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



   DEPARTMENT OF THE TREASURY BUDGET PRIORITIES FOR 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 4, 2004

                               __________

                           Serial No. 108-17

                               __________

           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 4, 2004.................     1
Statement of:
    Hon. John W. Snow, Secretary, Department of the Treasury.....     6
    Henry J. Aaron, Bruce and Virginia Mac Laury senior fellow, 
      the Brookings Institution..................................    31
Prepared statement:
    Hon. Lois Capps, a Representative in Congress from the State 
      of California..............................................     5
    Mr. Snow.....................................................     7
    Mr. Aaron....................................................    34

 
   DEPARTMENT OF THE TREASURY BUDGET PRIORITIES FOR FISCAL YEAR 2005

                              ----------                              


                      WEDNESDAY, FEBRUARY 4, 2004

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 2:10 p.m. in room 
210, Cannon House Office Building, Hon. Jim Nussle (chairman of 
the committee) presiding.
    Members present: Representatives Nussle, Shays, Gutknecht, 
Hastings, Portman, Brown, Crenshaw, Putnam, Tancredo, Garrett, 
Barrett, McCotter, Diaz-Balart, Hensarling, Spratt, Moran, 
Hooley, Baldwin, Moore, Lewis, DeLauro, Edwards, Scott, Capps, 
Thompson, Baird, Cooper, Emanuel, Majette, and Kind.
    Chairman Nussle. The committee will come to order. Good 
afternoon. Today we have before us the Department of the 
Treasury Budget Priorities for Fiscal Year 2005. Today we have 
two panels of witnesses. The first witness is, of course, the 
Secretary of the Treasury, the Honorable John Snow; the second 
panel will be Henry Aaron, a senior fellow of the Brookings 
Institute. So we invite the first panel forward and we welcome 
the Secretary of the Treasury back to the Budget Committee.
    Welcome, Mr. Secretary. We are glad to have you here today.
    Just before the hearing began, we had a little informal 
discuss with the Secretary back in the cloakroom, which is why 
we are starting slightly behind. We appreciate the chance to 
visit, though, informally. Today we have a lot before us.
    Yesterday this committee, Mr. Secretary, heard from the 
President's Director of Office of Management and Budget, Josh 
Bolton, about the President's budget request for fiscal year 
2005, as well as from Chairman Mankew from the Council of 
Economic Advisors on the administration's economic outlook.
    Today we want to focus on the top priorities that we face, 
and that is doing whatever we can at the Federal level to 
ensure that our economy continues to grow and that Americans 
can continue at increasing numbers to find jobs and go back to 
work.
    Thankfully, we are in a much different position, Mr. 
Secretary, than the last time you were before us last year. At 
that point we had seen quarterly GDP growth come in about 2.8 
percent. Today we have enjoyed two consecutive quarters of 
strong growth, with the fourth quarter growth at 4 percent and 
the third quarter growth at a whopping 8.2 percent, which was 
the highest surge in GDP in the last 20 years. Consumer 
sentiment jumped in January, for the highest 1-month gain in 11 
years, and to the highest overall level in 3 years. 
Manufacturing is soaring, hitting its highest pace of activity 
in the last 20 years just this last December. Housing starts 
are at their highest level in 20 years. Mortgage interest rates 
continue to run at their lowest levels in over three decades 
and the bank prime rate is at its lowest level in 45 years.
    Inflation has been running at its lowest rate in nearly 
four decades. U.S. real exports of goods and services rose in 
the fourth quarter at a 19 percent rate, the fastest pace in 7 
years. We have seen significant increases in the stock market. 
The Dow Jones Industrial Average was up 40 percent since March 
of last year. And the reports we have seen just this week 
confirm that strong economic activity and its continuation into 
this year, including personal income and consumer spending, 
continued their high rise; construction spending reached a 
record in December; manufacturing activity continued at a 
strong pace in January, following a 20-year high in December; 
and just today we heard that the service sector activity hit a 
record high in January and that manufacturers' orders and 
shipments increased again in December and by more than had been 
expected.
    Additionally, the most important, and what I feel is most 
important, the economic is once again beginning to create jobs. 
For the past 17 straight weeks, unemployment insurance claims 
have remained below the benchmark regarded by economists as a 
sign of an improving labor market.
    So today we are going to discuss not only the current state 
of the economy, but also what factors contributed to the better 
than expected growth we have seen over the past months. 
Certainly, as part of that discussion, we will take a look at 
the impact of the tax relief packages that we passed in 2001, 
2002, and again in 2003, and how the tax relief helped to ease 
the recession and cushion us through the difficulties following 
September 11 of 2001 and, for that matter, the uncertainties of 
war in Afghanistan and Iraq. We will also discuss what role the 
tax relief will continue to play as we now build a foundation 
for sustained economic growth and job creation.
    There is one thing that I would like to pin you down for 
now, and that is we need to do whatever we can to continue to 
get the economy growing and creating jobs. All of that great 
economic information that I was able to read for you is 
fantastic if you are a fully employed Treasury Secretary and 
Congressman or economist. If you are sitting around your 
kitchen table tonight, trying to figure out how to balance your 
checkbook and pay your heat bills and your college tuition, and 
you still haven't been able to find a job, all of that great 
economic data means absolutely nothing. And so we are going to 
continue to work to do whatever we can to make sure that the 
family budget comes first and that we can make sure that the 
economic relief that seems to be going well for the country at 
a macro level helps people around their kitchen tables.
    The President has proposed making permanent the tax relief, 
and I can guarantee you that in this budget that will be one of 
the top priorities as we look to formulate our budget. We want 
to keep the economic growth moving. We want to be able to 
ensure that taxpayers don't get an increased tax bill; we don't 
think that increasing taxes at this time is a way to solve the 
very difficult situation we find ourselves in with budget 
deficits. We believe the budget deficit is an important job 
