make it by 2006. But by 2007, 2008 and 2009, I think we are 
comfortable in that range if we adopt the President's policies. 
One important caveat I want to comment on is that we are making 
conservative economic growth assumptions. We are on the low 
side of CBO and the Blue Chip economic forecasters. The biggest 
factor in bringing these deficits down more rapidly is strong 
economic growth. And that is why we are so convinced that the 
right thing to do is not impose a tax increase in this economy, 
but to keep the tax cuts going, because if we can get better 
economic growth out of this economy, we will get that deficit 
down that much more rapidly.
    Mr. Mankiw. We do make conservative economic assumptions. 
We very much try to track the private sector, but our forecast 
was locked almost 2 months ago, and there has been good news in 
the economy. So I think right now, the forecast implicit in 
this budget is on the conservative side of the private sector 
forecasters. For example, in 2004, year over year, we have 4.4 
percent growth rate. The Blue Chip consensus of private sector 
forecasters is 4.6. And CBO was 4.8. The same thing is true in 
2005. We are a little conservative compared to the Blue Chip 
and CBO. If CBO turns out to be right on economic growth, that 
will be good news as far as the deficit concerned.
    Mr. Schrock. Do you think it is possible to grow our way 
out of this deficit?
    Mr. Mankiw. I don't think by itself. It is going to require 
spending constraint. But the way we are going to get ourselves 
out of the deficit is a combination of robust economic growth, 
which we are forecasting and CBO is forecasting even more over 
the next few years, together with the spending restraint.
    Mr. Schrock. Mr. Bolten, the President's budget also 
proposes two significant spending controls, caps on 
discretionary spending and then a pay as you go mechanism for 
entitlement programs. How serious do you think the President is 
this year in enacting the budget controls? And would you say 
insisting on them is the price for signing the appropriation 
bills?
    Mr. Bolten. The President is serious about them, and I have 
discussed them with him directly, and I have shared with him 
the keen interest among members of this committee with 
reinstituting those kinds of controls. So he is quite serious 
about it. It is probably not up to me from this witness chair 
to say what the President is likely to insist on or not, but I 
do know he attaches a priority to it. We at OMB and CEA, and I 
think I speak for Dr. Mankiw as well, attach a very high 
priority to it, and we are anxious to work with you on it.
    Mr. Schrock. He has threatened to veto and never has. He 
has never not signed a bill. Do you think he would not sign the 
appropriations bill? Is he that serious?
    Mr. Bolten. I think the President would certainly not sign 
an appropriations bill that went outside the limits that he was 
proposing to keep us to. And I repeat that I think the 
leadership, your chairman, the rest of the leadership and the 
Congress was very effective this past year in making sure that 
the appropriations did not exceed the limits that were agreed 
to by the President.
    Mr. Schrock. I hope so.
    Chairman Nussle. Mr. Thompson.
    Mr. Thompson. Thank you, Mr. Chairman and Mr. Bolten. I 
would agree that September 11 and a downturn in the economy 
created a bunch of challenges that we had to deal with, but I 
really don't think that they explain what I see is a real 
credibility gap in the document that we are looking at today. 
There are admissions. There are--outyear costs are ignored. If 
you look at the tax cut provisions, the big cost doesn't come 
until after 2009, and that is at the same time we have a huge 
spike in the baby boomers that are going to be dependent upon 
different services. And I think that has to be explained to 
have any credibility.
    There is a PAYGO provision in this document, but it only 
applies to one side. It doesn't take into effect the revenues. 
And I don't know how you can spend--do tax expenditures without 
calculating where those costs are going to come from, because 
like everything we have discussed here today, that money comes 
from someplace. And as it is right now, it is merely tacked on 
to this incredibly large and ever-growing national debt.
    There are discrepancies between the two entities that 
calculate the costs of these programs, most notably is the 
prescription drug bill. It is $135 billion different cost from 
one entity vis-a-vis the other. I hate to beat a dead horse, 
but the whole war-funding issue, it is just not here. We have a 
budget document that does not have one penny regarding funding 
for Iraq. And that is just not--you could not take that out to 
any one of our districts and get one constituent that any one 
of us represents to see where that is justified. It would be 
probably laughed at. And there are also cost shifts in this 
document. Some on this committee are fond of talking about what 
constitutes a tax cut.
    Well, if you are going to charge veterans who leave the 
military with an understanding that they get health care, a 
$250 charge and these aren't rich guys, these are 30,000-
something a year salary with five dependents, that is a cost 
shift that these people are having to bear. And then the idea 
of cutting local law enforcement by the number in your document 
and then put a slide up that suggests that we are increasing 
funds for homeland security, these are the first responders, 
the fire and the police guys.
    And if you take it with one hand and then give it back with 
another, the local guys who are going to have to respond, if 
there is a problem, are going to have trouble doing that. And I 
think these issues need to be addressed. And I would like to 
hear on PAYGO how you can possibly expect us to support half a 
PAYGO program. Seems to me we should look at both the 
expenditures and the tax expenditures as well.
    Mr. Bolten. Mr. Thompson, I am going to ask Dr. Mankiw to 
talk in more detail about the distinction between mandatory 
spending increase and a tax increase or a tax cut. But the 
short version here on that specific question is that it is, as 
Dr. Mankiw and others have described earlier, it is spending 
that is the problem. It is overspending in the economy that 
damages the economy, and it is not undertaxing that damages the 
economy.
    Mr. Thompson. But it is a loss of dollars that are 
available. That would be like saying I want to retire, work 
part-time, make 30,000 a year and put an addition on my house, 
and the banker is going to say how are you going to pay for it? 
That doesn't wash. You have to be able to assess where the 
money is going and where the money is coming from.
    Mr. Bolten. I want to take up one of the other things that 
you mentioned, because several of the things you mentioned, I 
think we have had a chance to have an exchange on. But one of 
the things you mentioned last, is the first responders, and I 
want to come to it because I think it is a very good example of 
where we in the administration and this Congress need to make 
some tough choices about priorities. The President is proposing 
to increase homeland security spending overall by 10 percent. 
There are large increases in biosurveillance. There are large 
increases in counterterrorism efforts and so on. And I 
apologize, Mr. Chairman, if I could go over just a minute here. 
But we can't spend on everything. And one of the areas where we 
have been spending in homeland robustly is in getting money out 
to first responders. And we have put that money out since 
September 11 as a capacity-building undertaking to bring the 
first responders all over America more up to the risks that we 
face.
    Mr. Thompson. That may be, but the point I am making, you 
give it up on one program and take it away from local law 
enforcement and firefighters on the other, and it comes out of 
the same pocket of the local law enforcement and local 
firefighters and first responders.
    Mr. Bolten. This is part of the very difficult exercise 
that we need to engage in jointly, which is making some 
choices. In our budget, we have made the choice that more of 
that first responder money--there is still a good chunk of that 
money in here, but a lot more of that first responder money 
needs to go to the high-threat areas, to the urban areas, 
critical infrastructure and so on and get moved away from your 
average city and town that probably is not realistically under 
as much threat. This would be unfortunate news to some, a lot 
of police chiefs and fire chiefs in all of your districts, but 
it is the right way to set our priorities if we are going to 
protect the homeland. Those are the kind of choices that are 
made in the budget. There is a lot of money in this budget 
going in to first responders, but we are going to focus it on 
the high-threat areas and unfortunately disappoint some people 
who are not in the high-threat areas. Let me ask Dr. Mankiw to 
respond on the other.
    Mr. Mankiw. When thinking about fiscal policy, there is 
more to think about than just the budget deficit. The budget 
deficit is obviously an important measure of what fiscal policy 
is doing, but what it doesn't capture is how fiscal policy is 
affecting the incentives that the tax code is giving for people 
to work and save, how the tax code is affecting the cost of 
capital and the incentives for people to start businesses and 
hire workers. So that is the sense in which you can't think of 
tax increases in equivalent ways of reducing much deficit. 
Taxes have important effects on incentives and typically 
adverse, and as a result, impede economic growth. Summary 
measure is an incomplete picture of what fiscal policy is doing 
to the entire economy.
    Chairman Nussle. Mr. Putnam.
    Mr. Putnam. Thank you, Mr. Chairman. I didn't mean for you 
to skip over Mr. Crenshaw, but I will be happy to move ahead. 
The agencies that are facing cuts, Agriculture, HHS, 
Transportation, there is a common thread there that I observed 
and I wanted to know if it is just a coincidence or it is 
material, they lost significant portions of their apparatus to 
homeland security, which has gotten huge increases in the last 
couple of years. So are we, in a sense realizing savings from 
some of these agencies? Now grant it, it is a transfer to 
homeland security and not necessarily a real savings, but are 
we seeing a net reduction in the size of these departments as a 
result of shifts of agency and personnel to homeland security? 
And if so, what kind of a number are we talking about?
    Mr. Bolten. We are undoubtedly seeing that but we have 
tried to adjust for it in the budget. We may have missed some 
things, but by and large as we presented the numbers to you, we 
have tried to adjust for the transfers that have taken place so 
that if you look at last year's budget or the year before, more 
importantly the year before, you would still be looking at 
apples to apples and not looking at a highly distorted 
situation because the Treasury Department lost the Customs 
Service over to the Department of Homeland Security.
    Mr. Putnam. So the reduction is a net real reduction in 
spending then?
    Mr. Bolten. In most cases, yes.
    Mr. Putnam. One of the things that I have observed in my 
very short period of time here as it relates to defense, in 
particular, is how outstanding our men and women in uniform are 
at doing exactly what they do best and how poor a job in many 
cases the underpinning logistics personnel, procurement, human 
resources, database, IT, all of the components of the democracy 
are. And while it is important while we hold homeland security 
and defense somewhat harmless, I am wondering if there is an 
effort to address some of the cost-saving recommendations that 
have been made by GAO and other congressional oversight 
agencies.
    Consistent double-digit increases, while clearly very 
important in wartime, they also create instances of waste. And 
I want to make sure we are not holding them harmless from 
oversight as well.
    Mr. Bolten. We are not, Mr. Putnam; and we appreciate the 
interest that you have and I know the chairman has, a lot of 
other members have, in holding the government's feet to the 
fire on this very issue. Because we have seen over the last 
decade or so enormous increases in productivity and efficiency 
in the private sector, and it is hard to see that in 
government, and we are doing the best we can to try to squeeze 
the same kind of things out of government that has happened in 
the private sector.
    One of the mechanisms we use to do that in this 
administration is through the President's management agenda. We 
keep a score card, and you can find it in the budget here. Look 
for the little red, yellow and green lights that appear next to 
agencies and to programs. We now are going around assessing all 
the programs in government and saying, is it delivering value 
for money, for the taxpayer's dollar?
    As we have gone about making our budget decisions for this 
2005 budget in the past, and increasingly in the future, we are 
going to be basing those budget decisions on which programs are 
delivering real value for the taxpayer's dollar; and, if they 
are not, we either need to fix it or take the money away from 
that program.
    Mr. Putnam. We appreciate that. You and your predecessor 
have put management back into the Office of Management and 
Budget, and that is important. I hope you stay on it.
    Mr. Bolten. I give Mitch Daniels a lot of credit for that. 
I think he has really set us on a good path; and we have a 
terrific deputy director at OMB who is not here with me today, 
Clay Johnson, who is driving that agenda very effectively. We 
are very grateful for that.
    Mr. Putnam. Dr. Mankiw, following up on some of the 
discussion about economic growth and the need to grow our way 
out in addition to spending restraint, your estimates are 
fairly conservative in terms of GDP growth. What would each 
additional point in GDP growth translate into in terms of 
revenues to the government and its impact on the deficit? Is 
there a way to calculate that?
    Mr. Mankiw. Yes. There are sensitivity assumptions in the 
budget that will tell you precisely how GDP translates into 
that. I don't have those numbers in front of me, although Steve 
is about to find them. So there is no question that higher GDP 
translates into higher revenues. We might even have that 
right--we will get that number to you. It is in the budget 
somewhere.
    Mr. Putnam. Thank you very much.
    Chairman Nussle. Mr. Baird.
    Mr. Baird. I thank the chairman.
    First of all, what happened to the lock box and what would 
be the actual deficit if we didn't actually borrow from Social 
Security and Medicare to mask the size of the true deficit?
    Mr. Bolten. I don't have the figure at hand. I think it is 
reflected in the budget documents. But we look at the budget on 
a unified basis, which is the way that previous administrations 
going back for decades and the CBO have always looked at the 
budget deficit. Because what is important about the deficit is 
what is it taking--what is it requiring the government to 
borrow from the private sector to meet its financing needs? So 
the unified budget deficit is, I think, the relevant measure to 
use for that purpose.
    Mr. Baird. So what is the on-budget deficit projected to be 
for 2005, then?
    Mr. Bolten. For 2005 we show if you were to take the Social 
Security surplus out it would come to $543 billion.
    Mr. Baird. And if you counted the borrowing we are doing 
from Social Security surplus, what would that deficit then be?
    Mr. Bolten. I think that is the figure I have just given 
you.
    Mr. Baird. So $543 billion.
    Mr. Bolten. Yes.
    Mr. Baird. I show, it looks to me--how much are we 
borrowing from Social Security then, from the trust fund?
    Mr. Bolten. Well, the Social Security surplus in 2005 is 
projected to be $179 billion.
    Mr. Baird. So, in other words, that is effectively what we 
are rolling into the budget, which I think we promised we 
wouldn't do when we talked about lock boxes.
    Mr. Bolten. Well, every dollar is still being set aside.
    Mr. Baird. I understand the economic theory, but the 
Congress and President talked a lot about a lock box, and we 
don't hear that much anymore, and the folks back home ask what 
happened to it.
    Mr. Bolten. But it remains true that every dollar that is 
going into Social Security that is coming in in Social Security 
taxes is being set aside in the accounts of the U.S. Government 
to be paid out for Social Security benefits.
    Mr. Baird. But we borrowed from it and written an IOU.
    Mr. Bolten. But that money will be there for Social 
Security beneficiaries. In the long run in Social Security that 
situation is going to change, and that is why I think we need 
to pursue fundamental Social Security reform.
    Mr. Baird. Let me ask a second question. As I look at the 
transportation bill, there is an enormous difference between 
the President's numbers and the numbers that the Transportation 
Committee has looked at. The Transportation Committee numbers 
came out of several years of hearings with experts from the 
States and the industries saying this is what we need to fix 
our infrastructure deficit. How do you propose we make up that 
difference? Does it fall to the States or the local 
communities, this more than $100 billion difference?
    Mr. Bolten. I think some of that burden is going to have to 
fall to the States and locals if there are actually unmet 
needs. In the administration's view we can meet the appropriate 
Federal share of highway spending with the $256 billion that we 
have proposed, which as I mentioned before is a 21 percent 
increase over the last 6-year Federal highway----
    Mr. Baird. It is fascinating, because that is not anywhere 
close to the indication that we have had from all the hearings 
we have had in the Transportation Committee; and, interestingly 
enough, that is one of the provisions of the budget that could 
actually be funded if we were to look at a pay-as-you-go kind 
of measure for transportation.
    It could be a self-funded measure, but the administration 
has drawn a line in the sand, which raises another question for 
me. Has anyone calculated how much the President's budget 
shifts the cost onto States and local communities in the name 
of patting ourselves on the back and saying we have lowered 
your taxes by a trillion dollars or so at the Federal level? If 
I look at COPS funding and the zeroing out of Byrne grants and 
the cut for wastewater treatment and inadequacy of funding of 
transportation, aren't we shifting literally hundreds of 
billions of dollars on to the States which are already 
financially strapped?
    Mr. Bolten. I don't believe that is the case. I don't have 
a calculation for you, but there is a great deal of Federal 
money that does go out the door in share money to the States, 
in grants to the States that are to be passed on, including 
especially for our education programs which have been 
dramatically increased under this President. I don't have a 
calculation for you, but I think what we need to do at the 
Federal level is to decide what is the proper Federal 
responsibility, and I think this budget and the administration 
thinks this budget hits the right target on meeting the Federal 
responsibilities in terms of what funding we need to be passing 
on to the States.
    Mr. Baird. I would be interested over the next few weeks, 
as all of us have folks coming back from districts asking how 
can we get some Federal help, to be honest with them and say we 
are cutting your budget like crazy.
    Mr. Mankiw, before I finish, I thought you heard you say 
something remarkable, all Federal spending, earlier, leads to 
increased taxes. You can think of no government programs, no 
Federal spending that have actually lowered taxes over time? 
The Internet creation, for example.
    Mr. Mankiw. What I am saying is that the government faces a 
budget constraint. Technically, that means that the present 
value of government spending has to equal the present value of 
tax revenues. So that if the government decides to change one 
side of the equation, it is going to have to at some point in 
time change the other side of the equation, much as a household 
over the long run its consumption and consumer spending and 
income have to sort of balance in some present value sense. So 
if the government is going to sort of spend more money, at some 
point it is going to have to raise revenue to pay for that 
spending.
    Mr. Baird. Thank you, Mr. Chairman.
    Chairman Nussle. Thank you.
    Mr. Brown.
    Mr. Brown. Thank you, Mr. Chairman.
    Mr. Bolten, while I hear a lot from the other side of the 
aisle about deficits, would you agree that the President has 
inherited a defense and homeland security deficit he had sought 
to correct?
    Mr. Bolten. The President did encounter a situation in 
which defense spending had been declining for many years. He 
made a commitment to restore that, and defense spending over 
the course of the President's four budgets is up over $100 
billion from where it was, from about $300 [billion] to $400 
billion, to transform the military, restore the strength of the 
military.
    On the homeland security side, in many respects an entirely 
new subject for this country. Funding as we measure it, and it 
is a little hard to measure, was at about $10 billion at the 
time the President came into office. The President has tripled 
that in his budgets, and we are now up in the $30 billion 
region.
    So these are necessary expenditures for our national 
security, for our homeland security that have been at the top 
of the President's priority list.
    Mr. Brown. Thank you very much. This has been my 
observation, too, as we talked about the supplemental bill, 
whenever that may come again.
    We were over in Iraq, and we actually saw firsthand what is 
going on over there. It is difficult to predict how long those 
troops will be there and exactly what their needs will be. I am 
just pleased we had a chance to meet with them and how high-
spirited they were and how much they believed in what action 
was taken.
    So I was pleased that I had a chance to see firsthand, but 
I think you are right on target. Why try to build in some 
margin of--a factor that we are not quite sure whether we will 
need it or not? So I applaud you for taking that initiative.
    I am concerned about the highway bill myself, coming from 
South Carolina where there is a tremendous amount of road 
needs. We have a tremendous influx of tourists. And I know that 
basically the highway system has been driven by user fee, I 
guess, on the fuel. But I notice, too, as part of the 256 I 
believe you mentioned in this budget here, how much of that is 
exactly mass transit and how much is being attributed to 
enhancement funds?
    Mr. Bolten. Congressman, if I could just provide you that 
for the record. I don't have that at hand, but my recollection 
is that it is about a four or five to one ratio, I think, if I 
have got that about right. But let me get that to you for the 
record.
    Can I make one comment about your earlier remark which is 
it may come as a surprise to many members but something I hear 
consistently from our folks over in Iraq, from the coalition 
provisional authority and from the military there, is that they 
very much appreciate it when you and other Members go to visit, 
that it puts a little extra burden on the security situation, 
but it means a lot to the men and women in uniform over there 
that people are concerned, people care, and that you go out to 
visit them. Somewhat surprisingly, the military actually 
encourages the visits that you all make because they are 
important for the morale and they are important for you all to 
see the important mission that is being done there.
    Mr. Brown. And then, on spending the trust fund money for 
items outside the trust fund like mass transit enhancement, how 
do you feel about that as you addressed the budget?
    Mr. Bolten. Well, those are also expenditures that are 
inherent in the highway program.
    Again, I will give you for the record exactly the breakdown 
that Secretary Mineta and Secretary Snow have in mind within 
that 256; and, if I may, I may ask them to be in touch with you 
directly to ask them to give you the full rationale for the 
numbers that are contained in the President's budget.
    Mr. Brown. OK. Because I think the Senate might have had a 
different idea about how they would fund some of those items. I 
noticed part of the three points I think the President 
introduced in this budget that he would not allow any general 
fund money to be used for highway money, but I certainly see 
mass transit enhancements as two different things other than 
just user-fee-driven items.
    Chairman Nussle. The gentleman from Illinois, Mr. Emanuel.
    Mr. Emanuel. Thank you, Mr. Chairman.
    When you run a record deficit of $521 billion, it goes to 
prove the theory that you cannot finance three wars with three 
tax cuts. And that is what we got. We got a historic deficit, 
and the reason we got it is we are trying to finance three 
separate wars with three tax cuts: the war on terrorism, the 
war in Iraq, and the war in Afghanistan.
    I have heard the lecture for the last year, for a longer 
period of time from a lot of other folks from the other side 
here, including members of the administration, that if you have 
a growing economy, the deficits will go down. You all are 
projecting growth in the mid 3 range, somebody has it at 4 
percent, and yet we are hitting a historic high deficit. So 
what we have here in my view is not just a fiscal deficit but a 
credibility deficit.
    You want to increase the war on terrorism, homeland 
security; yet you cut police and firefighters.
    You want to talk about the importance, as Secretary Evans 
did, about the importance of our manufacturing industry and how 
we are going to now focus where the manufacturings are; yet we 
cut the Manufacturing Extension Program which helps small 
business manufacturers.
    We talk about Medicare. We had a number of $400 billion. We 
all debate it. Yet it is coming in at $540 billion.
    You just a second ago, Mr. Bolten, whom I respect greatly, 
talk about government following how business do things in the 
private sector and get more efficient. Some of us believe that 
if Medicare was allowed to negotiate like the private sector we 
would get efficiencies, but because of the influence of the 
pharmaceutical industry, the government couldn't act like a 
business and be more efficient.
    Now the White House wants to talk about holding 
nondiscretionary spending, but if you look at the White House's 
expenditure and OMB expenditure, your own budgets have gone up 
7 and 15 percent respectively over the last 3 years.
    I also think, on Iraq, last year you didn't have a number 
for the war in Iraq and yet 2 months after the budget you 
presented a number. The chairman of the committee himself said, 
whom I greatly respect, and we all agreed, don't come back here 
next year without a number.
    Now if you can't predict a year number, how about putting 6 
months in? Because I think we can all safely agree around here 
we are not going to be out of there in 6 months. We are not 
going to have less than 100,000 troops there.
    So what we have here, as a great movie once said, is a 
failure to communicate. What we have here is a credibility 
deficit, let alone a fiscal deficit.
    I admire your ability of always talking about how the 
government should start catching up to where the private sector 
has been. There are members of both parties here who have 
talked on Medicare of how to get the government to act like the 
private sector. We permitted private sector insurance 
industries to do both negotiating. We want Medicare to create a 
Sam's Club for 41 million members, both negotiate, get reduced 
prices, get efficiencies. It is prohibited. So I compliment you 
and I really welcome that you want government to work like a 
business, but we are not allowed to do that here.
    I just find on a series of fronts, whether you look at the 
war on terror, cutting police and firefighters, whether you 
look at the Manufacturing Extension Program, which we have cut 
and not fully funded, Medicare, the White House funding, OMB 
funding compared to nondiscretionary, and then the war in Iraq, 
that in every one of those areas we have said one thing and 
done another.
    I think when the budget comes up it represents--as the 
President once said, your word has to be credible. I agree with 
that; and, unfortunately, we are woefully short of that goal, 
not that Congress has been all--ever perfect.
    Not all tax cuts are bad. In fact, some tax cuts lead to 
economic growth. But not all tax cuts lead to the same amount 
of economic growth, and not all government spending is good. 
Some is more productive in the areas of education, health care, 
and the environment; and some is wasteful. We in this budget 
don't make those choices, and so it is going to be left up to 
both--Members of both parties to start making those choices, 
because this budget doesn't give us, in my view, a starting 
point to make it.
    I yield back the rest of my time.
    Chairman Nussle. Thank you.
    Mr. Franks.
    Mr. Franks. Thank you, Mr. Chairman.
    Mr. Chairman, you mentioned when we began this committee 
that really the only way to deal with the deficit was one of 
three venues; and that was to raise taxes, to cut spending, or 
to grow the economy. I guess I just want to point out I think 
you are correct, but I want to point out that the President has 
done some pretty significant things toward trying to grow this 
economy, and if there is anything that is obvious in this 
process it is that the tax cuts that he implemented have had a 
dramatic impact on the economy.
    I think in terms of the spending aspects we should perhaps 
even look at the recent Medicare bill where the President had 
asked for something much smaller and much less costly than what 
we gave him.
    It is also important to keep in mind that the alternative 
that our friends on the other side of the aisle advocated was 
much more expensive.
    Having said that, the discussion related to the whole Iraq 
war and the projections that the Office of Management and 
Budget have to make is underscored by something. As it turns 
out, Henry Brown here took me with him to Iraq, and one of the 
things that we discovered over there was that in June there 
will be an election that will essentially put almost all of the 
control of that government into the hands of the new Iraqi 
leadership, which could encourage us to stay or encourage us to 
leave, and it really underscores the impossibility that you 
have to project what kind of spending that we will make over 
there.
    Having said that, it has been said that there are no easy 
or simple answers. I would suggest to you there are simple 
answers sometimes. There are no easy ones.
    When it comes to balancing this budget, Mr. Moore over here 
mentioned that 95 percent of us will support the President on 
homeland security and on the defense budget. I guess my 
question to you--and you probably are not going to be able to 
give me an answer here, but I really sincerely hope that you 
would perhaps try to make a collegial effort at trying to give 
us an answer at some point. What if we said, all right, so we 
will leave the homeland and defense numbers that you project 
the same, we will make the tax cuts permanent, and we will 
freeze everything else until she balances. How long would it 
take us to balance the budget if we simply froze it at the 
amounts that we have now?
    I know that people say that is outrageous, but it was 
pointed out recently here by a colleague that in World War II 
we saw this huge spike in the deficit, 30 percent or more, and 
yet that was the time when we actually saw a precipitous drop 
in discretionary spending. Those things show us that when 
people need to do something badly enough, they do do it.
    Is it impossible in this day and age that we could leave 
defense spending and homeland spending for the increases and 
freeze everything else until we balance this budget?
    Mr. Bolten. Mr. Franks, it is not impossible. The budget 
that we have presented is not all that far off of that 
particular goal. We are glad to work with you as we go through 
the budget resolution. We think we have done a lot of belt 
tightening in this budget. You have heard from some of your 
colleagues that the belt is pinching a little too tightly in 
some areas. We will be hearing from probably almost every 
Member at some point that the belt is tighter in some place 
than they want it to be. We have gone a long distance in that. 
I am sure there are other distances to go.
    So I would say to you, no, it is not impossible to get to 
the kind of budget you are talking about.
    Mr. Franks. I will just leave this last thought here. A lot 
of times in such a debate there is a lot of rhetoric that is 
used that the nomenclature becomes pretty confusing after a 
while. But I think one thing that the American public could 
understand and perhaps even support us on is if we said, all 
right, we are going to take care of homeland defense, we are 
going to take care of defending the Nation, we are going to do 
what we can to stimulate this economy, and we are simply going 
to freeze where we are until we balance this budget and deal 
with this crisis. I think you folks have made a magnificent 
effort, and I really sincerely would ask you if you might to 
give me what that projected date would be if we try to freeze 
it where we were until it balanced. Would you do that?
    Mr. Bolten. We will do our best, Mr. Franks.
    Mr. Franks. Thank you, sir.
    Chairman Nussle. Ms. DeLauro.
    Ms. DeLauro. Mr. Mankiw, you published a book in the 1990s, 
``Principles of Economics.'' It included a section on President 
Reagan's economic policies which, like those of President Bush, 
called for deep tax cuts based in part on the idea that tax 
cuts could help pay for themselves by producing faster economic 
growth. You entitled the portion called Charlatans and Cranks, 
where you ridiculed the Reagan policies as, quote, ``fad 
economics and tantamount to fad diets.''
    Quote: An example of fad economics occurred in 1980 when a 
small group of economists advised Presidential candidate Ronald 
Reagan that an across-the-board cut in income tax cuts would 
raise revenue.
    After reviewing the impact of the Reagan policies, which 
included a run of high-budget deficits that lasted into the mid 
1990s, Dr. Mankiw wrote that the moral of the experience was 
that, quote, ``when politicians rely on the advice of 
charlatans and cranks, they rarely get the desireable results 
they anticipate.''
    I am not going to ask you to answer the question, because I 
have to move on to say some other things, but do we have 
charlatans and cranks advising the President of the United 
States today? Apropos of that, the question is, in fact, can we 
have a strong economic growth in this country and continue to 
have deficit financing of tax cuts?
    Let me move to another portion. There is also another quote 
which is directly from a column from you, Dr. Mankiw, that 
talked about tax cuts and the candidates Al Gore and George 
Bush, that if this technology boom continues, Gore's smaller 
tax cut looks stingy; if it fizzles, Bush's large tax cut seems 
profligate. Whatever tax plan the next President adopts, we may 
have to rethink it in a few years. I hope we will rethink it.
    It would appear to me that we have got a repeat of 
something that happened last year, and that is really kind of 
sleight of hand in what comes out in the budget process. Three 
or four examples I think will tell the story.
    The war, we have no numbers, you say it is impossible. That 
is like my saying, I can't put aside money for my kids for 
college education because I don't know where he or she is going 
to get into. So let us do zero, nada, nothing, leave it there 
and hope for the best when it comes along. Impossible.
    That is not your job. You have an obligation in the same 
way that we have an obligation. If you tell the President--if I 
were President of the United States and you told me you 
couldn't tell me how much the war will cost, adios, you 