that we are called upon to provide answers for, but we also 
know that the security deficit that we faced over the last 
number of years, and the economic growth deficit that we faced 
over the last few years is still the most important thing that 
we can do to get the economy moving again, to keep our country 
strong and free, and get confidence not only to our investors 
here in this country, but around the world.
    That said, I look forward to hearing your testimony, and I 
would now turn it over to Mr. Spratt for any opening comments 
he would like to make.
    Mr. Spratt. Mr. Secretary, welcome back. We are glad to 
have you. Mr. Secretary, you weren't here when the Bush 
administration first took office, but the budget was in surplus 
then, as you know; it was in big time surplus, surplus by $127 
billion that year, $236 billion the year before, and your 
economists at Treasury and OMB looked out over the next 10 
years and saw a cumulative surplus of $5.6 trillion. Given 
these surpluses, both parties in Congress embraced a fiscal 
concept with a corny name called the ``lockbox.''
    Despite that name, it was a substantive, serious idea, 
namely that we would use the surpluses in the Social Security 
and Medicare Trust Funds not to fund new spending, but to buy 
up outstanding Treasury debt. And in 2001, the first year of 
the Bush administration, it appeared that if we stuck to this 
plan, we could buy up most of the outstanding Treasury debt 
held by the public over the next 10 years and radically reduce 
the interest we pay on the national debt, add $3 trillion to 
net national saving, and when the baby boomers began to retire 
and came to your window at the Treasury to draw down their 
benefits in Social Security and Medicare, Treasury would be 
more solvent than ever to meet those obligations. We had a 
golden opportunity.
    Both parties in Congress at least professed that they were 
committed to this concept, but the Bush administration chose a 
different course. And, as a consequence, the Government is not 
paying down its debt. From 2002-04, the Government will add 
$1.54 trillion, so much I can barely get it out of my mouth, to 
the national debt held by the public. And if the 5 year budget 
you now propose is adopted and carried out, the Government will 
stack $1.35 trillion on top of that over the next 5 years. 
Three years ago, three short years ago we were positioned to 
buy back almost all of the outstanding Treasury debt held by 
the public by the year 2009. Now we are looking at adding $2.5 
trillion in debt by the year 2009, and billions more in the 
years beyond.
    There is a series of charts that I am going to ask you to 
explain when we come to questions. They appear on pages 189-196 
of the Analytical Perspective. The first of these I was going 
to show on the screen here, but I will show it to you later. 
These charts depict a grim fiscal future; they show that after 
the year 2009, the stopping point for your forecast, after 
that, the last year in your forecast, the deficit in the budget 
doesn't get better. There is the chart. The deficit in the 
budget doesn't get better, it gets worse and worse. These 
charts test six different variables. This particular chart 
tests a health care cost variable, another makes certain 
assumptions about productivity, another makes certain 
assumptions about immigration. In none of these charts does the 
budget ever come to balance; indeed, it gets worse and worse 
and worse after 2009.
    Now, the Bush administration tells us that this budget is 
going to cut the deficit by half over the next 5 years. Mr. 
Secretary, you can put me down as doubtful on that claim, 
because I have looked through this budget well enough to know 
not just what is in it, but what is left out of it. On the 
spending side there is nothing, not a dime for our deployments 
in Iraq and Afghanistan, though we were told yesterday the 
costs could easily be $50 billion. On the revenue side, there 
is no reduction in revenues for what it will cost to fix the 
alternative minimum tax, even though the Treasury Department, 
your department, warns us that the number of taxpayers paying 
this higher tax will increase from 3 million this year to 36 
million in the year 2012, and most of these are middle income 
taxpayers. The AMT for them is a tax increase.
    The right fix to AMT could cut revenues by more than $500 
billion easily. I think you will agree. You asked for an 
additional $1.2 trillion in tax cuts, but never mentioned the 
inevitable, and that is the cost of fixing the alternative 
minimum tax, which could easily raise the revenue request, the 
tax revenue cut to almost $2 trillion.
    By leaving out big items like this, this budget is able to 
show a deficit reduced in half by 5 years. But it stops short 
in 2009 and leaves the public to believe, I would think, that 
this budget will sort of correct itself, eventually balance in 
the years after 2009. Unfortunately, most Americans won't be 
reading pages 189-197 of the Analytical Perspectives on the 
Federal Budget, and they won't see that when your budget for 
2005 is extended, as it is in this graph here, that is the 
middle green line, when this budget for 2005 is extended beyond 
2010 over 10, 20, 30 years, the deficit gets worse and worse 
and worse. There is no solution in sight.
    The Bush administration based its tax cuts on a blue sky 
forecast. We heard yesterday from OMB, and OMB now tells us 
that the $5.6 trillion projected surplus was an economist 
construct which is never going to come about. In fact, they are 
reducing it by 53 percent per economic miscalculation, which is 
to say the surplus was really 2.6 trillion at best, rather than 
5.6 trillion. The problem is the forecast has changed 
drastically, but the administration's tax agenda has not 
adjusted accordingly. The administration pictures itself and 
this budget as a victim of events beyond our control: 
terrorism, war, corporate scandals, the collapse of the stock 
market. And all these events have taken their toll, I wouldn't 
deny that, but from here out we are all on notice there are no 
more surpluses. Tax cuts and spending increases, particularly 
the tax cuts you are now proposing, $1.2 trillion in additional 
tax cuts, goes straight to the bottom line and add dollar to 
dollar for the deficit. The deficits going forward, therefore, 
result from a deliberate policy choice, and that is to borrow 
and spend; to prefer tax cuts over deficit reduction.
    Mr. Secretary, you are the keeper of one of our most 
precious national assets, our currency and our credit, and the 
big question we have for you today is how long can we sustain 
deficits of this size without consequences to our currency, our 
credit, and our economy. We look forward to your testimony.
    Chairman Nussle. I ask unanimous consent that all members 
be allowed to put a statement in the record at this point. 
Without objection, so ordered.
    [Prepared statement of Mrs. Capps follows:]