wouldn't be in the job today.
    Second, $139 billion Medicare costs all of a sudden 
appeared the very next day. You know, after we get through the 
passage of the bill, the discussion, et cetera, the cost is 
suddenly $139 billion. Five-year budget versus a 10-year 
budget, the $900 billion in tax cuts come after, you know, 
presumably a second Bush administration, and I say presumably. 
You have got nothing about AMT, nothing about Social Security 
in the budget. It doesn't pass the smell test.
    Take a look at today's New York Times. This is not coming 
from Congresswoman DeLauro, Democrat, Third Congressional 
District of Connecticut. The Concord Coalition: If you look at 
fiscal policy, it looks like an exploding cigar. You go to the 
moderates, you go to CATO, you go to the left, you go to 
anyone, no one believes that this is a credible budget; and, 
quite frankly, it is not credible. It does not pass the smell 
test.
    Given all that I have said, I think there is a minute and 
20 seconds left. Let me ask you this: In terms of your tax cut 
policy here, was it an oversight to leave out the 12 million 
kids, 6 million families who didn't make it into the last go-
round when they just yanked them out of the bill in the middle 
of the night, those people who make $10,500 a year to $26,000 a 
year, who pay payroll taxes, property taxes, and sales taxes? I 
have to believe it was an oversight.
    A question of people in jobs today. Let us take a look at 
the budget again, cuts, job training, employment services, 
training job cuts proposed in the last several years, 
vocational training cut, objection to extending unemployment 
benefits to workers. How are we going to put this money that 
our colleagues talk about back into the pockets of working 
Americans? We are doing nothing in this budget to do that, but 
we are taking the money out of their pockets to do that.
    I have 13 seconds left. You are welcome to answer or not to 
answer any of the questions.
    Chairman Nussle. Well, I would be happy to allow the 
witnesses to answer. The gentlewoman's time has expired, but we 
will let both witnesses answer if you care to.
    Mr. Mankiw. Let us me just answer very briefly some of your 
comments.
    Let me start with what you ended with, jobs. Jobs are very 
much the President's focus. The aim of the tax cuts was 
precisely to create economic growth and create jobs, and I 
think we are starting to see that happening. The unemployment 
rate has fallen from 6.3 in the summer.
    Ms. DeLauro. A thousand jobs in the summer.
    Chairman Nussle. The gentlelady's time has expired. The 
witnesses can answer the questions that the gentlelady has 
posed.
    Ms. DeLauro. Thank you very much, Mr. Chairman.
    Mr. Mankiw. The unemployment rate has fallen from 6.3 down 
to 5.7, and I think you will see continued good news in the job 
market. Obviously, it is not good enough. We want it to be 
better, but I think we are heading in the right direction.
    Regarding your comments on my previous writings, I have 
been critical in the past of claims that tax cuts are self-
financing; they fully pay for themselves with more upward 
economic growth. If I believed that, I wouldn't be calling for 
spending restraint. We could finance more spending with more 
tax cuts. The fact is the President has put forward cutting 
taxes and spending restraint as a dual program for creating 
economic growth, and that is perfectly consistent with things I 
have iterated before.
    On the Social Security numbers, as Mr. Bolten said, 
actuaries differ. This is a very complicated area. This is a 
bold new program. It is not surprising that people looking at a 
new program like this is going to have different estimates as 
to what the costs are going to be. The CBO has reiterated just 
a few days that ago they believe it will be under $400 billion 
and some actuaries believe differently. Even for someone like 
me, who is sort of very much in the weeds, a detail kind of 
nerd, it is very hard to figure out why these numbers differ 
and who is right; and I don't think anybody really knows who is 
right.
    Ms. DeLauro. No charlatans and cranks, though, huh?
    Thank you, Mr. Chairman.
    Chairman Nussle. Just a nerd I think is what he was 
referring to.
    Ms. DeLauro. We can all pick up our appellations.
    Mr. Garrett Yes. I don't know if I can get that chart back 
up. I just want to go back to that 1 percent, 10 percent of 
taxpayers who are in this country.
    While we are waiting for that, on TV a week or so ago, 
there was a show, 20/20, with John Stossel. I don't know if you 
saw it. He just wrote a book of--myths, misconceptions and 
stupidity I think was the name of the program. One of the 
issues was, who is paying the taxes in this country? He was 
talking to one of the many people running for President right 
now, and the question was, what should the top 1 percent in 
this country should be paying? And the response was maybe 5 
percent or maybe 10 percent, maybe even 15 percent.
    Finally, Mr. Stossel said, well, would you be surprised to 
know that they are already paying almost a third of the Federal 
budget? To which the candidate immediately did, as candidates 
do, change the subject to something else.
    That was a surprise to me a year ago when we find out that 
this tax package that we passed was a progressive tax cut, and 
it is actually shifting the burden, which I think is 
appropriate where we are and we should stick with that plan. 
Maybe it is no surprise then during the President's State of 
the Union address when the President spoke and said that 
certain taxes were going to be lapsing at the end of this 
year--and you may recall some people on the other side of the 
aisle actually started to applaud. Maybe they fall into the 
category. Because there is around 22 percent of the American 
public right now who believe that they are in the top 1 percent 
of the income tax range.
    All in all, then, what you can say out of this whole 2 
hours that we have been here, there is one thing we can agree 
on, that the deficit continues to be a problem for both sides 
of the aisle. I think we can probably agree that most people 
here are not going to be championing eliminating the child tax 
credit, the marriage penalty tax, nor the expansion of the 10 
percent. So if that is off the table, the tax cuts are off the 
table, increasing them, then it leaves us with the spending 
issue.
    Again, someone from the other side of the aisle in the 
paper today is reported as saying that the President's budget 
is crowding out health care, education, and veterans. Yet when 
I saw the chart, after you look at homeland security and 
defense and Medicare--of course, we already know what the 
spending is like on that in health care--education, we are 
still seeing substantial increases in educational spending; and 
veterans also is next in line after education. So I don't know 
how anyone can say that this budget is crowding out any of 
those areas.
    To some of us conservatives, we may actually raise some 
questions: Are we still spending appropriately in those areas? 
Because--maybe you can comment on this at the end--one report 
said that in certain States, not my State of New Jersey, but in 
certain States when it comes to educational funding so much 
money has been coming over the last several years from the 
Federal Government to the States that--so much money is coming 
into those States that they actually have to put it into 
reserve because they cannot spend it fast enough.
    I see you are nodding your head. I don't know if you heard 
that as well. If that is true, then why are we still seeing 
significant increases in spending on the education side of the 
equation?
    The other question I have is, 65 programs to be eliminated 
sounds like a whole lot of programs. I applaud you and would 
like to have more information on that. When you gave us the 
number of $4.9 billion, that that comes out to another $4 
[billion], $5 billion after that--I am bad with math--but the 
percentage of that out of the entire Federal budget of $2.4 
trillion is probably a pretty tiny number. So I guess I leave 
you with the question of can't we do better than that? Aren't 
there more programs that can be totally eliminated?
    You made reference before to one of the questions about the 
effort going on right now as far as efficiency studies--maybe 
the wrong term--of programs, and I think I saw on one of those 
charts someplace that one of the studies showed that around 6 
percent of the Federal programs that they looked at are 
operating efficiently--my words, not the study's report. Around 
23 percent said they were moderately efficient, but around 50 
percent of them, they really couldn't measure whether they are 
doing their job or not.
    I know you have to do this, but how do you come to us and 
say, even with all the information that we have, we don't know 
that half the programs are really doing the job, we know that 
only around 6 percent are actually doing the job, and yet we 
still want to spend more in all these areas? Can't we do better 
than that? Can't we at least do the idea of freezing all those 
programs until we get back to see how we improve them and make 
sure they are efficient, fallen at 6 percent, or to increase 
that number of eliminated programs from 65 to a much more 
significant percentage of the Federal budget?
    Mr. Bolten. Mr. Garrett, thank you for those comments. I 
think we can do better. We have gone a long way in this budget, 
I believe, to go after that portion of spending that we think 
is least warranted. But, as you can see from listening to your 
colleagues and from your own experience here on Capitol Hill, 
you know that we will have enormous difficulty going after even 
one of those programs, because every program has some merit, 
every program has a protector.
    You mentioned education spending. Of those 65 programs that 
are being terminated, almost half of them or somewhere in that 
range are actually in the Education Department. Because there 
are just dozens of programs filtered throughout the Education 
Program that are not showing results. We are trying to bring 
those programs down.
    At the same time, the President has put a very high 
priority on education in his administration, and we have seen 
under his administration K-12 funding increased if his 2005 
budget is enacted, a change from 2001-05 an increase of $12 
billion going into K-12 education, a 49 percent increase.
    Just this year in the 2005 budget, the President's budget, 
we will be proposing another billion dollar increase for Title 
I funding. That is for the lowest income schools. Overall in 
this administration that would make a 52 percent increase in 
Title I funding.
    I appreciate your raising it, because it gives me a chance 
to address the canard that this administration is somehow 
underfunding education. It has been very robustly funded. In a 
few cases, and I think it is being dealt with, States have not 
been able to absorb it quickly enough. I think that is being 
addressed, and I think we are putting money out in an 
appropriate fashion at this point. But even with as tight a 
budget as we have, even with cutting those programs that we 
think need to be eliminated, there is room in this budget for 
us to spend on priorities, and that is what this budget does.
    Chairman Nussle. Mr. Scott.
    Mr. Scott. Thank you, Mr. Chairman.
    Mr. Chairman, chart No. 1, we have had a lot of discussion 
about whose fault and who is doing what. I just wanted to 
remind people of the history.
    When President Clinton came into office, we passed a bill 
without any Republican votes on the floor of the House or 
Senate that created that green line going up toward surplus.
    In 1995, when Republicans took over, President Clinton 
actually vetoed several bills, so many that we actually had to 
close down the government because Congress wouldn't pass a bill 
that he would sign. He wouldn't sign those irresponsible tax 
cuts. The budgets passed from then for the rest of his term 
with a Republican Congress were under the threat of his vetoes.
    In 2001, you see that this President came in with a $236 
billion surplus and signed the kinds of tax cuts that President 
Clinton had vetoed and you see that read line falling off the 
side.
    In summary, President Clinton and the Democrats, the green 
line; President Bush and the Republicans, the red line.
    We have heard about people whining about where is the 
Democratic plan? The Democratic plan is the tough choices 
represented by the green. The Republican plan is the easy 
choices, increase spending, cut taxes, and you get the red.
    Now we have heard about 9/11 causing all these job losses 
that are dropping the economy. The fact is that this is the 
worst job creation record since Herbert Hoover. Jobs were 
created during the Korean war, during the Vietnam war, hostages 
in Iran, the cold war. Every President since Harry Truman has 
had more jobs created during their term than when they left 
except this one.
    Now all tax cuts do not have the same stimulus effect on 
the economy. There are other things you can do other than cut 
taxes and $40 billion I think we spent right after 9/11. We 
could have hired police officers and other domestic security 
types of jobs. With $40 billion you could have hired over 1 
million people. We hear that 3 million jobs lost, and we get 
the ``what, me, where are you'' explanation that that is good 
news about jobs.
    In 2005, the budget we know from discussion so far that it 
is not credible. We have got the $50 billion missing from the 
war.
    Could we get chart No. 3? The blue line in chart No. 3 is 
what we were told by this administration we would be dealing 
with now. The red line now is the present story. Offsets are 
not realistic. We are not going to cut veterans' benefits. We 
missed Medicare by $100 billion, and the program hadn't even 
started. That chart would require us to reject the President's 
suggestion about going to Mars, reject his position on 
privatizing Social Security. As a colleague of mine said, this 
might represent the President's faith-based initiative, trying 
to believe in his budget.
    Let me ask you a couple of questions, Mr. Bolten.
    On page 384 you have got the individual income tax revenue 
at $765 billion; is that right, $765 billion? Now, as this 
chart shows--go back to chart No. 1. As this chart shows, we 
began this administration with $236 billion. We are now in the 
hole $521 billion. That is a $757 billion swing; is that right? 
That is right. OK. Now, we have individual income tax, total 
revenue $765 billion, and we have had a swing of $757 billion. 
As the Director of the Office of Management and Budget, are you 
embarrassed at having to present that budget?
    Mr. Bolten. No, sir, I am not and----
    Mr. Scott. And we have got the ``what, me, where are you'' 
defense.
    Now, the interest on the national debt, when this 
administration came in, in 2009 isn't it true that the net 
interest on the national debt was going to be zero, when you 
came? Now don't you project it at $299 billion and going up at 
about $25 billion a year? How many people can you hire with 
that $300 billion at $30,000 a year? How many people can you 
hire with that $300 billion that we are going to be paying in 
interest that we did not expect to have to pay? Ten million. 
How many people are unemployed in America today? Nine million. 
Does that embarrass you? No.
    You said we need to fundamentally change Social Security. 
Is there any money in here to fundamentally change Social 
Security? Is there any transition cost in the budget that you 
presented?
    Mr. Bolten. Mr. Scott, would you like me to take your 
questions one at a time or in group now?
    Mr. Scott. Any kind of way you want.
    Mr. Bolten. All right.
    First--actually, could I have the pie chart up, please?
    If we are looking at the sources of the deficit we now 
face, this is an accurate reflection of what is behind the 
numbers you just saw. The economy is what brought us into the 
deficit situation we now face. There was a stock market bubble. 
There was a recession that started in at least the first 
quarter of 2001, some economists believe earlier. The stock 
market collapse started in 2000. If you take a look at the 
actual numbers of what led us into the deficit situation we now 
face, what you see is that the economy, the collapsing economy, 
was the overriding factor in bringing this out.
    The tax cuts are not responsible for the deficit situation. 
The tax cuts deserve the credit for turning that situation 
around, putting us back into an economic growth situation. 
Because it is economic growth that is going to make those 
revenue numbers turn around. If you look at the chart, what you 
see is the revenue numbers turning back up. That is the 
situation that is going to actually create jobs and make our 
deficit situation improve over the long run.
    Mr. Scott. So you are not embarrassed?
    Chairman Nussle. Mr. Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman.
    Gentlemen, first let me applaud the administration for 
interjecting words like ``pay-go'' and ``spending caps'' and 
``spending restraint'' into the vocabulary of the United States 
Congress. It appears that you are attempting to take that first 
turn of the wheel in the battleship of spending. But it is the 
United States Congress who are the sailors on this ship, and so 
the work has to be done here.
    Obviously, there has been a lot of talk about tax relief; 
however on one side of the aisle it appears to be part of the 
problem and on the other side, it appears to be part of the 
solution.
    As I look back through in the history of tax relief, I see 
that during the 1920s when we cut marginal rates we increased 
GDP, and tax revenues. I see that during the 1960s under 
President Kennedy, when we had tax relief we increased GDP and 
tax revenues. I see that during the 1980s under President 
Reagan we cut marginal rates again. We increased GDP and tax 
revenues because we were not attempting to take a larger 
portion of the family pie. We were trying to grow that pie.
    Most recently, I see a report from Treasury saying that 
with the Bush tax relief package, we have had the greatest 
increase in GDP for a 6-month period in 20 years, and tax 
revenues are up this last quarter over 1 year ago. Have you 
seen that report? Do you dispute those figures that tax 
revenues have indeed increased?
    Mr. Bolten. Tax revenues do seem to be firming, and the 
projections are for them to firm substantially more in the 
future as the economy strengthens.
    Mr. Hensarling. Let me ask you a little bit about spending. 
There is a lot of angst about the Federal budget deficit. I 
share that angst, but there are two different battles that I 
believe are taking place. One is between the balanced budget 
and the unbalanced budget. But there is another battle taking 
place between the Federal budget and the family budget, and I 
fear the Federal budget is winning.
    We are now spending $21,000 per household for the first 
time since World War II, the fourth highest in the history of 
the United States of America. I believe mandatory spending is 
now up to 11 percent of GDP for the first time ever. From 1998 
to 2003 spending increased from $16,000 per household to 
$21,000 per household, which I am told is the greatest 5-year 
spending spree, since World War II.
    I am concerned about American families and how they finance 
their education programs. How are they going to find the money 
to buy a computer for their son or daughter? I am concerned 
about their housing programs. How are they going to find money 
to pay the down payment on their first home? I am concerned 
about their jobs program. How are they going to find the 
capital to create that first small business? So as I look at it 
by any measure, it is spending that is out of control here. So 
I applaud you for taking steps toward budget process reform.
    I hear a lot of discussion about cuts, but under your 
budget, if I am reading it correctly, mandatory spending goes 
up, defense spending goes up, homeland security spending goes 
up and discretionary spending goes up. Is that correct? Do I 
have a correct reading of the budget?
    Mr. Bolten. You do, Mr. Hensarling. There are cuts in 
specific sectors and overall discretionary spending is held at 
a moderate 3.9 percent overall increase, but it is at that 
number because we need to accommodate larger increases in 
defense and homeland spending.
    Mr. Hensarling. Are there things that this Congress can do 
to introduce the concept of actually getting greater services 
for the American taxpayer at a lesser cost?
    For example, when I have looked at the HUD budget over the 
past few administrations they seem to routinely lose 8 to 10 
percent of their budget in the $3 billion range. Apparently, 26 
percent of the people who have received Federal student loans 
have them forgiven for disability while holding down full-time 
jobs. I have seen reports that say, conservatively, 8 percent 
of the cost of health care is due to frivolous lawsuits. What 
programs does the administration have to start rooting out 
waste, fraud and abuse and duplication so that we can do more 
for the poor beleaguered taxpayer and do more to protect the 
family budget from the Federal budget?
    Mr. Bolten. Mr. Hensarling, we have a number of programs to 
do that across--especially the entitlement programs in Medicare 
and Medicaid, the Earned Income Tax Credit, IRS. All of those 
areas are areas where the government is losing money because of 
waste, fraud and abuse.
    Your chairman has been one of the leaders for some time in 
trying to ensure that government goes after that money as 
aggressively as it possibly can. We are doing that, I think, in 
this budget, but we are anxious to work with you on ideas of 
how we can do it better.
    Chairman Nussle. Mr. Edwards.
    Mr. Edwards. Mr. Chairman, this budget may represent the 
largest faith-based initiative of this administration. I am a 
person of faith, but this budget is unbalanced, unfair, and 
unrealistic. Mr. Bolten, I will predict right now in your 
presence that the real deficit in fiscal year 2005 will be far 
closer to $600 billion in borrowing from our children than the 
$521 billion that you projected in this budget.
    Frankly, I think this supply-side, no-pain, all-gain 
proposal sounds more like voodoo economics than a good-faith 
effort to project what the real budget will be this year and 
the decade ahead. The last time an administration promised 
massive increase in defense spending, massive tax cuts, and 
balanced budgets was in 1981 in the Reagan administration. The 
result of that no pain/gain promise to the American people was 
quadrupling the national debt in a little over a decade; and I 
must say that at least David Stockman, President Reagan's 
budget director, had the integrity to later write a book where 
he admitted to the American people that that no-gain promise of 
higher defense spending, massive tax cuts and balanced budgets 
was something he knew simply wasn't true.
    It surprises me that some of the very same people that I 
hear using the principle of personal responsibility in our 
financial affairs as a basis for passing a crackdown on 
bankruptcies by middle-income and lower-income working families 
turn around and say, even though we are facing half a trillion 
dollar deficits, don't blame me. That is somebody else's 
responsibility, somebody else's cause.
    I believe these record-breaking deficits are a clear and 
present danger to the American economy and to our children's 
future. For 3 years in a row, the budget deficit will have been 
larger than any deficit in American history prior to this 
administration. Let me repeat that. For 3 years in a row, the 
Federal budget deficit will be larger than any administration 
in American history prior to this one.
    Let us be specific. In just 2 years, fiscal years 2003 and 
2004, we will have added $896 billion to our already massive 
national debt. Now, let us assume, as the Congressional Budget 
Office has, approximately a 4 percent borrowing cost for that 
money. What does that mean to the average American? It means 
that Americans today and our children tomorrow will pay $36 
billion a year in taxes simply to pay the interest on 2 years 
of irresponsible budget deficits, and they will pay that debt 
tax until the day they die--ourselves, our children, and our 
grandchildren.
    My colleagues, the debt tax is the one tax you cannot 
repeal, because we must pay the interest on the national debt, 
which to those who talk about holding down spending just 
happens to be one of the fastest-rising and largest single 
component of the Federal spending budget. This debt tax on 
average will be a permanent tax, a permanent tax increase, for 
a family of four of over $400 a year once again until the day 
they die.
    The irresponsible level of deficit spending that we are 
seeing I believe will harm economic growth and jobs growth by 
driving up the cost of expanding businesses and buying homes 
and cars; and, like Mr. Hensarling, I, too, worry about a 
family's ability to buy a house. Because once the economy gets 
back on its feet, these kinds of massive borrowings in the 
marketplace are going to drive up home mortgage rates to the 
point where Americans will no longer be able to afford to buy 
homes and to buy cars.
    This budget unbelievably and unfairly forces America's 
veterans to accept $14.9 billion in cuts over the next 5 years 
in veterans' health care and other services. As someone who 
represents 17,000 soldiers from Fort Hood, TX, who are now 
fighting in Iraq, I think it is bitterly unfair to ask those 
soldiers today who are tomorrow's veterans to pay with reduced 
health care services for tax cuts that in many cases go to the 
largest, wealthiest Americans in this land of ours, Americans 
who will never have to risk their lives in combat.
    I just want to suggest that--and I will finish in 30 
seconds if that is with your permission, Mr. Chairman--for 
those who suggest that spending cuts is the honest way to 
balance this budget, tell me why then the administration is 
asking for an increase in three of the five largest Federal 
programs that represent 70 percent of all Federal spending: 
defense, interest on the debt, and Medicare. The other two are 
Medicaid and Social Security, and I do not hear any cuts for 
that.
    Let us be honest with the American people, Democrats, 
frankly, as well as Republicans, and deal with this issue on a 
bipartisan basis to solve this problem for the good of our 
children and our grandchildren.
    Mr. Bolten. Mr. Chairman, if I could just take 60 seconds. 
I know Mr. Edwards didn't ask a question, but I wanted to 
correct one item in case there was some misimpression about the 
spending on veterans' care. There is no cut in veterans' care 
spending. There are, in fact, increases and have been 
throughout the Bush budgets.
    At the time that the President took office, there were 3.9 
million veterans getting health care from the VA. There are at 
this point 5 million VA patients getting health care. They are 
getting it more quickly, they are getting better health care, 
there is less of a backlog in getting claims processed, and the 
overall budget for veterans' health care has gone up 
substantially. The overall budget of the Veterans Affairs 
Department has gone up by 32.5 percent under President Bush, 
and medical care alone has grown by 34 percent, and we are 
continuing those kinds of increases in this budget.
    I think the veterans are well cared for in this budget, and 
it seems to me that we are handling this in a very responsible 
fashion to meet the needs of those who have served our country 
so honorably.
    One general comment, if I may, Mr. Edwards. I think we can 
disagree on exactly what the solution is. There is no lack of 
concern about the budget of the United States within the 
administration. We think we have presented a budget that 
addresses that situation credibly and effectively, and where we 
have a disagreement is whether the right answer here is to 
raise taxes to try to bring the budget back into a favorable 
situation. That seems to me to be the nub of all of our 
conversation here.
    Mr. Mankiw and I and the rest of the administration say, 
no, the wrong answer is raising taxes on this economy. The 
right answer is maintaining a path of responsible fiscal 
restraint and ensuring that there is sufficient economic growth 
to bring back both jobs and a reasonable deficit situation.
    Mr. Edwards. Mr. Chairman, can I ask you a question 
briefly?
    Chairman Nussle. The gentleman's time has expired.
    Mr. Edwards. That is why I would like to ask you a 
question.
    Chairman Nussle. I am sitting up here. I don't----
    Mr. Edwards. If I could ask a brief question----
    Chairman Nussle. I will try.
    Mr. Edwards [continuing]. Since Mr. Bolten answered a 
question I didn't ask, but he had a right to make his comments. 
But since in my opinion he did not accurately reflect what I 
said, may I have 30 seconds to reflect what I honestly said 
regarding veteran spending?
    Chairman Nussle. Just so we are clear on the record here, 
the gentleman went well beyond his 5 minutes. I will allow the 
gentleman to respond. You have 30 seconds and please do so. But 
members will be allowed to put statements in the record, and I 
think the gentleman's advocacy for veterans is well-known. I am 
not sure you have to take 30 seconds to defend that. I think 
you certainly have----
    Mr. Edwards. Twenty-five.
    Chairman Nussle. Twenty-four and we will make it a CBO 
score. How about that?
    Mr. Edwards. You have got it. Thank you, Mr. Chairman.
    Mr. Bolten, you and I both know that it doesn't tell the 
honest information to the American veteran if you say you 
increase veteran spending by 1 or 2 percent, that veterans' 
health care costs are going up 12 to 14 percent. That is why I 
said it is a cut in real services by $14.9 billion over the 
next 5 years and I stand by that. Thank you, Mr. Chairman, for 
your courtesy.
    Chairman Nussle. Thank you, Mr. Portman.
    Mr. Portman. Thank you, Mr. Chairman. And I want to 
congratulate Mr. Bolten and Mr. Mankiw on their testimony 
today. I know they haven't gotten to answer a lot of questions 
because they haven't been given much time on the other side, 
but they have done a great job in talking about what I think is 
a very realistic budget. To my friend Mr. Edwards, your 
complaint was this is a no paying budget and then where we 
ended up there is not enough money for veterans. I mean, I 
just--I think that says it all. We have increased veterans' 
spending by 30 percent over the last 3 years as I look at this. 
And it is a 9 percent increase in this budget. And they do it 
in the context of an overall nondefense, nonhomeland security 
budget of .5 percent. I mean, it is tough. You have to make 
priorities. Do you disagree with those numbers?
    Mr. Edwards. I do disagree with those numbers. If you 
listen to Veterans of Foreign Wars national commander, he calls 
this budget----
    Mr. Portman. That is not the point. The point is you can't 
call it a no-paying budget and saying we are not spending 
enough in an area where we are increasing it 9 percent.
    Mr. Edwards. It is not what I said.
    Mr. Portman. I understand what you said about health care 
costs. All I am saying is this is a budget that prioritizes. 
That is why it is realistic. It basically says to us look, we 
all agree, I hope on both sides of the aisle that the tragic 
events of 9/11, the corporate scandals, inheriting an economy 
that was beginning to spiral into recession, caused this, and 
let us put up the pie chart again, or chart 9. It shows very 
clearly.
    The pie chart says half of it was due to the economy 
getting into the deficit. This chart up here now takes it year 
to year. It basically says it is half. I will say 45 percent. 
About 30 percent is new spending. And we can say whether we 
should have spent that or not. We spent a lot more on veterans. 
We spent a lot more on defense. We spent a lot more on our 
homeland security because of the war on terrorism. Maybe we 
shouldn't have spent so much, but we did. About 18.5 percent, 
as I read it, 20 percent was due to the tax relief. And the 
question is, was that a good investment? Was that 20 percent a 
good investment? 20 percent of the deficit we are facing was 
due to the tax cuts. And I would ask Mr. Mankiw and Mr. Bolten 
to respond. What has been the effect of these tax cuts? Have 
they helped?
    Mr. Mankiw. Absolutely. There is a large economics 
literature that suggests that one of the ways to stimulate an 
economy that is in recession is to cut taxes and put money in 
peoples' pockets, to reduce the cost of capital, to stimulate 
investment spending and that is exactly what these tax cuts 
were aimed to do.
    Mr. Portman. So the economic growth in the second half of 
this year 2003 was the fastest since 1984. I mean we didn't get 
all the jobs back we hoped to, but we have real growth and that 
leads to revenue and that is way we got into a balanced budget 
in the late 1990s. It wasn't by cutting by spending, although 
we restrained spending as this budget does and that is 
admirable. It was because the economy grew. That is how we got 
into surpluses last time. I think you have to make a decision, 
was it worth it or not? It looks like it was worth it because 
the economy is coming back and we have incredible growth.
    I would ask you the following question then, which is 
should we increase taxes at this point? If we don't make the 
tax cuts permanent--I hate to use the word term ``permanent,'' 
because it is really keeping taxes from going up and it is 
going to happen next year starting with the child credit, 10 
percent bracket, marriage penalty, what impact would that have 
on the economy?
    Mr. Mankiw. Not making the tax cuts permanent would be 
contractionary much in the same way that cutting taxes was 
expansionary.
    Mr. Portman. I think what chart 3 shows is that growing the 
economy and restraining spending is the key. And this shows 
what the total discretionary spending is out to the year 2009. 
And if you look at that chart, it talks about discretionary 
spending having increased by an average of 9.7 percent. Maybe 
that was good and maybe it wasn't. We did what we thought we 
had to do to protect this country, take care of our veterans 
and so on. But in the next 5 years, their total discretionary 
spending would grow at 1 percent. If the economy grows, as we 
all hope it will and we keep the spending under control, what 
will happen, Mr. Mankiw?
    Mr. Mankiw. If we keep spending under control and make the 
tax cuts permanent, we will set the conditions for continued 
robust economic growth.
    Mr. Portman. And we will end up having a lower deficit. And 
I just got to say, when I was first running in Congress 1992, 
the deficit, as a percentage of the economy, was 4.7 percent. 
Is the deficit bigger this year or was it bigger the year I ran 
for Congress?
    Mr. Mankiw. It is 4.5 percent in this budget. Whenever 
looking at the size of a deficit, the nominal dollar figure is 
not tremendously meaningful. What is meaningful is to look at 
it relative to the size of the economy. And we are a much 
bigger economy today than we were 20 years ago.
    Mr. Portman. The relative size of the economy which is the 
key determinant as any economist will say, this is not the 
biggest deficit in history. Nobody likes them. We want to get 
out of them and this is the plan to do that. How about we 
talked about interest on the debt as a percentage of GDP. When 
I was first elected, it was a higher percentage of GDP than 
that. Why? Because interest rates are low. Why? Because people 
don't think these deficits are going to continue forever. And 
that is key. Thank you, gentlemen, for your testimony.
    Mr. Scott. Parliamentary inquiry. Will we be allowed to 
submit questions in writing?
    Chairman Nussle. What we usually do--I just needed to check 
how we have done this in the past. I will ask unanimous consent 
that not only members be allowed to submit statements for the 
record, but also to submit questions for the record. Any 
objection? Without objection, so ordered.
    [Prepared statement of Mr. Putnam follows:]

Prepared Statement of Hon. Adam H. Putnam, a Representative in Congress 
                       From the State of Florida

    Mr. Chairman, I am pleased that we have convened today to receive 
the fiscal year 2005 budget from the President of the United States. I 
am honored to be here today with you, Ranking Member Spratt, and the 
rest of the committee, to begin the process of reviewing and passing a 
budget for our country. I would like to thank the Mr. Bolten, for 
joining us to discuss in detail the President's budget. This budget, 
which holds spending growth to less than 1 percent of the rate of 
inflation and aims to cut the deficit in half over the next 5 years, is 
a step in the right direction in addressing the growing Federal 
deficit. I am confident that together the President and Congress can 
act in a fiscally responsible manner while also providing a budget to 
make America more secure, more prosperous, and more hopeful.
    The President has presented a bold plan to provide substantial 
increases to improve our nation's security and win the war on terror. 
It also increases funding for key priorities such as economic growth 
and job creation, and affordable health care. This budget reflects two 
realities. First, we have an obligation to protect our homeland from 
terrorists who want to attack us. Second, we must act in a fiscally 
responsible manner in order to fight deficits, we need to grow the 
economy and hold the line on spending.
    This budget goes far to strengthen America's domestic opportunity. 
This budget shows the President's commitment to continue to grow 
America's economy. The President proposes to continue the strong pro-
growth policies that are creating jobs and opportunities for the 
American people. I am pleased this budget makes permanent the tax 
relief Congress passed: doubling the child tax credit; reducing the 
marriage penalty; phasing out the death tax; lowering rates on capital 
gains, stock dividends, and small businesses to create incentives for 
job creation; and lowering rates for every American who pays income 
taxes. I am delighted that the President's tax relief agenda has 
resulted in significant benefits for the people of Florida including 
more than 6.1 million taxpayers in Florida seeing their income tax 
bills reduced, more than 1.7 million married couples in Florida 
benefiting from marriage penalty relief and over 1.5 million families 
in Florida benefiting from the increase in the child tax credit from 
$600 to $1000. The President's budget will secure these positive 
economic trends for Floridians by making the tax relief permanent.
    The budget also stays on the path to creating better quality 
healthcare in America. Last year, Congress passed the Medicare 
Prescription Drug and Modernization Act of 2003 to improve healthcare 
for America's seniors. This year, the President has proposed making 
healthcare more affordable for all Americans by creating new tax 
credits for the purchase of health insurance.
    The President has also presented a budget that lays out a solid, 
aggressive plan to bolster our nation's strength and stability abroad. 
This budget makes a clear commitment to provide our nation with the 
best trained, best equipped and most efficient military force in the 
world. The budget provides the newly created Department of Homeland 
Security and related agencies with the resources necessary to win the 
war on terror.
    While the President has shown a strong commitment to enhancing our 
domestic and national security, he has also presented a budget that 
takes into account the mounting deficit that threatens to bankrupt 
future generations. The President has made a strong commitment to 
reduce the deficit, cutting it in half in the next 5 years. I am 
hopeful that Congress can make the tough choices to help restrain 
spending, so that our budget is brought back to balance, as soon as 
possible. We have a moral obligation to Americans not yet born o get 
out fiscal house in order.
    I look forward to Director Bolten's testimony as I am sure he will 
provide all of us with a clear picture of the President's budget and 
its focus on the most urgent needs of our country: winning the war 
against terror, ensuring that our citizens are safe, strengthening and 
stabilizing our economy, and shrinking the Federal deficit.
    [The prepared statement of Mrs. Capps follows:]