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

    Thank you, Mr. Chairman. I said yesterday that the President's 
budget represents skewed priorities and this is clearly illustrated in 
his tax proposals.
    For example, the President has called for making permanent 
virtually all of the tax cuts from the last 3 years. The budget notes 
that these changes will cost nearly $1 trillion over 10 years. But 
since most of this cost occurs after the 5 years actually covered in 
the budget, the dramatically negative effect of this irresponsible 
proposal on the budget deficit is glossed over by the administration.
    In addition, the benefits of extending the cuts go 
disproportionately to the wealthiest in our society even as the 
President underfunds education, veteran's care and environmental 
protection that are so important to tens of millions of American 
families.
    Yesterday the administration witness, OMB Director Bolten, and many 
of my Republican colleagues constantly pointed to three tax provisions 
in particular--the child tax credit, the 10 percent individual rate and 
elimation of the marriage penalty--as evidence that extension of the 
tax cuts would benefit middle class families.
    But those three provisions account for only 14 percent of the 
nearly $1 trillion cost of making the tax cuts permanent. In addtion, 
those benefits aren't just going to middle income families.
    In reality, the vast majority of the $1 trillion in tax relief goes 
to higher income taxpayers: income tax reductions for higher income 
taxpayers ($395 billion), elimination of the estate tax ($180 billion) 
and cuts in capital gains and dividend taxes ($131 billion).
    Similarly, the administration's proposals for new savings accounts 
will drain money from the Treasury to let the well-off avoid paying 
taxes on portions of their income under the guise of helping middle 
class families save for retirement.
    Middle-class families can already put up to $3,000 in various IRAs 
each year and many workers have 401k's at work. But only 4 percent of 
families actually fully fund their IRA's each year, most likely because 
they can't afford to save more.
    The President proposes to create two new accounts, raise the 
current limits and loosen the restrictions for withdrawals. This will 
likely effectively allow higher income taxpayers to shelter more of 
their income from taxes without encouraging any real new savings.
    Finally, the President's proposals for helping the more than 43 
million Americans without health insurance get coverage are expensive 
and will not work. The $70 billion in tax credits for purchasing health 
insurance are supposed to be paid for with offsets the administration 
can't or won't identify so one has to wonder how serious the 
administration is about the proposal.
    In addition, according to OMB's own mid-session review from last 
summer the tax credits have not been shown to be especially effective 
and can be expected to be used by younger, healthier people currently 
insured. If so, this proposal benefits people who already have 
insurance, not the uninsured.
    The Health Savings Accounts proposal will likely encourage younger, 
healthier people to drop out of the insurance pool thereby increasing 
rates for older, less healthy persons left behind. Similarly, HSAs may 
encourage employers to drop coverage. And HSAs will likely offer little 
help to the uninsured since the vast majority of the uninsured are low 
income persons who really won't benefit from the deduction and other 
HSA tax benefits.
    The common theme running through these proposals echo that of the 
overall budget. The impacts of these proposals on the budget are 
dramatically understated, the proposals will primarily benefit 
wealthier Americans, and adoption of them leaves little funding to 
address critical national needs that benefit middle class families.
    We should reject these ill-thought out tax proposals and return 
some sanity to this budget process.

    Chairman Nussle. Secretary Snow, we welcome you back to the 
committee. We are pleased to put your entire testimony into the 
record, and you may summarize as you wish. Welcome back.

 STATEMENT OF HON. JOHN W. SNOW, SECRETARY, DEPARTMENT OF THE 
                            TREASURY

    Secretary Snow. Mr. Chairman, thank you very much.
    Congressman Spratt, thank you for your opening comments as 
well. It is a great pleasure to be back here with you.
    As the chairman said, when I appeared a year ago, the 
American economy was on a far different course. Thanks to your 
actions in the Congress in adopting the President's Jobs and 
Growth Bill, we are now on a good course, we are on a strong 
course. I don't need to recite the numbers, the chairman did. 
There can't be any doubt about the fact that the American 
economy is in a fundamentally better position today, poised for 
long-term sustainable growth; whereas, a year ago, you will 
recall, the concern was of a double-dip recession; the concern 
was of deflation, it was all in the year, deflation; the 
recovery was described as anemic or wobbly. Today it is a 
strong recovery: 8.2 percent growth rates in the third quarter; 
4 percent growth rates in the fourth quarter; 4.4 for the year, 
which is a recovery year; with the outlook for 4 percent plus 
for the coming year. With 4 percent growth, we get jobs coming 
back.
    The labor markets have begun to firm up, and we are 
confident we will see a considerable number of jobs added to 
the workforce of America. We have seen the unemployment rate 
march down from 6.3 to 5.7, we have seen the initial claims for 
unemployment insurance march down over the course of the last 6 
months, we have seen the stock market rise 26 percent or so, 
reflecting, reflecting the expectations of a stronger economy 
directly related, directly related to the actions of this 
Congress in passing thoughtful and far-reaching and visionary 
tax legislation that makes the American economy fundamentally 
more efficient. When you make something more efficient, you get 
good results, and those results have been reflected and 
captured in the sizeable increase in the equity values of 
America, which have restored people's IRAs and 401(k)s, which 
had been so badly, badly depleted. I think we are on a good 
course, and I want to commend all of you for your actions and 
leadership in putting us on that course.
    Now the fundamental question is how do we sustain the 
growth we have, and, as the chairman has suggested, I think the 
worst thing you could do is have a tax increase. A tax increase 
would roll it back, it would take us right back down the path 
we have come up. We don't want to go there; that would be a 
mistake. Can we afford the tax reductions? Of course we can. Of 
course we can. What we can't do is afford not to keep them, 
because if we don't keep them, then we don't grow the economy, 
and we put a tax increase on literally every single American; 
millions and millions of small businesses, millions and 
millions of middle income people who are making economic 
decisions today, spending money today in the expectation that 
they will have those tax reductions going forward. So I would 
argue as strongly as I can that we need to keep those tax 
reductions in place. We need to make it clear to the American 
people that those tax reductions will be sustained.
    Now, moving to Congressman Spratt's comments, he rightly 
points out, I think we would all agree, that deficits matter. 
Of course deficits matter. Deficits matter because, unless they 
are addressed, the financial markets will respond in ways that 
are negative: they will raise real interest rates. But they 
will do that only if they think we aren't going to act 
responsibly and we are going to act responsibly. Deficits are 
troublesome when they are large and growing and ingrained and 
entrenched. These deficits aren't that. These deficits will be 
declining, falling to a level which is lower than the historic 
average of deficits as a percent of GDP, to under 2 percent. 
The best single evidence, the best single evidence that the 
stock markets credit us, all of us, with the ability to manage 
the fisc of the United States well is the fact that today we 
have the lowest interest rates in 45 years. If the financial 
markets doubted our ability to manage our way through the 
deficit, they would begin immediately, Congressman, to exact a 
price, and that price would be higher real interest rates. The 
fact that we have 40-year low interest rates is compelling 
evidence that the markets trust our ability to work through 
these deficits, to hit the targets the President set of cutting 
those deficits in half over the course of the next 5 years.
    I very much look forward to working with all of you to see 
those proposals put in effect, but we will do it also in the 
proposals in the President's budget to improve savings in this 
country, and I have talked with a number of you about it, 
importantly, Congressman Portman; to continue to move forward 
to find ways to make health care more affordable, and that is 
incorporated in a number of ways in the budget; to help to 
ensure that pensions are properly funded and, of course, that 
is part of the administration's proposal.
    So I very much appreciate--Mr. Chairman--the chance to be 
up here today with you and to respond to your questions, and to 
work with you in seeing that we sustain the growth path that 
the American economy is on and the path to cutting this deficit 
in half over the course of the next 5 years. I thank you very 
much.
    [The prepared statement of Mr. Snow follows:]

 Prepared Statement of the Hon. John W. Snow, Secretary, Department of 
                              the Treasury

    Thank you, Mr. Chairman. Thank you all for having me here today to 
talk about the President's budget.
    I believe you'll find that this budget reflects the priorities of 
our Nation as well as the leadership of President George W. Bush. The 
over-riding theme of the budget, and the President's plan for the 
future, is that a safer world is a more prosperous world. That's why 
I'll be discussing both national and economic security here today.