  Prepared Statement of Hon. Lois Capps, a Representative in Congress 
                      From the State of California

    The President's budget submitted yesterday represents yet another 
low point for this administration. The President tells us in this 
document that we will have a record-breaking deficit of $521 billion in 
fiscal year 2005. But he greatly understates the deficit at hand, 
advocates policies that will enlarge the problem, and leaves critical 
national needs unmet. The administration witnesses and the President 
have tried yet again to downplay the magnitude of the fiscal problems 
we face today and for the foreseeable future.
    But we have heard this song before. Last year, OMB Director Daniels 
explained how the size of the deficit wasn't that great and that the 
administration had everything under control. He even produced us charts 
that showed us how the deficits would decrease in each of the 
successive years.
    Mr. Chairman, one year ago, the predicted deficit for fiscal year 
2005 was $208 billion. Now the projected deficit for fiscal year 2005 
is $521 billion. And this actually understates the problem.
    For example, the President's budget includes no money for the 
continuing occupation of Iraq and Afghanistan. No one believes that our 
troops will be out of Iraq by October 1, the start of fiscal year 2005. 
Right now we are spending several billion dollars a month and that will 
likely continue for at least the next few years. Yet there is nothing 
in the budget to pay for these costs.
    The President's budget doesn't fix the Alternative Minimum Tax 
problem in the tax code that will result in a hidden tax hike for tens 
of millions of middle class taxpayers over the next 10 years. A true 
fix of this problem will cost over $500 billion over the next 10 years, 
according to CBO.
    In addition, the President has advocated proposals that cost 
trillions more that he doesn't have any plans to pay for. For example, 
he has called on Congress to make permanent the tax cuts of the last 
few years that have mostly benefited the wealthiest in our society. 
That would add another $1 trillion to the deficit over the next 10 
years. The President wants to go to Mars and the moon. Fifteen years 
ago, another President Bush advocated going to Mars and it was 
estimated to cost at least $400 billion. And the President wants to 
privatize Social Security with transition costs that are at least $1 
trillion.
    To his credit, the chairman of the Budget Committee has repeatedly 
stated that ``deficits do matter.'' I completely agree with him. But 
what matters even more are the steps we take to deal with these 
deficits and how that affects our citizens. And again, the President's 
plan fails. His plan is to continue giving big tax cuts to the 
wealthiest among us and pay for them by ignoring the needs of everyone 
else.
    This is irresponsible, unfair and it won't work. This budget 
underfunds the President's commitment to fix our failing schools by 
more than $9 billion. It freezes the maximum Pell Grant award and 
reduces the average award for the third straight year, even any parent 
with a child in college knows that college costs have risen 
dramatically. In addition, the budget offers little help for the more 
than 43 million uninsured Americans. The President's tax credit 
proposals will serve mostly to undermine the current insurance market 
and the Health Savings Accounts will mostly benefit the wealthy and 
healthy.
    The President's budget underfunds by $13.5 billion over 5 years the 
amount needed just to continue providing current medical care for our 
nation's veterans. In my district, the VA is scrambling to find a way 
to continue offering specialty services in Santa Barbara. At a time 
where the President's policies in Iraq are creating thousands of new 
disabled vets, this cut is unconscionable.
    This budget represents skewed priorities that are hurting American 
families and it should be rejected.
    [Questions submitted for the record follows:]

Questions From Hon. John Spratt, Jr., a Representative in Congress From 
                      the State of South Carolina

    Question. In your oral testimony, you claimed that the ``total tax 
burden'' paid by the top 5 percent increased as a result of the 2001 
and 2003 tax cuts. Yet the chart you showed related only to the Federal 
income tax burden. Could you please provide the Committee with the 
share of total Federal taxes paid, with and without the 2001/2003 tax 
cuts, by the top 1 percent and the top 5 percent of the income 
distribution? Please provide the figures for 2004 and for 2010.
    Answer. The data from which this analysis is drawn comes from the 
Department of Treasury, which has not done a similar analysis for all 
Federal taxes paid. To our knowledge, neither the Congressional Budget 
Office nor the Joint Tax Committee have produced such analysis 
recently.
    An analysis of the share of total taxes paid with and without the 
2001/2003 tax cuts would undoubtedly show different levels of the tax 
shares than does the chart showing only Federal income taxes. However, 
one can also suggest that such an analysis would undoubtedly continue 
to show that the effect of the tax cuts has been to make the overall 
tax system more progressive because there were no legislative changes 
to the non-income tax components of the Federal tax system that would 
have altered their distribution.

    Question. In your oral testimony, you intimated that an appropriate 
benchmark for the growth of discretionary spending is the nominal 
growth of household income. Could you please provide a comparison, on a 
year-by-year basis for each year between 2004-09, of the projected 
nominal growth in household income and the projected growth in 
discretionary spending under your budget?
    Answer. I do believe that discretionary spending growth for fiscal 
year 2005 should not exceed the growth in family income. The President 
has proposed 3.9 percent discretionary spending growth in fiscal year 
2005. The budget shows discretionary spending increasing 3 percent in 
2006, and by 2.9 percent in the following years of the budget window.
    In looking at the data, we find a multitude of measures of family 
income which tend to show about 4 percent growth. For example, the 
Census measure of the average annual rate of increase of median family 
income for the twenty year period from 1983 to 2002 was just under 4 
percent.
    Our economic forecast for 2004 and beyond does not attempt to 
forecast family incomes in any way. Consistent with the practice of 
previous administrations, our economic forecasts focus on economic 
parameters that are directly relevant for forecasting future tax 
receipts and spending levels. Thus, for example, the administration 
forecasts the levels of income in each forecast year, and how that 
income is likely to be distributed across categories such as corporate 
income, wages and salaries, and sole proprietorship income.
    It is possible to develop forecasts of family income growth using 
the administration's existing forecasts of national income growth, but 
to do so would require making additional assumptions such as how the 
income distribution is likely to change, and additional demographic 
assumptions such as how the percentage of individuals in families as 
defined by the Census Bureau is likely to change. The administration 
has not heretofore attempted to forecast these additional variables, 
and thus it is not possible to construct a forecast of family incomes 
without this additional information.

Questions From Hon. David Vitter, a Representative in Congress From the 
                           State of Louisiana

    Question. At least 4 months have passed since the study was 
originally expected to be released, and apparently the delay is now 
with an OMB review of the study. Can you explain what is holding up the 
study and why the original deadline was not met?
    Answer. OMB completed its review of a draft report in November 
2003. As a result of that review, we provided recommendations to the 
Army Corps of Engineers for improving the report and its strategy for 
addressing the needs of this ecosystem. At this point, the Corps is 
working to reach agreement with the State on the revisions that will be 
needed to (1) focus the restoration effort on the parts of the 
ecosystem that require the most immediate attention, (2) identify the 
key long-term scientific uncertainties and engineering challenges 
facing the effort to restore the ecosystem, and (3) make the best 
possible use and leveraging of Federal, State, NGO and private sector 
funds.

    Question. Bureaucratic hold-ups only mean more of Louisiana's coast 
will be lost before a restoration plan can be developed and then 
implemented. What assurances can you give that this study will be 
released soon? Can you think of anything that I or the state government 
can do to help you speed up the study's release?
    Answer. Under the 1990 Breaux Act and numerous other state and 
local authorities, a strong regional collaboration on restoration is 
already underway and is providing an important science, technical, and 
policy foundation for the work that lies ahead in protecting and 
restoring the ecosystem. The administration is working diligently to 
release a report that contributes strategically to this effort as soon 
as possible. The State and the Corps are working together in good faith 
to come to agreement on the revised plan, particularly regarding the 
most important near-term actions. Previous experience indicates that 
moving forward too quickly with a flawed plan eventually makes matters 
worse rather than better. We want to get this right at each stage of 
the process.

    Question. Can you commit to working with me and the rest of the 
Louisiana delegation to provide additional funding for Louisiana's 
coastal restoration efforts?
    Answer. We welcome the opportunity to work with you and the 
delegation on this important issue. The most recent budget already 
commits the administration to seeking a major increase in funding for 
coastal and wetland efforts. For example, we propose to nearly double 
last year's estimate of funds that the Federal-State task force would 
obligate for fiscal year 2004--from $49 million to $95 million.
    Regarding the Coastal Louisiana draft report, it is premature to 
make any funding commitments. Once a feasibility report is completed 
and approved, it can be used to inform future funding decisions.

 Question From Hon. Mac Thornberry, a Representative in Congress From 
                           the State of Texas

    Question. My understanding is that some of the reductions in taxes 
which we have passed in previous years are set to expire at the end of 
this calendar year. I would like to know what those tax cuts that are 
set to expire, how many people are affected, if you have those numbers, 
and how they would be affected if they expire in taxes and those areas 
are allowed to go back up?
    Answer. The Economic Growth and Tax Relief Reconciliation Act of 
2001 (EGTRRA) phased in tax relief over a number of years, the exact 
timing and amount of relief depending on the specific provision. The 
Jobs and Growth Tax Relief Act of 2003 (JGTRRA) accelerated much of 
this relief, including the marriage tax penalty relief, the increase in 
the child tax credit, and the increase in the income threshold for the 
10 percent tax bracket to their fully phased in levels, but only for 
2003 and 2004. After 2004 the tax relief reverts to the phase-in 
schedule described in the 2001 tax bill. The President has called on 
Congress to make the tax relief permanent at the 2004 levels. Unless 
Congress acts to extend the relief in effect in 2004, millions of 
American families are going to face a very large tax increase in 2005.
    The exemption amount of the individual Alternative Minimum Tax 
(AMT) was also increased in EGTRRA for taxable years 2001-04, and 
increased further by JGTRRA for taxable years 2003-04. For 2004, the 
exemption level is $40,250 for single filers, $58,000 for married 
filers filing joint returns, and $29,000 for married filers filing 
separate returns; under current law the exemption amount would revert 
to its pre-EGTRRA levels of $33,750, $45,000, and $22,500, 
respectively. The President has called on Congress to maintain through 
2005 the exemption amounts at their 2004 levels. The President has also 
called on Congress to extend a provision from the 2002 tax bill that 
allows taxpayers to use nonrefundable tax credits against AMT 
liability.
    The 2002 tax stimulus bill included a provision to allow taxpayers 
purchasing qualified business assets to deduct 30 percent of the cost 
in the year of the purchase, with the balance of the amount depreciated 
under the normal schedules. The provision, commonly, referred to as 
``bonus depreciation,'' applies to investments made prior to January 1, 
2005. The 2003 tax bill increased the upfront deductible percentage to 
50 percent.
    The bonus depreciation provision was intended to stimulate business 
investment by reducing the cost of capital to new investment; it 
appears to have had its intended effect and should be allowed to 
expire.
    If the Congress fails to extend the four expiring tax provisions--
the increased child tax credit, the increased 10 percent bracket 
amount, the marriage penalty relief, and the AMT relief--then taxpayers 
will face a $20.9 billion tax increase in 2005, and a $118.6 billion 
tax increase over the 2005-09 period. Such an enormous tax increase 
would slow the economy as it continues to return to full employment, 
and it would be a great burden to impose on family incomes. We do not 
yet have figures from the Treasury Department as to how many taxpayers 
would be affected in each year.

 Question From Hon. Henry E. Brown, a Representative in Congress From 
                      the State of South Carolina

    Question. But I notice, too, as part of the 256 I believe you 
mentioned in this budget here, how much of that is exactly mass transit 
and how much is being attributed to enhancement funds?
    Answer. The funding level requested in the fiscal year 2005 budget 
would provide $44 billion for transit programs from fiscal year 2004-
09. The administration's SAFETEA proposal would retain the 10 percent 
transportation enhancements set-aside of Surface Transportation Program 
funds, as was provided under TEA-21, for transportation-related 
activities that strengthen the cultural, aesthetic, and environmental 
aspects of the Nation's transportation system.

    Mr. Nussle. Mr. Cooper.
    Mr. Scott. Questions to the witness?
    Chairman Nussle. Yes, sir. Mr. Cooper. You aren't going to 
ask me any questions or you can try. Mr. Cooper.
    Mr. Cooper. Thank you, Mr. Chairman. When you run a 
deficit, that means you have to borrow money from somebody to 
fund the deficit. And in absolute dollar terms, we are running 
the largest deficit in American history. And in percent of GDP 
terms they are not quite as large, but they are still pretty 
sizeable. But nothing changes the fact that you have to borrow 
the money from somebody. And you can sell these bonds either to 
U.S. folks or you can sell them to foreign folks. So with a 
$500 billion deficit, doesn't that mean we have to sell $500 
billion worth of bonds? Is that about right?
    Mr. Mankiw. That is correct.
    Mr. Cooper. And there are 365 days a year, so that is over 
a billion dollars a day that we have to borrow from somebody. 
Many of our bond borrowers are foreigners?
    Mr. Mankiw. That is correct.
    Mr. Cooper. Do you have an estimate of how much we depend 
on foreign bond borrowers everyday?
    Mr. Mankiw. The Treasury Department has those numbers, but 
there are sizeable purchases of U.S. Treasury bonds overseas.
    Mr. Cooper. Is it on the order of 30, 40 percent of the 
total?
    Mr. Mankiw. Yes.
    Mr. Cooper. And when the value of the dollar fluctuates, 
that can affect the return of the foreign bond buyer, right?
    Mr. Mankiw. That is correct.
    Mr. Cooper. And recently, I think we have had a softer 
dollar than in some years, and that can hurt the return that a 
foreign bond buyer receives, right?
    Mr. Mankiw. That is correct.
    Mr. Cooper. That could affect their willingness to lend us 
more money in the future?
    Mr. Mankiw. Well, in principle it could, but so far the 
U.S. bond market has held up quite well, even with fluctuations 
in the dollar. The U.S. the dollar is very much to the world 
standard. And we continue to be able to borrow at quite low 
rates because of the confidence in the American economy.
    Mr. Cooper. So far so good. And we all pray that good news 
will continue. But in your own deficit or your own budget, you 
say the current path of deficits unsustainable. My good friend, 
the Wall Street journal columnist Alan Murray has a little 
three-part question in today's paper. He says who says deficits 
are unsustainable, John Kerry, Barbara Streisand or Josh 
Bolten? And the answer is all three. That is probably one of 
the few things I probably agree on, but it is on page 191 of 
your analytical supplement. And it is pretty scary reading for 
anybody who wants to get on the Web and read that part of it.
    Mr. Bolten. It is scary for me to be lumped in with Barbara 
Streisand.
    Mr. Cooper. I don't want to ruin your reputation. But every 
day when you run a deficit, you have to depend on somebody to 
loan you money, U.S. citizens who are presumably more willing 
to do that and also foreigners. What guarantees do we have 
these nice foreign folks are going to be willing to continue to 
loan us money in historically high amounts, for, as David 
Stockman used to say, as far as the eye can see? What 
guarantees do we have that they are going to be interested in 
loaning us this money in the future?
    Mr. Mankiw. The U.S. dollar remains at a standard and a 
place of safety. Also a place where people put when they want a 
very safe asset, and that reflects large confidence in the U.S. 
economy. But it is probably true that over time, the trade 
deficit will shrink and that will affect our--how we finance 
the deficits. It is one of the reasons why one would want to 
get the budget deficit down. I think we share your concern. The 
issue is not goals. I think we share the goal of reducing the 
budget deficit and I think a difference of opinion may be over 
means.
    Mr. Cooper. The U.S. dollar is not the only store of value 
in the world. The euro, in recent years, has appreciated 
substantially, hasn't it, a relatively new up-start currency. 
It went from 80 cents to $1.20. So if you had invested in euro 
bonds, you would have gotten an appreciation that might have 
exceeded your return on having invested in U.S. paper. So it 
would have been wiser if you were a savvy world investor to 
have invested in their debt instead of ours. This is the heart 
of the capitalist system.
    Mr. Mankiw. Despite that appreciation of the euro, the 
United States has been growing faster than Europe and is 
expected to continue growing faster than Europe.
    Mr. Cooper. In terms of dollar returns.
    Mr. Mankiw. Interest rates have been higher in Europe.
    Mr. Cooper. I see my time has expired, but the core issue 
is that if we run a deficit, someone on this earth is going to 
have to be willing to loan us money, over a billion dollars a 
day, and you haven't told me any guarantee or reason other than 
historical path that they are going to be willing to continue 
to loan us this money in the future.
    Mr. Mankiw. I think because they believe correctly that the 
U.S. Government will honor its debt obligations.
    Mr. Cooper. I see that my time has expired, Mr. Chairman.
    Chairman Nussle. Mr. Davis.
    Mr. Davis. Thank you, Mr. Chairman. One of the challenges 
Mr. Bolten and Mr. Mankiw as being at the low end of the totem 
pole is that there is not a whole lot of new ground to cover 
with you, but we are not notorious for sacrificing 5 minutes 
either. It is a general habit we have when we get elected to 
something. Let me try a little different ground. One of the 
things that is crystal clear, I think from listening to this 
entire colloquy over the last 2 hours is that there clearly is 
a scenario that one could envision in which that these tax cuts 
might seem enormously successful if your projections are right 
about rising revenues, if your projections are right about the 
deficits as a percentage of GDP, if your projections are right 
about economic growth.
    At the same time, it seems fairly clear there is a scenario 
in which all of those numbers could be very wrong and the whole 
house of cards could come tumbling down, if you will. Given 
that, it strikes me that there may be a real opportunity for 
this Congress to think about the tax cuts in terms of tying 
them to what our relative percentage of what the deficits' 
relative percentage to GDP is in 2007, 2008 and 2009. For 
whatever reason, I think I understand the politics of it, but 
for whatever reason, the Bush administration is committed to 
getting this Congress to act now in dealing with the sunset 
issue.
    That is why I think some of us on both sides of the aisle 
think it is a bit premature. Why not simply tie for the largest 
portion of these tax cuts, why don't you simply tie whether 
they sunset or not, to what the deficits' percentage of GDP is 
at any given time over the next several years instead of making 
a decision right now to just lock in the tax cut strategy, 
irrespective of what the economic consequence might be.
    Mr. Mankiw. You are absolutely right that economic 
projections are uncertain and indeed, as many forces that 
affect an economy well beyond economic policy. We saw that in 
the 1990s with the high tech bubble, which came collapsing 
down. Had tremendous positive influences in budget projections 
in the late 1990s and negative influences as the bubble 
collapsed. Uncertainty is never good for an economy. Investors 
thinking about starting a new business will often delay. We 
can't eliminate uncertainty. Uncertainty is a natural part of 
the economic environment. But it is good to keep uncertainty to 
a minimum.
    Uncertainty about tax policy is one kind of uncertainty 
that can be eliminated, or at least reduced. But the less 
uncertainty there is, the better. Thinking, for example, about 
the reduction of the tax on dividends. That has had a positive 
effect on the stock market. To the extent that it is uncertain 
as to whether that is going to continue, that is going to 
mitigate the positive effect in the stock market and mitigate 
the positive effect it will have on the cost of capital, 
investment and economic growth. So the argument for making the 
tax cuts permanent is to try to reduce uncertainty. If you are 
not going to eliminate uncertainty, that is part of economic 
life. But by leaving the uncertainty on the table is a negative 
for the economy.
    Mr. Davis. I understand that at the abstract level, but I 
guess my concern is that given the incredible number of 
imponderables that we have from what our international 
obligations may be to what tax revenues may be and frankly, 
given the backdrop to all of this, you all have gotten wrong 
the last 3 years in terms of the job growth and revenue rise 
and in terms of what the deficit would be. And we can debate 
until we are blue in the face why that has happened, but make 
no mistake, we have gotten it dramatically wrong the last 3 
years. And it is my guess that we are going to get it 
dramatically wrong again.
    So from an economic standpoint, what is the risk in 
tolerating a little bit more uncertainty to forego the question 
for now of whether these tax cuts need to be permanent? What is 
the rush to deal with this now? We have had the uncertainty for 
the past year and that didn't prevent 8.2 percent growth in the 
third quarter of last year and prevent 4.3 percent growth in 
the last quarter. So what is the rush to deal with this 
question now other than the fact that it is a good election 
year issue?
    Mr. Mankiw. Because the sooner we resolve uncertainty, the 
better. It is very hard to quantify the impact of uncertainty.
    Mr. Davis. I understand that. Obviously the uncertainty has 
been here all of last year. It didn't prevent 8.2 percent 
growth in the third quarter. It didn't prevent 4.3 in the last 
quarter. I would be happy to have the average of those two, 6.6 
this year. I would be happy to take that. So again, what is the 
rush? What is the rush to deal with this now as opposed to 
dealing with it in future Congresses?
    Mr. Bolten. If I could say one thing, I think a lot of 
people out there in the country and the markets are expecting 
that this Congress will do the right thing and will extend the 
tax cuts into the future.
    Mr. Davis. The uncertainty has been there.
    Mr. Bolten. I actually think the uncertainty is pretty low 
because the American people are pretty confident that this 
Congress will do the right thing, as am I.
    Mr. Davis. Why not wait until 2007 or 2008?
    Chairman Nussle. The gentleman's time has expired. For the 
last series of questions for this panel, Mr. Shays.
    Mr. Shays. Thank you. None of us are in love with this 
budget. None of us are in love with the fact that the economy 
has fallen significantly. I think none of us are thrilled about 
the fact that we had 2001, that we had an industry that fell 
apart in terms of a confidence in the marketplace and the fact 
that the stock market went down. None of us are thrilled about 
it, the question is what do we do about it. And I was with Mr. 
Edwards for part of this conversation until he mentioned 
veterans and talked about a 1-percent increase and.
    I thought there lies some of the problem. We kind of gained 
the issue that is most sensitive because any way you look at 
it, if we look at veterans spending from 2001 to now, we have 
added 49.4 percent. That is one huge increase. Nearly 50 
percent of the budget. Or if we just do the last 3 years, we 
have added 32 percent. We have added $16 billion. Only in 
Washington when you have such a significant increase do people 
call it a cut. I know we have some veterans who want even more 
benefits. But what I tell them is we are doing a heck of a lot. 
What I didn't hear, at least in the time I was here was any 
solutions. I heard no solutions frankly from anyone. I heard 
that we need to work on a bipartisan basis, and I agree with 
that. But I don't hear my colleagues on the Democratic side of 
the aisle say they want tax cuts--I hear they criticize tax 
cuts but they don't want tax increases.
    There is a bill going around that restores--makes--
eliminates the tax cuts, and there are only a handful I think 
that are on the bill; is that correct? Just a handful. So it 
strikes me also a bit discouraging.
    Last year, I want to say this to Mr. Bolten, we cut 1 
percent off the President's increase and it would have been 
great to have the President's support. We got it out of 
committee, but we didn't get any help from our Democratic 
colleagues. And we would have reduced the increase by 1 
percent. And that would have had significant benefit I think 
each and every year.
    I certainly don't fault this administration for the fact 
that we have to fight this war on terrorism and it takes more 
money or that we are engaged in a horrific conflict in Iraq 
that can have huge benefits, but we are at war and we are going 
to have deficits. I know that. I congratulate this 
administration for encouraging tax cuts and growing the 
economy. I have one difference on the tax increase. I have not, 
even in my wealthiest community, had anyone tell me they wanted 
the total elimination of the inheritance tax. They would like a 
tax rate come from 55, say, down to 25. They would like the 
threshold to go from 1 million up to something, but nobody has 
asked for the total elimination of it. And I am kind of hard-
pressed why the administration pushes that. And let me ask you 
this. Wouldn't it be wiser just to extend the tax cuts that are 
coming due now rather than do all of them; continue to look at 
it and have the confidence, frankly, that this administration, 
because of the good job it has done, will get reelected and 
revisit that in years to come?
    Mr. Bolten. I will ask Greg to talk about the death tax in 
detail.
    Mr. Shays. Not in detail, spare me.
    Mr. Bolten. In as much detail as is possible in 1 minute 
and 16 seconds.
    Mr. Shays. I don't want him to use that much time. You got 
about 20 seconds to tell me about the death tax. Go for it.
    Mr. Bolten. Let me take 8 seconds and say about the timing. 
We absolutely need to extend those tax cuts that are expiring 
this year. And we also think it is the moment to extend all of 
the others as well. When Mr. Davis was asking me about why not 
leave some uncertainty out there, I think there is confidence 
out there that we will extend those tax cuts. I think we will 
undermine that confidence if this Congress does not act to 
extend all of them permanently.
    Mr. Shays. That is an argument.
    Mr. Mankiw. On the death tax I will be very brief. Two 
issues, growth and fairness. On growth, the death tax is a tax 
on capital. As a tax on capital, it beats capital accumulation 
and economic growth. On the fairness issue, the question is why 
should someone who chooses to leave his money to his children 
face a higher tax rate than someone who chooses to spend on 
himself when he is living?
    Mr. Shays. We have others who decide to give it to charity.
    Mr. Mankiw. And they get a charitable deduction for that. 
The question is why should I stop spending on myself, give me a 
tax break relative to rather than giving it to my children. It 
is an issue of fairness. Those are the two arguments.
    Mr. Shays. All I say we look forward to working with you. 
We need to do a better job working with our colleagues on the 
Democratic side of the aisle. But we didn't hear a lot of 
solutions today from members, which obviously is part of the 
challenge.
    Chairman Nussle. I thank our two witnesses for their 
testimony, and we will certainly look forward to working with 
you as we craft the budget and put it together this year and 
particularly we want to be helpful and we hope and we know you 
join us in the endeavor to control spending. We have a lot of 
work as I said in the outset. It is not just about the budget, 
we have an energy bill. We have a transportation bill. We have 
other mile markers on the road here to deficit reduction that 
will tell us whether we are on the road or whether or not we 
are veering off. I hope colleagues and the administration are 
ready to work together to control spending, not just budgetary 
spending 2, 3, 4 years in the future.
    Mr. Bolten. We are indeed, Mr. Chairman, and we thank you 
for your attention.
    Chairman Nussle. The second panel for today we will call up 
and allow for our first panel to depart. The second panel is 
Peter Orszag--at least that is how I would pronounce it in 
Iowa--doctor and senior fellow from the Brookings Institute. 
And we are certainly honored to have you with us today and 
honored to receive your testimony at this time.
    Chairman Nussle. And your entire testimony will be made 
part of the record.