                 OVERVIEW OF THE PRESIDENT'S PRIORITIES

    Decisions about how to collect and spend taxpayer dollars--for this 
is what a budget is--must be made with both caution and vision.
    The fiscal year 2005 budget proposal is, therefore, a plan that 
does three core things:
     One: Keeps Americans safe by providing the resources 
necessary to win the war on terror and protect our homeland;
     Two: Increases the economic security of our citizens as 
well, by strengthening our economy; and
     Three: Exercises the kind of spending discipline that is 
required by a government that respects the source of its money (hard-
working taxpayers!) and is unwilling to live with a deficit. 
Discussions of our budget and our economy are not, and should not, be 
separate.
    The two are inextricably connected.
    Today, our economy is doing better. Homeownership is up, 
unemployment rates are heading down, and GDP growth has been extremely 
strong. This administration came to office when those indicators were 
not nearly as positive. The President inherited an economy that was in 
decline--one that was then battered by terrorist attacks and 
revelations of corporate corruption dating back to the 1990s.
    The President and his administration took these challenges 
seriously and we have made serious progress in changing the economic 
direction of this country. The President's tax cuts--passed by you--
have worked. They provided the stimulus that was necessary to turn the 
economic ship around and they are now encouraging and allowing for the 
economic growth that is continuing into the future.
     Economic growth in the second half of 2003 was the fastest 
since 1984;
     New home construction was the highest in almost 20 years;
     Homeownership levels are at historic highs;
     Manufacturing activity is increasing;
     Inflation and interest rates are low;
     Over a quarter million jobs were created in the last 5 
months of 2003.
     Unemployment claims--both initial claims and continuing 
claims--are falling, indicating improvement in the labor market;
     And last Monday, the Dow closed at a 31-month-high. This 
translates into more than three trillion dollars of growth in value in 
the markets.
    These economic indicators all point to the same conclusion: We are 
on a path to sustained economic growth.
    However, there is more to do. We are not, by any means, satisfied. 
There are still Americans who want to find work and cannot, and this 
administration will not rest until that most critical need is met and 
until every American looking for work can find a job. Our budget 
addresses that need by continuing to focus on improving our economy.
    For example, the President's Jobs for the 21st Century plan, 
announced in his State of the Union Address, directs the resources of 
several branches of government toward matching skills with jobs, and 
helping workers acquire the skills they need to qualify for the jobs in 
their community.
    We can also encourage the creation of jobs by sticking to the 
President's six-point plan for growth.
    That includes making health care more affordable and costs more 
predictable.We can do this by passing Association Health Plan 
legislation that would allow small businesses to pool together to 
purchase health coverage for workers at lower rates. We also need to 
promote and expand the advantages of using health savings accounts--how 
they can give workers more control over their health insurance and 
costs. And we've got to reduce frivolous and excessive lawsuits against 
doctors and hospitals. Baseless lawsuits, driven by lottery-minded 
attorneys, drive up health insurance costs for workers and businesses.
    The need to reduce the lawsuit burden on our economy stretches 
beyond the area of health care. That's why President Bush has proposed, 
and the House has approved, measures that would allow more class action 
and mass tort lawsuits to be moved into Federal court--so that trial 
lawyers will have a harder time shopping for a favorable court.
    These steps are the second key part of the President's pro-jobs, 
pro-growth plan.
    Ensuring an affordable, reliable energy supply is a third part. We 
must enact comprehensive national energy legislation to upgrade the 
Nation's electrical grid, promote energy efficiency, increase domestic 
energy production, and provide enhanced conservation efforts, all while 
protecting the environment.
    Again, we need Congressional action: we ask that you pass 
legislation based on the President's energy plan. Streamlining 
regulations and reporting requirements are another critical reform 
element that benefit small businesses, who represent the majority of 
new job creation: three out of every four net new jobs come from the 
small-business sector! Let's give them a break wherever we can so 
they're free to do what they do best: create those jobs.
    Opening new markets for American products is another necessary step 
toward job creation. That's why President Bush recently signed into law 
new free trade agreements with Chile and Singapore that will enable 
U.S. companies to compete on a level playing field in these markets for 
the first time--and he will continue to work to open new markets for 
American products and services.
    Finally, we've got to enable families and businesses to plan for 
the future with confidence. That means making the President's tax 
relief permanent. Rate reductions, the increase in the child tax credit 
and the new incentives for small-business investment--these will all 
expire in a few years. The accelerated rate reductions that took effect 
in 2003 will expire at the end of this year. Expiration dates are not 
acceptable--we want permanent relief.
    The ability of American families and businesses to make financial 
decisions with confidence determines the future of our economy. And 
without permanent relief, incentives upon which they can count, we risk 
losing the momentum of the recovery and growth that we have experienced 
in recent months.
    The tax relief is the key stimulus for increased capital formation, 
entrepreneurship and investment that cause true economic growth.
    Budgets work better when the economy is growing--because a growing 
economy means more jobs. That means more tax revenue--which leads to 
all-important deficit reduction.
    Which leads me to my next area of discussion.