  STATEMENT OF PETER R. ORSZAG, SENIOR FELLOW, THE BROOKINGS 
                          INSTITUTION

    Mr. Orszag. And I will be brief because I know the late 
hour is difficult for everyone. Let me make three or four 
points, and actually follow up on some of the discussion that 
has occurred earlier this afternoon. First I want to talk about 
the alternative minimum tax. There has been a lot of discussion 
about tax increases in the future. In 2010, under the 
administration's budget, 34 percent of the 2001 tax cut would 
be taken back by the AMT. There would be 30 million taxpayers 
or so on AMT, and roughly a third of the total 2001 tax cut 
would be taken back. In my view, the administration neither 
needs to admit that and indicate that families will not be 
receiving these tax cuts that the President is talking about or 
show the costs of avoiding that outcome, which, by way the way, 
in 2009, 2010, would amount to $70 billion. That is one of the 
reasons why the claim that the deficit would be cut in half by 
2009 in my opinion is not credible.
    Second point that was discussed was the effects of locking 
in the tax cuts on uncertainty in the future. And I think, in 
some sense, this misses the boat. Think of a family that has 
leased a car that it can't afford and then has something bad 
happen to it. Makes it even less affordable to have the car. 
The lease comes up for expiration and the family decides to 
purchase it because it really wants to make sure it knows what 
kind of car it is driving.
    That is similar to locking in these tax cuts. The 
fundamental source of uncertainty is the fiscal imbalance in 
this country. What taxes are we going to increase and what 
spending programs are we going to reduce in order to bring 
balance back to the Federal budget. Locking in the tax cuts 
does not resolve that source of uncertainty. It actually makes 
it worse.
    We are kind of having a discussion that really doesn't 
match up to the underlying source of uncertainty which is the 
Nation's large fiscal gap.
    Third point I want to make is something that has not been 
remarked upon very much this afternoon, which has to do with 
the savings accounts, that came up a little bit. What is 
remarkable about the budget is that among the only tax cuts 
that are not extended, in other words, that would be eliminated 
under the administration's budget is the savers' credit for 
moderate income families who struggled to put away some money 
in a 401(k) or IRA. And under current law, have some of that 
matched by a Federal tax credit. That would expire under the 
administration's budget. And yet there are large new tax 
subsidies for savings done by high income households. This has 
to do with national saving. High income households offered a 
tax break are much more likely to just shift assets from other 
accounts into the tax-preferred account than low income 
households.
    So if we care about raising national saving, where we 
should be concentrating incentives are at the bottom end of the 
income distribution where families don't have other assets to 
shift. That means that any dollar that actually shows up in the 
account is much more likely to be new saving rather than just 
shifting of assets. And finally, I wanted to stay very brief. 
Let me talk about the budget rules that are proposed in this 
budget. I think that it is not only on balance to impose 
restraints just on one side of the budget and not another, but 
actually unlikely to work. And the reason it is unlikely to 
work is that you will have stronger incentives to shift 
programs from the spending side to the tax side as we have seen 
has already occurred over the past 2 decades or so creating 
what Chairman Greenspan has called a tax entitlement. It 
doesn't do any good to potentially inefficiently shift programs 
from the spending side to the tax side, which is what the 
incentives would be under the type of budget rules that the 
administration is proposing. So my written testimony, Mr. 
Chairman, goes through these issues in much more detail. But 
given the late hour, I will leave it at that for now.
    [The prepared statement of Mr. Orszag follows:]

The Prepared Statement of Peter R. Orszag\1\, Joseph A. Pechman Senior 
   Fellow, the Brookings Institution, Co-director, Tax Policy Center
---------------------------------------------------------------------------

    \1\ The views expressed are those of Dr. Orszag alone and should 
not be attributed to the trustees, officers, or staff of the Brookings 
Institution or the Tax Policy Center. Much of this testimony draws 
directly upon joint work with William Gale of Brookings, Robert Rubin 
of Citigroup, and Allen Sinai of Decision Economics, Inc. See, in 
particular, William G. Gale and Peter R. Orszag, ``The Budget Outlook: 
Updates and Implications,'' Brookings Institution, January 29, 2004, 
and Robert Rubin, Peter R. Orszag, and Allen Sinai, ``Sustained Budget 
Deficits: Longer-Run U.S. Economic Performance and the Risk of 
Financial and Fiscal Disarray,'' Paper presented at the AEA-NAEFA Joint 
Session, Allied Social Science Associations Annual Meetings, The Andrew 
Brimmer Policy Forum, January 2004. My co-authors should not be held 
responsible for the views expressed in this testimony, however.
---------------------------------------------------------------------------
    Mr. Chairman and members of the committee, thank you for the 
opportunity to testify on the President's fiscal year 2005 budget and 
the budget outlook. My testimony makes several key points:
     The Nation is on an unsustainable fiscal path--and the 
administration's budget makes the long-term fiscal problem 
substantially worse.
     Assuming that we extend expiring tax provisions, maintain 
a constant level of real per capita discretionary spending, and reform 
the alternative minimum tax, the unified budget deficit over the next 
10 years amounts to $5 trillion or more, according to a wide variety of 
independent analysts.
     The unified budget projections include large cash-flow 
surpluses accruing in trust funds for Social Security, Medicare, and 
government pensions over the next 10 years. In the longer term, Social 
Security and Medicare face significant deficits. Outside of the 
retirement trust funds, the adjusted budget now faces a deficit of more 
than $8 trillion over the next decade.
     Sustained budget deficits have damaging economic 
consequences. Ongoing fiscal deficits will reduce future national 
income, reduce flexibility to respond to unforeseen events in the 
future, and increase the risk of fiscal and financial disarray, with 
potential costs far larger than those presented in conventional 
economic analyses:
     Using conventional economic tools and conservative 
assumptions that have previously been adopted by the Bush 
administration's Council of Economic Advisers, the deterioration in the 
official CBO projections since January 2001 will, by 2012, raise 
interest rates by 125 basis points, reduce annual national income by 
more than $300 billion, and increase U.S. indebtedness to foreign 
investors. The adverse effects would persist and grow over time.
     The conventional analysis may well understate the costs 
from large, sustained budget deficits such as the ones we now face in 
the United States. As Robert Rubin, Allen Sinai, and I recently 
concluded, ``The scale of the nation's projected budgetary imbalances 
is now so large that the risk of severe adverse consequences must be 
taken very seriously, although it is impossible to predict when such 
consequences may occur.''
     The administration's budget substantially understates the 
fiscal imbalance likely over the next decade or so, because it ignores 
many likely costs:
     Among other factors, under the administration's policies, 
more than 33 million taxpayers would be on the Alternative Minimum Tax 
(AMT) by 2010--and 34 percent of the 2001 tax cuts would be erased by 
the AMT. For households with incomes between $100,000 and $200,000, the 
AMT would take back almost two-thirds of the 2001 tax cuts by 2010.
     The administration's budget does not fully finance the 
Future Year Defense Plan and other likely defense costs.
     Because it leaves out many likely costs, the 
administration's claim to cut the budget deficit in half over the next 
5 years is not credible.
    Even if the administration's claim for the unified budget were 
credible, furthermore, the deficit outside Social Security under the 
administration's own projections would remain 3.6 percent of GDP in 
2009. And after 2009, according to the administration's own projections 
of its extended policies, the budget would deteriorate rapidly.
     The tax cuts are a major fiscal issue for the next decade 
and thereafter. If the 2001 and 2003 tax cuts were extended, they would 
contribute significantly to the nation's long-term fiscal imbalance:
     Making the 2001 and 2003 tax cuts permanent would increase 
the deficit by $1.7 trillion over the next decade. The administration's 
budget shows a lower cost, but that is mostly because it assumes that 
the AMT ``takes back'' a growing part of the 2001 and 2003 tax cuts 
over time.
     The total budget cost (with interest) from extending the 
2001 and 2003 tax cuts, along with other expiring provisions such as 
the R&E credit, exceeds $2 trillion. If these tax provisions are worth 
extending, they should be paid for.
     Over the next 75 years, the tax cuts would cost more than 
three times the actuarial deficit in Social Security.
     Fixing the budget problem at this point will require both 
spending reductions and revenue increases. Both are necessary to create 
an atmosphere of fiscal discipline, and abandoning fiscal discipline on 
one side of the budget likely induces a period of fiscal 
irresponsibility on the other side of the budget--exactly the opposite 
of what the ``starve the beast'' theory suggests.
     A new Brookings study, entitled Restoring Fiscal Sanity, 
illustrates the tradeoffs that the nation now faces in balancing the 
budget. The study puts forward three different plans for reaching 
balance in the unified budget by 2014: One approach primarily involves 
spending cuts and smaller government, another relies more heavily on 
tax increases to support an activist government, and the third suggests 
a balanced mix of spending cuts and tax increases along with a 
reallocation of government priorities. All three are designed to 
restore fiscal sanity over the coming decade and reach balance by 2014.
     To help create and enforce the steps needed to close the 
deficit, policy-makers should reinstate a set of workable budget rules. 
Unfortunately, the administration's proposal to apply pay-as-you-go 
rules to mandatory spending only, and not to revenue changes, is 
counterproductive:
     First, it would fail to foster the atmosphere of fiscal 
discipline that can come only from restraining both sides of the 
budget.
     Second, it would create strong incentives for accelerating 
the trend of disguising spending changes as revenue provisions, thereby 
creating ``tax entitlements.''
    The Congress should restore pay-as-you-go rules to both mandatory 
spending and revenue changes, and should adopt more protections against 
gaming the rules with sunsets. It should also impose discretionary 
spending caps, although care must be taken to choose an appropriate 
level of spending allowed under such caps.
     In conclusion, the administration's budget is most notable 
for what is not in it, rather than what is. It doesn't contain serious 
entitlement reform. It doesn't contain serious reform of the tax system 
or the Alternative Minimum Tax. And it doesn't contain a serious plan 
to reduce the nation's budget deficit over the next 10 years, let alone 
over the long term.
                     i. the changing budget outlook
    Table 1 examines the actual decline in budget outcomes between 
fiscal years 2000 and 2004. Despite recent assertions that domestic 
spending is skyrocketing out of control, the table shows that the vast 
majority of the recent increase in budget deficits is due to lower 
revenue, not higher spending. Between 2000 and 2004, the budget changed 
from a surplus of 2.4 percent of GDP to a projected deficit of 4.2 
percent of GDP. Of this 6.6 percentage points of GDP change, 5.0 
percentage points--slightly more than 75 percent--is due to lower 
revenues.
    Much attention has been focused in particular on the growth of 
domestic discretionary spending. The table shows, however, that non-
defense discretionary spending (which includes international assistance 
and pieces of homeland security) can account for less than 10 percent 
of the increase in the deficit as a share of GDP. The share of the 
deterioration attributable specifically to non-homeland security 
domestic spending (i.e., excluding both international assistance and 
non-defense homeland security) is well under 10 percent.

        TABLE 1.--SOURCES OF CHANGE IN UNIFIED BUDGET, 2000-2004
                            [Percent of GDP]
------------------------------------------------------------------------
                                                               Share of
                                2000     2004    Difference     Change
------------------------------------------------------------------------
Unified Budget Surplus (or        2.4     -4.2         -6.6          100
 Deficit)...................
Revenues....................     20.8     15.8         -5.0           76
Spending....................     18.4     20.0          1.6           24
  Net Interest..............      2.3      1.4         -0.9          -14
Non-Interest Spending.......     16.1     18.6          2.5           38
  Mandatory.................      9.8     10.8          1.0           16
  Discretionary.............      6.3      7.8          1.5           23
    Defense.................      3.0      3.9          0.9           14
    Non-Defense.............      3.3      3.9          0.6            9
------------------------------------------------------------------------


    Other perspectives also support the view that revenue declines, not 
spending increases, are the main driving force behind the increase in 
deficits. Federal revenue in 2004 will be a smaller share of the 
economy than at any time since 1950. Spending, in contrast, is at its 
average share of GDP over the past 40 years.
                     ii. 10-year budget projections
    The Congressional Budget Office recently issued a new set of 10-
year budget projections. These new projections again underscore how 
dramatically projected budget outcomes have deteriorated since January 
2001. Under the official CBO baseline projections, the unified budget 
now shows a cumulative decline of $8.5 trillion over the 2002 to 2011 
horizon, the equivalent of 6.5 percent of projected GDP over the same 
period. The changes are not temporary--they clearly represent a 
fundamental downward shift in fiscal trajectories. For example, the 
projected outcomes for 2005 and 2011 have each fallen by about 6.6 
percent of projected GDP in that year.
    The official CBO projections, furthermore, are not predicated on 
credible assumptions about the current thrust of budget policy, since 
statutory and other restrictions prevent the CBO from adopting more 
reasonable assumptions in its baseline. Figure 1 shows the sizable 
effects of adjusting the CBO projections in various ways. The CBO 
unified budget baseline for fiscal year 2005-14 projects a 10-year 
deficit of $1.9 trillion, with deficits falling sharply over time. 
Adjusting the CBO baseline by extending expiring tax provisions, 
reforming the Alternative Minimum Tax, and maintaining a constant level 
of real discretionary spending per capita generates a unified budget 
deficit to the tune of $5.5 trillion over the next decade.\2\
---------------------------------------------------------------------------
    \2\ William G. Gale and Peter R. Orszag, ``The Budget Outlook: 
Updates and Implications,'' Brookings Institution, January 29, 2004. 
Note that these calculations assume that the bonus depreciation 
provisions from the 2002 and 2003 tax cuts are extended. The 
administration has indicated that it will not support extension of 
these provisions. As Table 3 below shows, if these provisions were not 
extended, the unified budget deficit over the next 10 years would be 
roughly $600 billion lower.
---------------------------------------------------------------------------
    Other recent estimates are similar. The Center on Budget and Policy 
Priorities, for example, estimates a 10-year unified deficit of $5.2 
trillion.\3\
---------------------------------------------------------------------------
    \3\ Richard Kogan, David Kamin, and Joel Friedman, ``Deficit 
Picture Grimmer than new CBO Projections Suggest,'' Center on Budget 
and Policy Priorities, revised February 1, 2004.
---------------------------------------------------------------------------
    Note also that the unified budget includes retirement trust fund 
surpluses of almost $3 trillion. The estimates in Figure 1 suggest that 
taking the retirement funds off-budget generates a 10-year deficit, 
other than retirement funds, of $8.5 trillion.
    These figures, although based on the CBO baseline projections, 
underscore why the administration's budget substantially understates 
the fiscal imbalance likely over the next decade or so:
    The administration's budget ignores many likely costs, such as:
     Fixing the Alternative Minimum Tax (see below). Preventing 
tens of millions of taxpayers from becoming subject to the AMT would 
reduce revenue by about $70 billion in 2009.
     Funding likely defense costs. The Center on Budget and 
Policy Priorities, using estimates from the Center on Strategic and 
Budgetary Assessments on the costs of financing the Future Year Defense 
Plan and other likely defense needs, recently concluded that defense 
discretionary outlays would total 3.8 percent of GDP in 2009.\4\ The 
administration's budget, by contrast, shows defense discretionary 
outlays that are roughly half a percent of GDP lower in 2009. The 
difference amounts to about another $70 billion.
---------------------------------------------------------------------------
    \4\ Based on calculations in Richard Kogan, David Kamin, and Joel 
Friedman, ``Deficit Picture Grimmer than new CBO Projections Suggest,'' 
Center on Budget and Policy Priorities, revised February 1, 2004.
---------------------------------------------------------------------------
     The administration's budget likely excludes other costs, 
such as in international discretionary spending, raising the gap 
between a realistic projection and the figures in the administration's 
budget.
    The budget also includes proposals, such as those creating 
Retirement Savings Accounts and Lifetime Savings Accounts, whose long-
term costs are masked in the short term.
    Finally, the budget does not include the cost of diverting Social 
Security revenue into private accounts, a step that the President has 
embraced. Over the next 10 years, such a proposal could expand the 
unified deficit by more than $1 trillion.
    In summary, the administration's claim to cut the budget deficit in 
half over the next 5 years is not credible.
    Even if the administration's claims about the unified budget were 
credible, two further points are worth noting. First, according to the 
administration's own numbers, the budget outside Social Security would 
still be running a deficit of 3.6 percent of GDP in 2009. Second, the 
unified deficit would deteriorate rapidly after 2009, again as the 
administration's own figures show. Figure 2 is taken from the 
Analytical Perspectives part of the administration's fiscal year 2005 
budget. It shows that even with somewhat faster productivity growth 
than assumed in the central projections, an extension of the 
administration's 2005 budget policies would be associated with large 
and growing deficits over time.
                      iii. expiring tax provisions
    As the figure suggests, the extension of expiring tax provisions 
has a substantial effect on the budget outlook over the coming decade. 
All of the tax cuts enacted in 2001, 2002, and 2003 expire or 
``sunset'' by the beginning of 2011. A variety of other tax provisions 
that have statutory expiration dates are routinely extended for a few 
years at a time as their expiration date approaches. Making all of the 
provisions in the 2001 and 2003 tax cuts permanent would reduce 
revenues by about $2 trillion over the next decade. Counting the added 
interest payments to service higher levels of Federal debt, the total 
increase in the deficit would be $2.35 trillion.
    Table 2 shows that about $600 billion of the cost associated with 
extending the tax cuts is attributable to the 50 percent bonus 
depreciation provision. The administration has indicated that it does 
not support extension of the bonus depreciation provision. Excluding 
the bonus depreciation provision, extension of the other provisions in 
the 2001 and 2003 tax cuts would reduce revenue by $1.5 trillion over 
the next 10 years and add $246 billion in debt service costs, for a 
total budget cost of $1.8 trillion. Extending other expiring provisions 
would cost another $400 billion, for a total cost of more than $2 
trillion excluding the bonus depreciation provision.