                OVERVIEW OF THE BUDGET DEFICIT SITUATION

    Let me be clear on this:
     The budget deficit that we face today is unwelcome.
     It needs to be addressed.
     The President's budget calls for cutting the deficit in 
half over the next 5 years.
     While addressing the deficit, we must remember that it is 
not historically overwhelming.
     It is understandable, given the extraordinary 
circumstances of recent history. Remember that we are fighting a type 
of war that we have never fought before. We are fighting an enemy that 
requires a much broader variety of government resources than anything 
we've ever confronted. And we began this fight when we were 
economically wounded.
    What's most important to remember is that we will be able to fight 
this war and climb out of the deficit. We can manage this deficit, and 
we can cut it in half over the next 5 years by controlling spending and 
growing our economy. Three-quarters of the discretionary spending 
increases during this administration have been related to the global 
war on terror and the response to 9/11.
    Meanwhile, President Bush has reduced the rate of increase in non-
security-related spending every year he has been in office: to 6 
percent in 2002, 5 percent in 2003, and to 4 percent in the current 
fiscal year. For fiscal year 2005 we're going to reduce the rate of 
increase in non-security spending to less than 1 percent. Total annual 
appropriated spending will increase by less than 4 percent next year.
    Holding the line on spending--while ensuring that our country is 
safe and our most important needs, from jobs to health care, are met--
will achieve deficit reduction when coupled with all-important economic 
growth.
    Again, this is why the budget cannot be discussed separately from 
the economy. Separating the two is what gets government into trouble.
    Make no mistake; President Bush is serious about the deficit. We 
see it as unwelcome, but manageable--and we intend to achieve: rapid 
deficit reduction.
    A recent CBO report raised concerns about this matter, and it is 
important to note that recent and short-term projected budget deficits 
and the existence of long-term deficits for Social Security and 
Medicare are not connected.
    These unfunded long-term net obligations are also a concern, and 
ones that this administration has highlighted and invited bipartisan 
dialogue on.
    The President has been clear on this: younger workers should have 
the opportunity to build a nest egg by saving part of their Social 
Security taxes in personal retirement accounts. His vision for the 
program is economically wise, and it is that we should make the Social 
Security system a source of ownership for the American people.

                               CONCLUSION

    Are we dedicating ourselves to increased spending on the war on 
terror and protecting the homeland? The answer is yes. Yes, without 
sacrificing other necessities. And that is because a nation must be 
safe in order for it to be prosperous. A nation of entrepreneurs must 
also be able to plan, and to be relieved of as many burdens as 
possible, in order to be prosperous.
    All of the budget issues and policy proposals that I've discussed 
today may seem, at times, to be a complicated recipe. But these 
ingredients combine to make something that is simply put, and is of 
utmost importance--and that is economic growth. Growth is the key to 
every economic problem we confront. That's why we urge other countries 
to institute pro-growth policies. It's good for them, and it's good for 
the global economy that we are a significant part of.
    Thank you for hearing my testimony today. I'll be happy to take 
your questions now.