                 TABLE 2.--EFFECTS OF EXTENDING TAX CUTS
                        [In billions of dollars]
------------------------------------------------------------------------
                                      2005     2009     2014   2005-2014
------------------------------------------------------------------------
Expiring 2001 And 2003 Tax Cuts\1\
    Extend Estate and Gift Tax           -1       -2      -61       -206
     Repeal.......................
    Extend Other Non-AMT                -13      -16     -182       -748
     Provisions of EGTRRA, JGTRRA.
    Extend AMT Provisions of            -10      -51      -99       -564
     EGTRRA, JGTRRA...............
    Interest......................       -1      -13      -77       -246
      Subtotal....................      -25      -81     -419     -1,764
Extend 50 Percent Bonus
 Depreciation from 2002 and 2003
 Tax Cut
    Revenue.......................      -41      -48      -28       -440
    Interest......................       -1      -14      -28       -148
      Subtotal....................      -42      -62      -56       -588
Other Expiring Provisions
    Revenue.......................        1      -31      -59       -342
    Interest......................        0       -3      -18        -61
      Subtotal....................        1      -34      -77       -403
All Expiring Tax Provisions
    Revenue.......................      -65     -148     -429     -2,299
    Interest......................       -1      -30     -123       -455
      Total.......................      -66     -178     -551     -2,754
------------------------------------------------------------------------
\1\ Excluding bonus depreciation provision.

    The administration's budget displays a smaller cost of extending 
the 2001 and 2003 tax cuts (even excluding the bonus depreciation 
provision), but that is mostly because the administration's budget does 
not extend the temporary Alternative Minimum Tax (AMT) relief included 
in the recent tax cuts beyond 2005. The result is that an increasing 
share of the 2001 and 2003 tax cuts are ``taken back'' by the AMT over 
time. Figure 3 shows estimates from the Tax Policy Center of the number 
of taxpayers on the AMT under the administration's proposal. As the 
Figure shows, more than 33 million taxpayers would be on the AMT by 
2010 under the administration's policies.
    Table 3 shows that under the administration's policies, 34 percent 
of the tax cuts from the 2001 tax legislation would be erased by the 
AMT by 2010. For households with incomes between $100,000 and $200,000, 
the AMT would take back almost two-thirds of the 2001 tax cut by 2010. 
These shares would grow thereafter. The administration's estimates 
assume that the AMT substantially reduces the cost of extending the tax 
cuts in this manner.

                            TABLE 3.--EFFECT OF THE AMT ON 2001 INCOME TAX CUTS, 2010
----------------------------------------------------------------------------------------------------------------
    AGI Class (Thousands of 2001        Percent of Tax Filers With No Cut
              Dollars)                             Due to AMT                 Percent of Cut Taken Back By AMT
----------------------------------------------------------------------------------------------------------------
All                                                             5.1                                  33.8
Less than 30                                                    0.0                                   0.0
30-50                                                           0.7                                   1.2
50-75                                                           4.0                                  15.3
75-100                                                          4.8                                  37.2
100-200                                                        24.1                                  65.0
200-500                                                        45.1                                  71.8
500-1,000                                                       9.3                                  15.9
More than 1,000                                                 8.1                                   8.2
----------------------------------------------------------------------------------------------------------------
Source: Urban-Brookings Tax Policy Center Microsimulation Model.


    Assuming an AMT reform, the projected 75-year cost of the 2001 and 
2003 tax cuts over the next 75 years is more than three times the 
projected 75-year actuarial deficit in Social Security. The tax cuts 
would cost more than 2 percent of GDP over the next 75 years in present 
value; the Social Security actuarial deficit over the next 75 years 
amounts to 0.7 percent of GDP in present value.
    In evaluating the policy choices surrounding extension of the 
expiring tax cuts, it is worth emphasizing that they are highly 
regressive--they provide a much larger percentage cut in after-tax 
income for high-income households than for low-income households.\5\ If 
the tax cuts were made permanent, the top 1 percent of the income 
distribution in 2011 would experience an 8.6 percent increase in their 
after-tax income, whereas the middle quintile of the income 
distribution would experience a 2.7 percent average increase in their 
after-tax income.
---------------------------------------------------------------------------
    \5\ This section draws upon William Gale, Matthew Hall, and Peter 
Orszag, ``Key Points on Making the Bush Tax Cuts Permanent,'' The 
Brookings Institution, January 21, 2004. These distributional estimates 
assume that the AMT exemption remains at $58,000 and the nonrefundable 
credits are allowed against the AMT.
---------------------------------------------------------------------------
    Is extension of the provisions expiring in 2010 necessary to ensure 
economic prosperity? In the short run, the answer is clearly no. 
Reducing taxes after 2010 can actually hurt the economy today because 
financial markets are forward-looking; larger projected deficits in the 
future can therefore raise long-term interest rates in the short term. 
In the long run, the answer is also clearly no. The tax cuts themselves 
may have a modest positive effect on the economy, but they also 
increase the budget deficit, which has a negative effect on the 
economy.
    The net effect of the tax cuts, according to a variety of 
estimates, is likely to be negative, not positive, in the long run:
     Gale and Potter (2002) estimate that the 2001 tax cut will 
likely reduce GNP over the next 10 years; that is, they find that the 
negative effect of the decline in national saving outweighs the 
positive effect of reduced marginal tax rates.\6\
---------------------------------------------------------------------------
    \6\ William G. Gale and Samara R. Potter, ``An Economic Evaluation 
of the Economic Growth and Tax Relief and Reconciliation Act of 2001,'' 
National Tax Journal, March 2002, pp. 133-86.
---------------------------------------------------------------------------
     Elmendorf and Reifschneider (2002) use a large-scale 
econometric model developed at the Federal Reserve and find that a 
reduction in taxes that appears similar to the personal income tax cuts 
in the 2001 law reduces long-term output and has only a slight positive 
effect on output in the first 10 years.\7\
---------------------------------------------------------------------------
    \7\ Douglas W. Elmendorf and David L. Reifschneider, ``Short-Run 
Effects of Fiscal Policy with Forward-Looking Financial Markets,'' 
National Tax Journal, May 2002, pp. 357-386.
---------------------------------------------------------------------------
     Auerbach (2002) estimates that the 2001 tax cut will 
reduce the long-term size of the economy unless it is financed entirely 
by spending reductions--that is, unless it has no net effect on the 
surplus or deficit.\8\
---------------------------------------------------------------------------
    \8\ Alan J. Auerbach, ``The Bush Tax Cut and National Saving'' 
National Tax Journal, May 2002, pp. 387-408.
---------------------------------------------------------------------------
     Orszag (2001) concludes that the net effect of legislation 
resembling the 2001 tax cut would be to reduce GNP by 0.1 to 0.5 
percent after a decade.\9\
---------------------------------------------------------------------------
    \9\ Peter R. Orszag, ``Marginal Tax Rate Reductions and the 
Economy: What Would Be The Long-Term Effects of the Bush Tax Cut?'' 
Center on Budget and Policy Priorities, March 2001.
---------------------------------------------------------------------------
     JCT (2003) found that the 2003 jobs and growth package 
would generate zero or negative effects on jobs and growth in the 
second half of the decade.\10\
---------------------------------------------------------------------------
    \10\ Joint Committee on Taxation, Macroeconomics Analysis of H.R. 
2, The ``Jobs and Growth Reconciliation Tax Act of 2003, ``108th 
Congress, 1st session, 2003.
---------------------------------------------------------------------------
    Finally, the administration has claimed that the tax cuts need to 
be made permanent to reduce the uncertainty that taxpayers face. This 
argument is misleading. Making the tax cuts permanent would not help 
resolve the fundamental uncertainty about future tax rates or future 
policy. The reason is that the true underlying source of uncertainty in 
fiscal policy is how the fiscal gap is going to be closed-what 
combination of revenue increases and spending cuts will be used. 
Enacting another fiscally unsustainable policy (making the tax cuts 
permanent) on top of the already unsustainable fiscal situation does 
not make the situation more stable, only less so. This instability is 
particularly relevant given the risk of disarray that could ensue if 
financial markets become more concerned about how the fiscal gap will 
be addressed.
              iv. economic implications of budget deficits
    The projections above indicate that the nation faces substantial 
deficits in the short-term and the medium-term, with no apparent relief 
within the next 10 years. Thereafter, the fiscal picture just gets 
worse as the baby boomers increasingly retire and ongoing health care 
cost increases drive up expenditures on Medicare and Medicaid. Several 
recent studies--including from the International Monetary Fund--have 
similarly warned about the unsustainable fiscal conditions in the 
United States.
    If allowed to persist, the nation's fiscal gap will impose 
significant and growing economic costs over the medium term and 
potentially devastating effects over the longer term. The conventional 
economic analysis of sustained budget deficits emphasizes that ongoing 
budget deficits decrease national saving, which reduces domestic 
investment and increases borrowing from abroad. The reduction in 
domestic investment (which lowers productivity growth) and the increase 
in the current account deficit (which requires that more of the returns 
from the domestic capital stock accrue to foreigners) both reduce 
future national income, with the loss in income steadily growing over 
time.
    As an example of the conventional analysis of budget deficits, 
President Bush's Council of Economic Advisers reported in the Economic 
Report of the President 2003 that ``one dollar of [public] debt reduces 
the capital stock by about 60 cents'' and ``a conservative rule of 
thumb based on this relationship is that interest rates rise by about 3 
basis points for every additional $200 billion in government debt.'' 
Applying the CEA calculations to the $8.5 trillion decline over the 
past 3 years in official CBO baseline projections for 2002-11 implies 
that interest rates will rise by 125 basis points. The CEA calculations 
also imply that the domestic capital stock will fall by $5.1 trillion 
by 2012 because of the deterioration in the fiscal outlook, even 
allowing for foreign inflows of capital. This means that the stock of 
net assets owned by Americans at the end of 2011 will fall by more than 
$5.1 trillion, and assuming a 6 percent return to capital, national 
income in 2012 would be more than $300 billion lower than it otherwise 
would have been.
    An alternative set of assumptions used in the recent Brookings 
volume suggests the fiscal deterioration since January 2001 will raise 
interest rates by much more than 125 basis points, and that the 
reduction in national income would amount to $340 billion in 2012. This 
translates into a cost of more than $2,900 per household in that year 
alone. The adverse effect of deficits would persist (and grow) over 
time.
    Robert Rubin, Allen Sinai, and I recently noted that the 
conventional analysis may understate the costs associated with large, 
ongoing deficits. As we wrote, ``The adverse consequences of sustained 
large budget deficits may well be far larger and occur more suddenly 
than traditional analysis suggests, however. Substantial deficits 
projected far into the future can cause a fundamental shift in market 
expectations and a related loss of confidence both at home and abroad. 
The unfavorable dynamic effects that could ensue are largely if not 
entirely excluded from the conventional analysis of budget deficits. 
This omission is understandable and appropriate in the context of 
deficits that are small and temporary; it is increasingly untenable, 
however, in an environment with deficits that are large and permanent. 
Substantial ongoing deficits may severely and adversely affect 
expectations and confidence, which in turn can generate a self-
reinforcing negative cycle among the underlying fiscal deficit, 
financial markets, and the real economy * * * Although it is impossible 
to know at what point market expectations about the nation's large 
projected fiscal imbalance could trigger these types of dynamics, the 
harmful impacts on the economy, once these effects were in motion, 
would substantially magnify the costs associated with any given 
underlying budget deficit and depress economic activity much more than 
the conventional analysis would suggest. Indeed, the potential costs 
and fallout from such fiscal and financial disarray provide perhaps the 
strongest motivation for avoiding substantial, ongoing budget 
deficits.''\11\
---------------------------------------------------------------------------
    \11\ Robert Rubin, Peter R. Orszag, and Allen Sinai, ``Sustained 
Budget Deficits: Longer-Run U.S. Economic Performance and the Risk of 
Financial and Fiscal Disarray,'' Paper presented at the AEA-NAEFA Joint 
Session, Allied Social Science Associations Annual Meetings, The Andrew 
Brimmer Policy Forum, January 2004.
---------------------------------------------------------------------------
                    v. addressing the fiscal problem
    Given the scale of the Nation's budget problems and the need to 
reduce our reliance on borrowing from abroad, the time has come to move 
beyond merely not digging the budget hole deeper. Balancing the budget 
over time will require a combination of expenditure restraint and 
revenue increases. On the revenue side, a key issue is the treatment of 
legislation that contains expiring tax provisions. As one of the tables 
above indicates, extending the expiring tax provisions would cost in 
excess of $2 trillion over the next decade alone. If these tax cuts are 
worth extending, they should be paid for.
    On the expenditure side, let me emphasize that although spending 
restraint is critical to restoring fiscal discipline, it is unrealistic 
at this point to expect it to generate the lion's share of the 
adjustment over the next 10 years. Indeed, a recent Brookings volume 
edited by Alice Rivlin and Isabel Sawhill presents several possible 
avenues for restoring fiscal balance in the medium-term.\12\ These 
proposals combine spending cuts and tax increases, phase in gradually 
over time, and avoid budget gimmicks.
---------------------------------------------------------------------------
    \12\ A. Rivlin and I. Sawhill, eds, Restoring Fiscal Sanity: How to 
Balance the Budget, Brookings Institution, January 2004.
---------------------------------------------------------------------------
    Even the ``smaller government'' plan devised by the more 
conservative members of the Brookings budget team required revenue 
increases (relative to a baseline in which the tax cuts were extended). 
The smaller government plan includes extremely aggressive reductions in 
Federal spending--including elimination of all Federal discretionary 
spending for elementary and secondary education, housing and urban 
development, manpower training and related programs, and Environmental 
Protection Agency spending for clean water, drinking water, 
brownfields, targeted water infrastructure, Superfund, and related 
programs, as well as termination of the NASA's program of manned flight 
and all earmarks for local projects in the highway construction 
program. Yet even with these dramatic spending reductions, revenue 
increases were still necessary: The smaller government plan therefore 
includes measures such as an increase in the Federal gas tax of 12 
cents a gallon and reform rather than repeal of the estate tax.
    The Rivlin-Sawhill volume should be required reading for those 
serious about balancing the budget over the medium term. To be sure, 
people may disagree with the options presented in the volume. The 
fundamental point of the book, however, is to provide insight into the 
types of steps necessary; some other change would have to substitute 
for any objectionable provisions in order to restore balance by 2014.
    Moving toward budget balance over the medium term should be coupled 
with more serious discussion of reforming our long-term entitlement 
programs. Given the scale of the long-term budget deficit, it is 
imperative that long-term entitlement reform not be predicated on 
accounting gimmicks or massive assumed general revenue transfers from 
the rest of the budget to the entitlement programs.\13\
---------------------------------------------------------------------------
    \13\ As one possible example, Professor Peter Diamond of MIT and I 
have recently proposed a Social Security reform plan that involves no 
transfers from the rest of the budget to Social Security. See Peter A. 
Diamond and Peter R. Orszag, Saving Social Security: A Balanced 
Approach (Washington, DC: Brookings Institution Press, 2004).
---------------------------------------------------------------------------
    Finally, to help create and enforce the steps needed to close the 
budget deficit, policy-makers should re-institute a set of effective 
budget rules that include both discretionary spending caps and pay-as-
you-go constraints. The budget rules must apply to both sides of the 
budget, however. The administration's proposal to apply pay-as-you-go 
rules to mandatory spending only, and not to revenue changes, is 
counterproductive. By exempting revenue changes from the rules, the 
proposal has two fatal flaws. First, it would fail to foster the 
atmosphere of fiscal discipline that can come only from restraining 
both sides of the budget. Second, it would create strong incentives for 
accelerating the trend of disguising spending changes as revenue 
provisions, thereby creating ``tax entitlements.'' The Congress should 
restore effective pay-as-you-go rules to both mandatory spending and 
revenue changes, and adopt tighter restrictions against gaming the 
rules with sunsets.

    Chairman Nussle. Well, I appreciate that and I am going to 
reach for the bait just on one in particular, because you 
dangled it out there. And I think the point about the car and 
lease or purchase, I think it is very valuable, and it helps me 
particularly, because the next time I buy a car, I may come and 
talk to you and figure out what is the best, because I still, 
to this day, have not figured out whether leasing or 
purchasing, whether it is used or new makes any sense. But the 
thing--and the reason why the analogy is less than perfect in 
dealing with the current circumstances is that it is not just a 
matter of leasing a car or purchasing a car and whether it is 
used or new and the economic impact of that, you have to add to 
that, I believe in my opinion the fact that the person just 
lost their job and would need a car to get to work and if they 
didn't have a car to get to work, they wouldn't have a job.
    And in order to get the car, they may be even taking out a 
loan to buy it would make sense because of the return they 
would get from the income of that job. And add to that, the 
fact that they had a sick child during that same period of time 
and their roof collapsed or they had a robbery because of 
something going on. I mean----
    Mr. Orszag. Family is in tough shape. I guess we miss 
sometimes the point. We parachute in. They parachute in to the 
current circumstance here on February 3 and they say oh, my 
God. Look at the size of the deficit. How in the world did that 
happen and they forget about the fact that we did have a 
robbery, 9/11, we did have a tough situation where lots of 
people lost their jobs and the economy was on its knees. So the 
analogies about this I think are important, but the investment 
that we made--and yes it required some borrowing to protect the 
country is important. And Mr. Cooper, you were talking about 
the bond and vis-a-vis Europe and the United States.
    What would happen--what would have happened--it is 
impossible to answer this, but this is why we have these 
debates, what would have happened if we left America 
unprotected, which of course we did not do, and would not have 
done. But what investment incentive from a foreign investor 
would have been in an economy or in a country that was left 
unprotected, more than just 9/11 with ongoing incidents of 
terrorism and with no likelihood that that would be repaired. 
So confidence in the system, which we have--and quite frankly 
without being too disrespectful, Europe ain't got or certainly 
not to the extent in a long-term fashion that the United States 
has, I believe is much more important, or as important than 
taking it and parachuting in and only looking at one indicator 
and saying, that must be the cause and effect relationship and 
why we find ourselves today. I will let you respond.
    Mr. Orszag. I guess just to extend the analogy here, not to 
make it too ridiculous, but I think the concern is that the 
low-income family who just lost the job and has a sick kid 
should not go out and lease an expensive Lexus. It should lease 
what will get the job done and not lock into long-term 
commitments that it can't afford. That would not be the advice 
that you would give and it is not the advice I would give to 
the family. So the problem here is not what is happening over 
the last year or 2 years. The problem here is that even after 
the economy is expected to recover under realistic projections, 
we still face a very large deficit. And that brings me to the 
concern about foreign competitors.
    The paper I wrote with Bob Rubin and Alan Sinai highlights 
how sensitive we are now to the confidence of foreign creditors 
in our Nation. Bob Rubin is concerned that at some point, we 
can't predict exactly when, we keep running these large 
deficits and showing not enough concern about what the 
implications are and we could be faced with a very unpleasant 
set of circumstances.
    Chairman Nussle. And I agree. I am only saying that 
confidence is more than just economic confidence. One last 
thing I would say to you or I would just ask and I think this 
is important, how tall is the Empire State Building?
    Mr. Orszag. I don't know the answer to that.
    Chairman Nussle. I don't know either. But it is some 90-
some floors, or it is however many feet or how many inches or 
whatever. How do you know that? It is because it is in relative 
terms to something else. And the same is true with regard to 
our budget deficit. If you compare it to nothing, it is big. I 
mean every time my mother hears me talk about a billion 
dollars, she cringes, because have I lost my perspective. But 
it is only large or it is only whatever size it is if you 
compare it to something. And we have used the economy as a way 
to compare it. Would you say that is a fair comparison?
    Mr. Orszag. Absolutely. And my concern about the deficit, 
again, under realistic projections, you are looking at unified 
deficits and I am talking not having AMT eat back a third of 
the tax cut. Under realistic projections, you are talking about 
3, 3\1/2\ percent of GDP and unified deficits for the next 
decade. Outside of Social Security, it is 5\1/2\ percent. And 
frankly, the coming wave of the baby boomers makes that just 
not a good policy to be running over the next decade. We should 
be running much smaller deficits, or even surpluses.
    Chairman Nussle. I agree.
    Mr. Spratt.
    Mr. Spratt. Thank you, Mr. Chairman and thank you, Dr. 
Orszag, and I am sorry that we came to you so late in the 
afternoon, but we appreciate your perseverance in staying here 
and your willingness to come and testify. You mentioned the 
AMT, the alternative minimum tax. For several reasons, one 
being that the threshold amount which the AMT applies has not 
been indexed to inflation, another being that we are expanding 
deductions, credits, preferences as part of the tax cuts that 
have been passed. This AMT will apply to more and more 
taxpayers. Would it be correct in your estimation to say it is 
effectively a tax increase?
    Mr. Orszag. It certainly prevents the tax cuts from taking 
effect. And from that perspective, it is a tax increase.
    Mr. Spratt. People say if they are affected by the AMT, 
they pay more in taxes than they would pay under the regular--
--
    Mr. Orszag. They would pay more in taxes than under--than 
if the AMT were reformed. And the taxes will go up over time 
because the AMT is not indexed for inflation.
    Mr. Spratt. The Treasury Department has predicted that by 
2010, 20 to 30 million tax filers may be affected by the AMT; 
find themselves paying under those higher rates than the 
regular rates in the rest of the code.
    Mr. Orszag. Our estimates suggest 33 million taxpayers on 
AMT by 2010.
    Mr. Spratt. 33 million taxpayers as opposed to how many 
today?
    Mr. Orszag. About 3 million or so.
    Mr. Spratt. That would mean for 30 million taxpayers, there 
will be a tax increase affected by the AMT?
    Mr. Orszag. That is correct. Another perspective on the 
same point, again, as I mentioned, 34 percent of it, the 2001 
tax cut would be erased by the AMT in 2010. For households with 
incomes between 100 and $200,000 in income, it is 65 percent. 
So we are frankly playing a cruel hoax on the American public 
if we are simultaneously saying you are getting these tax cuts 
and then not counting the cost of addressing the thing that is 
erasing the tax cut.
    Mr. Spratt. We give with one hand and take away with the 
other. And we are talking about 30 million people and what 
percentage can you estimate how much more--how great a 
percentage they will pay in taxes.
    Mr. Orszag. That will vary by households. It will be 
increasingly concentrated in basically the upper middle class 
and then seeping down into the middle class itself, especially 
families with lots of children.
    Mr. Spratt. So we almost inevitably have a rendezvous with 
this problem over the next 5, 6 fiscal years.
    Mr. Orszag. I think every independent budget analyst thinks 
this is an exploding problem on the horizon that needs to be 
addressed.
    Mr. Spratt. To be complete and frank and open you have to 
include some estimation of fixing, repairing or revising the 
AMT and any kind of tax cut agenda for the next 10 years.
    Mr. Orszag. I would think you would either need to do that 
or be up front about the fact that the tax cuts that look like 
they are occurring on paper won't actually occur.
    Mr. Spratt. Let me ask you one other question. You have 
just done this, but if you elaborate a bit more, let me read 
what you wrote, Bob Rubin wrote. I got a feeling this is your 
prose. The adverse consequences of sustained large budget 
deficits may well be far larger and occur more suddenly than 
traditional analysis suggests. Substantial deficits projected 
far into the future can cause a fundamental shift in market 
expectations and a related loss of confidence at home and 
abroad. The unfavorable dynamic effects that could ensue 
largely if not entirely excluded from conventional analysis of 
budget deficits. This is understandable and appropriate in the 
context of deficits that are small and temporary. It is 
increasingly untenable, however, in an environment with 
deficits that are large and permanent. Substantial ongoing 
deficits may severely and adversely affect expectations and 
confidence which in turn can generate a self-reinforcing 
negative cycle among the underlying fiscal deficits, financial 
markets and real economy. Would you translate that for us?
    Mr. Orszag. Bad things happen when you run really large 
deficits, and financial markets lose confidence if your fiscal 
probity.
    Mr. Spratt. And it could happen suddenly and unexpectedly?
    Mr. Orszag. One of the features of financial markets is 
that confidence can shift rapidly and unexpectedly. And I want 
to note, Bob Rubin and I are not the only ones raising this 
concern. There have been a variety of others, including Mr. 
Mankiw talking about the dangers that could be associated with 
the so-called hard landing, at some point, if investors do lose 
confidence. And in my opinion, the scales of the Nation's 
fiscal imbalance is now so large that perhaps the biggest 
reason for us to get our fiscal discipline back on track is to 
avoid the possible risk of that kind of collapse. No one knows 
exactly when or if it could happen, but the costs, if it does 
happen, are large enough, that it is worth having a precaution 
against that from occurring.
    Mr. Spratt. Thank you very much.
    Chairman Nussle. Mr. Portman.
    Mr. Portman. Thank you, Mr. Chairman and Dr. Orszag for 
your patience with us. I was intrigued by a couple of things 
you said. One, if I could ask you about the minimum tax. How 
would you feel about keeping it in place, given what you said 
about the fact that it would take away from some of the tax 
relief that you believe is not appropriate to make permanent?
    Mr. Orszag. In comparing sort of doing fiscal balancing, 
what I would call in an honest way or straightforward way or 
having kind of a stealth approach through the AMT, the stealth 
approach of the AMT is not as preferable because it adds 
complexity, people have to fill out two tax forms; it is less 
transparent, and for a variety of other reasons it would be 
better to do it up front and be straightforward with the 
American public. Other people may have different views.
    Mr. Portman. It would give them the compliance cost. 
Particularly I think it would be better to do it in a 
straightforward way, but it is interesting that the effect of 
it might be more or less what you think might be appropriate.
    Mr. Orszag. One can argue that on both sides that the 
administration claims that it doesn't have a tax increase and 
then of course the AMT is. Those who oppose making permanent 
the tax cuts, I guess could count on the AMT to make that 
happen over time. Again, I don't think that is a particularly 
good policy.
    Mr. Portman. Why haven't interest rates gone up? If you 
were to listen to our former colleague and my friend Bob Rubin, 
it would be very surprising that interest rates had not gone up 
in the last couple of years.
    Mr. Orszag. Two points: One is if you look at long-term 
interest rates relative to short-term interest rates, the so-
called yield curve is quite steep and that occurs for a lot of 
reasons. The Federal Reserve has dramatically reduced short-
term rates. It normally happens during recessions, et cetera. 
One cannot rule out the possibility that one of the things 
affecting the yield curve is also the fiscal outlook. Second 
point is at least in his experience and other people who are 
experienced in financial markets, there is this thought that 
might not make the most sense to some academic economists, but 
it does makes sense to the financial market types, which is 
that financial markets don't really focus on long-term forces 
during economic downturns. And it is only as the economy starts 
to recover that you will see that fact manifest itself.
    Mr. Portman. But the economy has begun to recover and you 
would have thought that 6 months ago when we first saw those 
signs of recovery and certainly that GDP number in the third 
quarter, you would have seen that long-term perspective by the 
bond traders and others and the financial markets beginning to 
respond. It is a curious thing. I think honestly we don't know 
much about our economy. Every time we seem think there is a 
certitude and it turns that it doesn't work that way. And 
interest rates being at what, a 40-year low, seems inconsistent 
with this notion that high deficits lead to high interest 
rates.
    Final one, you talked saver's credit. You talked about the 
fact that it was not made permanent in the budget. There are 
two proposals as you know that relate to personal savings 
called the RSA and the LSA and there is a third one called the 
ERSA, which is basically consolidating the existing employer 
base defined contribution plans. What do you think about the 
LSA?
    Mr. Orszag. Just to step back before getting to that 
specific proposal that the fundamental problem we have in 
retirement saving and frankly saving in general in the United 
States is that the incentives are upside down. We provide the 
strongest incentives for tax deferred saving for high income 
households who frankly would save anyway and who are generally 
better prepared for retirement and we do very little for 
moderate or lower income households who get a very small 
incentive under the tax code to save and who generally aren't 
as well prepared.
    And actually that matches up interestingly with the fact 
that high income households tend to have more assets to shift 
into these tax deferred accounts so you don't get as much new 
saving as a result. From that perspective, both LSA and RSA 
proposals have the fundamental flaw that they provide too large 
of a subsidy at the top of the income distribution for savings 
that households would have done anyway. I would prefer a much 
more progressive policy and I certainly hope that you and Mr. 
Cardin and others who are very interested in these issues will 
come forward with something that is more progressive than RSA 
and LSA proposal is.
    Mr. Portman. I don't want to get into a debate. I do think 
there are income caps and the deductible IRA and there are 
income caps in the Roth IRA and the way the nondiscrimination 
testing works, I see a lot of low-income folks do get a benefit 
from the system. As you know, they don't all take advantage of 
it, but 75 percent of people in a 4019(k) take advantage of it.
    Mr. Orszag. I think that is important, but just briefly and 
I know we are running out of time, that is within an employer-
provided system. Outside the employer provided system, take-up 
rates in IRAs are very low. So one of the other problems----
    Mr. Portman. But still, the deductible income average is 
29,000 bucks a year, so they are not maxing out obviously based 
on the data, but people are using it to some extent. But I 
don't disagree with your general point on the fact that we need 
to focus on those who have more modest income, because that is 
where most of the benefits are going to be in terms of the net 
national savings rate. But let me ask you just specifically on 
LSA versus other forms. Long-term versus short-term savings, is 
there a difference in terms of its impact on the economy?
    Mr. Orszag. One of the concerns with LSA relative to RSAs 
is that the generous withdrawal provisions would allow more 
seepage out of the account system, and therefore less positive 
saving. Just analytically, that does have to be weighed against 
the positive effect of getting more people to save in the first 
place if they know they are not locking their funds in a liquid 
form for a long period of time.
    So that is a trade-off that needs to be evaluated. My 
general conclusion is that especially as you go higher up the 
income distribution providing these tax subsidies that can be 
taken out at will is going to get you very little new saving.
    Chairman Nussle. Mr. Shays.
    Mr. Shays. Thank you, Doctor, for your patience, and I am 
assuming that you stayed--you were here for most of the 
questioning of the budget director.
    Mr. Orszag. Indeed I was.
    Mr. Shays. Can you list me all the suggestions you heard 
from members, particularly on the Democratic side of the aisle 
on ways to balance our Federal budget? What were the 
suggestions that you heard that you particularly liked?
    Mr. Orszag. I don't believe I heard very many suggestions 
from either side of the aisle on specific proposals to balance 
the budget. And on that point, I was part of a Brookings team, 
bipartisan team that tried to look at three different scenarios 
for balancing the budget by 2014: Small government plan, large 
government plan and a so-called better government plan, and 
they involved a lot of pain. And they are not things that I 
think any member will wholeheartedly endorse, but they 
illustrate the scale of the problem we face in this country.
    Mr. Shays. The challenge is we are not going to get support 
in passing this budget from frankly the Democratic side of the 
aisle. So we have to pass it on our own. And unfortunately, 
that makes it even more difficult. But I didn't hear many 
suggestions on ways to balance the budget on either side of the 
aisle. But I do know this, that we do need to move this economy 
forward. And I don't believe that the economy alone is going to 
reduce the overall deficits, so I do believe we have to make 
some tough choices. We did that last year at least in this 
committee. We cut 1 percent off what the President had 
suggested. A penny off a dollar doesn't seem like a lot, but 
even that we couldn't pass on the House floor.
    We might have been more successful had we had organizations 
support what we did in the subcommittee. And we might have been 
more successful if people had come to our aid when we were 
adding 8 or 9 percent and 10 percent to veterans budgets and 
people were still calling it a cut. You know, that was really a 
tough one for us. We were spending so much more and yet people 
were still calling it a cut. It is a tough task. And I know 
that you are sounding some honest and heartfelt concern that we 
need to pay attention to, and I thank you for that.
    Chairman Nussle. I thank you for your testimony and we 
appreciate the thoughts you provided us today. The committee, 
if there is nothing more to come before it, stands adjourned 
until tomorrow at 2 o'clock, where we will have a hearing with 
Secretary Snow from the Department of Treasury.
    [Whereupon, at 6 p.m., the committee was adjourned.]

                                
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