    Chairman Nussle. Thank you, Mr. Secretary. Mr. Secretary, 
you used to, prior to being in this job, you used to, as I did 
and many of my colleagues on both sides of the isle have done, 
preached about the benefits of balanced budgets. Remind us 
about the benefits of a balanced budget. What is so good about 
having a balanced budget?
    Secretary Snow. The virtue of fiscal restraint, the virtue 
of having deficits manageable is, of course, that it secures 
the confidence of the financial markets; and the confidence of 
the financial markets is important because if financial markets 
don't have confidence, they exact a price. That price is higher 
real interest rates. We have seen this in countries that don't 
have sound fiscal policy. We have seen many Latin American 
countries pay extraordinarily high interest rates, reflecting, 
the financial markets' lack of confidence in those countries. 
High real interest rates have bad consequences. High real 
interest rates choke off growth and contain the future growth 
path of a country to a lower level. We don't want to get on 
that path, and we won't, we won't if we follow the guidance of 
this budget.
    Chairman Nussle. On January 1, 2001, we had a balanced 
budget. On September 8, 2001, we had a balanced budget. 
September 9, we had a balanced budget. Even September 10, we 
had a balanced budget. We had a surplus. How come we weren't in 
nirvana? What was wrong? I mean, was that surplus protecting 
the country? Was it creating jobs? Was it strengthening our 
economy? Why, if we had a surplus and had a balanced budget, 
did we find out just a day later that it wasn't enough to 
protect the country, that it wasn't enough to create jobs and 
keep our economy strong? What was wrong at that moment in time 
that a balanced budget was not enough to, in a compelling way, 
provide us with security for?
    Secretary Snow. Your question suggests its own answer: tax 
rates were too high. We were heading into a recession at the 
dates that you have cited, a recession that the President, 
unfortunately, inherited.
    Chairman Nussle. But we had a balanced budget. How did we 
get into a recession if we had a balanced budget? You mean 
balanced budgets don't prevent us from going into recession?
    Secretary Snow. No. No, not by any means. They are not a 
panacea, Mr. Chairman. Everything else the same, smaller 
deficits are advantageous, but they are not, in and of 
themselves, economic nirvana. That is your point, I think. They 
are not economic nirvana. An awful lot else has to be right. An 
awful lot else has to be right, including appropriate tax 
policies, appropriate trade policies, a sense of security on 
the part of the citizens so that they have confidence in their 
institutions. An awful lot has to be right for an economy to 
work well.
    In the period you cited, we had a balanced budget, but we 
had a lot of other things that weren't going right. We just had 
a meltdown in the stock market. It was to get worse. We had 
just seen the collapse of manufacturing output that started in 
the summer of 2000. We were beginning to see the effects of 
corporate scandals, mistrust of people in the corporate suites 
and in the boardrooms. Those things took their toll and the 
economy, of course, went into a tailspin; and that tailspin 
would have been a lot worse, in my view, if the Congress, in 
2001, had not taken the actions you took to lower tax rates, 
and the actions in 2002 to encourage investment spending, and, 
most importantly, the actions in 2003 to do the things you did 
there with capital gains and dividends and lowering marginal 
tax rates across the board, expending for small business, and 
so on. That was far-reaching tax legislation without which the 
economy, in my view, would be far poorer today, would not be on 
the strong growth path that it is on, and we would have as many 
as a couple million additional people unemployed and growth 
rates of 2 percent or so less than we have today.
    Chairman Nussle. Well, I hear a lot of discussion about the 
fact that our President inherited a surplus, and how that must 
have been able to do so much, and yet it appears to have done 
very little, because I believe while the books of the 
Government may have been in balance, this President inherited a 
security deficit, an economic deficit, certainly an economic 
growth deficit, a job-creating deficit, a wasteful Government 
spending deficit. This surplus wasn't preventing us from 
wasting money in Washington, it wasn't preventing us from doing 
a lot of things, but it sure made a lot of people feel good 
that worked in the fancy white buildings in Washington, DC. But 
it doesn't appear it was helping many people back home that 
were working in the factories and the farms and the villages 
that I represent and so many of my colleagues represent. And 
what I see us doing now is trying to repair some of those 
deficits. Yes, it means the books of the Government are going 
to be unbalanced for a period of time, and we are about the job 
of making sure that they get back in balance and that we do 
reduce that deficit.
    But I want you, if you would, just to finish, because my 
time has expired, if you would finish on the topic of 
confidence, because, again, you spoke to this earlier, but I 
want you to compare the two periods of time: pre-9/11 
confidence and post-9/11 confidence. It would seem to me, or at 
least it may appear to some, as though our investors from 
around our country and world may have had a lack of confidence 
based on purely the deficit figures. But is there more to 
confidence than merely whether or not the books are balanced in 
the Government? Would you speak to both sides of the ledger, 
please?
    Secretary Snow. Yes. Yes, sir, Mr. Chairman, I would be 
pleased to and maybe a little anecdote will help begin my 
answer. I was in Charleston, WV last week meeting with people 
who were engaged in the housing business, and happened to go to 
a community that was of new homes. And the investor and 
construction person who was leading this effort to build these 
new homes took me to the site of a new house, and he is taking 
me through this and he pointed to another house and he said, on 
September 12, 2001, I stood at that house over there, a block 
away, and he pointed to it, and he said, I thought to myself 
what have I got myself into? I am way in hock for this 
development project; we have just had the terrorist attacks on 
America. Will America lose its way? Will America sustain its 
confidence in itself so that people like me, who are investing 
capital, and others will see their projects be able to go 
forward, or will America unravel? Those were his words, will 
America unravel. He said thanks to the leadership, and Congress 
certainly played an important role in that leadership, and most 
of all the President, I would say, he said, thanks to that 
leadership, the country didn't unravel. The country sustained 
its confidence in itself and its institutions and its ability 
to move forward.
    That confidence in the leadership of the country, in the 
institutions in the country, the resiliency of the country I 
think is critically important, and on that score we are far 
stronger today. We are far stronger. We have demonstrated our 
ability to weather extraordinary shocks and to put them behind 
us; the shocks of the corporate scandals, the shocks of 9/11, 
homeland security, the war in Iraq, the war in Afghanistan, so 
on. We have sustained enormous shocks and we have come out of 
it stronger and better.
    I agree with you fully that balancing the budget is 
desirable, but in and of itself it is not enough to sustain the 
institutions of the country or the economy of the country. I 
associate myself with your comments on that subject.
    Chairman Nussle. Thank you, Mr. Secretary.
    Mr. Spratt.
    Mr. Spratt. Mr. Secretary, let me show you again the chart 
I referred to in my opening statement, which comes from the 
Analytical Perspectives on the Federal budget. And this 
particular chart, which we simply copied electronically, shows 
an extension of the 2005 budget, the one now before us, out 
over the next 30, 40, 50 years. And what it shows is that 
slightly after the terminal year in your budget presentation, 
which is 2009, around 2012 the budget begins to worsen. This is 
your 2005 budget extended, it is not hypothesized. And, as a 
consequence, the deficit does all the things that you said are 
iniquitous about deficits, namely, they are permanent, 
persistent, and increasing as a percentage of GDP. Is this a 
correct depiction of what we are looking at in our near future? 
It is not far off; 2010, 2012 is not far away; easy enough for 
markets to perceive and anticipate and begin to respond to.
    Secretary Snow. Congressman, I think what you are referring 
to, if I have it right, is the projections on Medicare costs, 
health care costs.
    Mr. Spratt. Well, there are six variables that are tested 
in these presentations here. One is health care cost, one is 
immigration, one is productivity. There are six different 
variables. One of the variables not tested is revenues but, 
nevertheless, there are six different variables. I only copied 
one, and in every case the deficit gets worse and worse and 
worse; it doesn't get better. And that green line right there 
in the middle, or whatever color it is, is the 2005 budget. And 
you get a little higher growth or lower growth depending on 
what the health care cost assumptions are, but they don't 
correct the problem.
    Secretary Snow. The problem depicted in this chart has 
virtually nothing to do with the budget proposals that we have 
put in front of you or with making the tax cuts permanent, 
virtually nothing.
    Mr. Spratt. Why is it in the budget, then? Why was it put 
in there?
    Secretary Snow. Well, because it is honest budgeting; it is 
telling you where Medicare and Social Security are headed.
    Mr. Spratt. This is the 2005 budget and there are some 
variations on the health care costs assumptions in it, showing 
you the band of variability.
    Secretary Snow. But what it is depicting is something that 
we are all aware of: that with the retirements of the baby 
boomers here in the years ahead, and we are coming up on the 
first wave of the baby boomers, demographics are destiny. What 
you are seeing here is the effect simply of demographics 
playing out as we move from the 3 workers for every retiree to 
2.9, 2.8, 2.7, 2.6, 2.5 That is the trend we are, and that 
trend produces these numbers, and it is why we need to get 
control of health care costs, because what is driving this is 
demographics and rising health care costs.
    Mr. Spratt. Well, what is driving this is demographics, I 
agree with that, but the baby boomers are already born; there 
are 77 million of them marching to their retirement as we talk 
right now. It is a fiscal inevitability that we will have to 
confront by 2008, and it gets worse each year. So my question 
to you is this is a depiction of the budget. One would think, 
from reading your budget, that after 2009 it kind of self-
corrected, it would eventually balance itself. This chart, 
replicated six times with different variables, shows that it 
gets worse and worse and worse; it is persistent, and as a 
percentage of GDP and an absolute amount, it gets worse every 
year shortly after the terminal year in your budget, which 
causes one to suspect is that why the budget wasn't run out 10 
years in the first place.
    Secretary Snow. Can I suggest to you, Congressman, 
something I think you know? And that is if you took the tax 
reductions out of the numbers depicted in this graph, the graph 
wouldn't look much different.
    Mr. Spratt. I am just asking you this is the course of the 
budget after 2009. It doesn't self-correct, it doesn't get 
better, and, therefore, instead of looking out over the 
promised land, we are looking into a chasm in 2009, 2010.
    Secretary Snow. I serve on the Medicare and Social Security 
trusts, as the trustee of both of those trusts. These numbers 
are the numbers we see as trustees of Social Security and 
Medicare, and unless something is done about the unfunded 
status of those two major programs, we are going to see numbers 
like this, which means we can't let those numbers evolve; we 
have to be taking the steps soon to deal with the problem so 
that these numbers don't come to pass. That is why the 
President has proposed the reforms on Social Security; it is 
why we have proposed a number of measures on health care.
    Mr. Spratt. Mr. Secretary, if the President's proposal on 
Social Security, which has not come to us fully formed, but if 
it were, let us say, a 2 percentage points diversion of FICA 
into private accounts, that would create a diversion of $100 
billion dollars of revenues away from the general fund into 
private funds; you would have to back that out of your revenue 
estimates. You would never balance the budget over the next 5 
years. So the Social Security proposal is mutually exclusive 
with the claim that you can get the budget deficit cut by half 
in 5 years.
    Secretary Snow. The Social Security problem, Congressman 
Spratt, as you know as well as I, is going to have to be dealt 
with, and it will cost something to deal with it.
    Mr. Spratt. Cost in benefits, you mean, benefit reduction?
    Secretary Snow. Well, it will cost something. It will cost 
something. Putting in place the personal accounts would require 
some borrowing; it would require some transition costs.
    Mr. Spratt. Well, it would enlarge the deficit, would it 
not? You are diverting revenues out of the general fund into 
private funds.
    Secretary Snow. Any fix for Social Security, any fix for 
Medicare will inevitably involve some give somewhere in 
something.
    Mr. Spratt. Let me switch to a couple of things and then 
turn these questions over to others. The alternative minimum 
tax, also in the Analytical Perspectives pages 76 and 77, which 
Treasury probably wrote, you said if we don't do something to 
fix this, not just amend it, but permanently revise and fix it, 
that by 2012 36 million taxpayers will be paying this higher 
rate, and most of them will be middle income taxpayers for whom 
the tax alternative minimum tax was never intended. We have 
seen estimates that the cost of fixing this would range from 
$500 to $600 billion.
    Now, you are warning us that it is coming, that it has to 
be handled, but you didn't put it in your agenda, and whenever 
we see the tax cut agenda from the Bush administration, for 
some reason this gets omitted from it, even though you are 
saying here it is inevitable, unavoidable. Indeed, if we pass 
the additional tax cuts and make them permanent, then we add to 
the deductions and credits to preference items that make the 
AMT applicable to more and more taxpayers. Why are you not 
proposing in your tax proposals, which are $1.2 trillion in 
additional tax relief, some fix to the AMT?
    Secretary Snow. Because we don't have the fix in mind yet. 
We did indicate, though, in the budget that we would be working 
hard to be in a position a year from now, when we are up before 
you, to talk about a fix. The fix is going to be complicated, 
though, because the alternative minimum tax so intimately 
affects the regular tax and is so interlaced with the regular 
tax. This is an incredibly complicated thing, complex thing to 
deal with.
    Mr. Spratt. Wouldn't you agree that if it isn't fixed, it 
amounts to a tax increase for 36 million Americans?
    Secretary Snow. Well, of course, it is in the baseline now, 
so I guess under current law it wouldn't be a tax increase. I 
will grant you, though, that a lot of people that don't 
anticipate paying the tax will find themselves paying a tax if 
we don't fix it, yes.
    Mr. Spratt. And the cost would be five to $600 billion, 
would it not? Substantial.
    Secretary Snow. It could be. The alternative minimum tax is 
scheduled to generate very sizeable revenues in the years 
ahead.
    Mr. Spratt. One final question. One of the unpleasant 
consequences of running substantial deficits is that, from time 
to time, we have to raise the debt ceiling. The debt ceiling is 
now $7.384 trillion. It was recently raised on May 27, by $984 
billion, the biggest increase in history. When do you expect us 
to raise it again, and when will you present that request to 
the Congress?
    Secretary Snow. Well, as we look at the numbers now, 
Congressman, it looks like sometime late summer that we would 
need to raise the debt ceiling.
    Mr. Spratt. By how much?
    Secretary Snow. Well, that depends on how far out you want 
to avoid facing that issue again, because one thing we know in 
life, death, taxes, and the debt ceiling confront us.
    Mr. Spratt. Well, it would be at least six, $700 billion, 
would it not, because you are running deficits close to $400 
billion?
    Secretary Snow. Congressman, it just depends how far out 
the Congress wants to confront the issue again, really.
    Mr. Spratt. Thank you very much, Mr. Secretary.
    Chairman Nussle. Mr. Hastings.
    Mr. Hastings. Thank you, Mr. Chairman.
    And thank you, Mr. Secretary, for appearing before us 
today. I was struck, and I don't know, in deference to the 
distinguished ranking member, what all made up that chart, but 
one thing did strike me in looking at that chart, where you are 
estimating some sort of action 20 or 30 years in advance. And 
we all know, and that is the frustration I have certainly 
experienced in my time in office, is trying to make decisions 
based on the expectations in the future; they change a lot. And 
I recall my first term in office, just to give an example of 
that. We were confronted in this Congress with the board of 
trustees of Medicare saying that unless we acted by 2002, 
Medicare would be dead broke. And so that was the best 
information that we had. We attempted to change that, it got 
caught up in politics in the 1996 election. We came back in 
1997, I recall, and the trustees came back and said we have got 
bad news: it is no longer 2002, it is 2001. So we made those 
changes.
    Now, I suspect that if that chart showed Medicare 
expenditures in the future based on 1995, it would probably 
have been a lot worse, but the actions of future Congresses 
change the course of those things. I think that the President 
and the administration taking on, looking at Social Security, 
the sacred cow that I recall going on for many, many years, 
nobody would ever touch it, is entirely the right thing to do, 
because future Congresses will confront that. So I just wanted 
to say that, recognizing that trying to estimate revenues and 
expenditures in the future, without taking in the dynamics what 
future Congresses could do, sometimes is an exercise that is 
pretty hard to confront directly.
    But what I would want to ask you, though, is because when 
you were here last year, things looked pretty bleak; they look 
a whole lot better. In those projections that you are looking 
at, is there anything that you can see from your responsibility 
in all this could be characterized as a rosy scenario as to the 
economy, the effect of tax relief that we give to the producers 
in this country, and so forth?
    Secretary Snow. I think our budget is quite conservative 
with respect to the economic assumptions; more conservative, 
for instance, than CBO in many respects, and more conservative 
in many ways than the blue chips. So there may be some upside 
sensitivity here. But this is conservative and I hope we could 
do better than this in terms of the revenue side and the 
receipt side.
    Mr. Hastings. Well, I think that sometimes when we get 
inside the Beltway here, we tend not to trust the people in our 
respective districts to make their own economic decisions for 
themselves. I certainly hear that when I go home, and so I 
think we are on the right course. Sometimes the hard part is to 
stay on that. And I congratulate you for your enthusiasm as to 
where we have come in the past. So I thank you very much for 
your presence being here.
    Chairman Nussle. Mr. Moran.
    Mr. Moran. Thank you, Mr. Chairman. Mr. Chairman, I have 
been reading this book about Treasury Secretary Snow's 
predecessor, and I would recommend it to you as well, in fact, 
all the members of the panel.
    I was particularly struck by a passage that is on page 291, 
if you want to review it at some later point, Mr. Treasury 
Secretary. It talks about Vice President Cheney arguing with 
regard to the elimination of taxes on dividends, saying that it 
would provide positive stimulus. Treasury Secretary O'Neill 
jumped in, arguing sharply that the Government is moving toward 
a fiscal crisis, and then pointing out what rising deficits 
will mean to our economic and fiscal soundness. Dick cut him 
off, that is the Vice President. Mr. Cheney said, ``Reagan 
proved deficits don't matter,'' he said. Treasury Secretary 
O'Neill shook his head, hardly believing that Cheney would say 
such a thing. He was speechless. Cheney moved to fill the void: 
``We won the midterms. This is our due.'' And then he left, 
contemplating the difference between philosophy and ideology, 
because this was brazen ideology. And his last quote in this 
paragraph is ``Ideology is so much easier because you don't 
have to know anything or search for anything, you already know 
the answer to everything. It is not penetrable by facts, it is 
absolutism.''
    Now let me point out what is happening to the deficits. 
That dark blue line is President Bush No. 1--41 we will call 
him--Bush 41; and then that very positive light blue line is 
after President Clinton took over, balanced the budget and put 
some credibility into the idea of a balanced budget amendment, 
restricted spending, raised revenues sufficiently. And, in 
fact, you can see an extraordinary positive line and, of 
course, that took place simultaneous with the greatest economic 
boom that our Nation sustained, boom that our Nation has ever 
experienced. That very frightening red line at the end, that 
tail, is your watch basically, our President Bush 43's watch. 
You can see why many of us are very much troubled by what has 
happened with regard to deficits.
    And let me point out why deficits do matter. I would like 
to get that chart on the debt tax, if we could. This is how 
much each family owes on the debt tax, which is something we 
will have no control over; the Congress has to pay off interest 
on the debt that we have already incurred. And if you look at 
this chart today, the American family owes about $4,400; by 
2014, in 10 years, they will owe more than $10,000. But David 
Walker, the head of the General Accounting Office, just told us 
last week in a speech that, in fact, if we try to pay off that 
debt, to eliminate this debt tax of interest that families are 
having to pay, that would be $96,000 per family, $24,000 for 
every man, woman, and child in America. And if we try to 
reimburse the trust funds, the Social Security and Medicare 
Trust Funds, that are the only reason you can make the claim 
you are going to try to balance the budget, eliminate deficits 
over the next 5 years, because you are taking it all from 
Social Security to make up that gap, if you added that in, it 
is another $100,000.
    So we are talking about astronomical numbers that we have 
dumped on the backs of our children and grandchildren. That is 
the most outrageous thing that any administration has done to 
the American public. And, of all people, when you were head of 
the business roundtable, I thought that you made a pretty 
compelling point that you understood how much deficits matter, 
and yet here it is your watch, and look at the debt tax that we 
are dumping on American families. And, of course, we have got 
this jobless recovery. That doesn't make it any better. I don't 
know where they are supposed to get the money to pay off this 
tax you are giving them. We have got a transportation bill that 
you are opposed to. Here you headed CSX; you know that for 
every billion dollars you invest in transportation 
infrastructure, it generates 42,000 new jobs. How wonderful 
that might have been last month, instead of seeing a net gain 
of 1,000 jobs, if we had actually seen jobs increase in the 
tens of thousands.
    So we are troubled, and I would like for you to reassert 
your position on deficits. Do they matter? And, if so, what are 
you going to do about the debt tax, Mr. Secretary?
    Secretary Snow. Congressman, thank you.
    Mr. Moran. Nice to see you. I think you are a constituent, 
too.
    Secretary Snow. I am.
    Chairman Nussle. The gentleman's time has expired, but if 
you would like to respond to your Congressman, you can do that.
    Secretary Snow. He is my Congressman and I will find a 
chance to have a more elaborate answer. But your first chart 
didn't show the red line turning post-2005, and it will turn, 
and it will turn sharply, and it will bring the deficit to a 
level which is a percentage GDP, and that is really the way to 
look at it, that is lower than the historic level for the 
United States. And, as I said, if the financial markets thought 
that we were not properly managing the fiscal policy of the 
United States, if they thought that we were derelict in our 
duties, if they thought we didn't have an approach to reduce 
the deficit, we wouldn't have, today, the lowest interest rates 
in 45 years. So I think the red line there is going to turn up 
nicely, and as it turns up nicely, the deficit will fall to 
levels that are quite low by historical standards.
    Mr. Moran. I hope you will excuse us for our skepticism, 
Mr. Secretary. We will believe it when we see it. Thank you.
    Chairman Nussle. Mr. Putnam.
    Mr. Putnam. Thank you, Mr. Chairman.
    Welcome, Mr. Secretary. I was observing the previous 
gentleman's line of questioning, and as somebody who, along 
with Harold Ford, is going to be around to pay the debt tax, I 
appreciate his concern about that, the deficit, although I am a 
little confused about the last concern about there not being 
enough spending, but I think that reflects the reality around 
here, that a lot of us have tried to have it both ways for a 
long time and now it is time to make some tough decisions.
    You have commented about the effect of the low interest 
rates, and they have certainly softened this past recession; 
they have fueled an unprecedented housing boom, they have 
allowed people to extract equity from their homes and use that 
to continue to be consumers. What are your thoughts on 
maintaining those low interest rates, and what effect will an 
increase in those interest rates have on our continued economic 
expansion?
    Secretary Snow. There is no doubt about the fact that 
current low interest rates have been very helpful for this 
economy, and they have led to, as you know, a tremendous 
refinancing in the housing market. We now have home ownership 
in the United States approaching 70 percent, the highest level 
ever. New housing starts last year were, what, 1.85 million 
another record. The housing industry has done very well and has 
been a bulwark of strength for the economy, which the low 
interest rates and our good capital markets, housing finance 
markets, are part of the underlying strength of the country. 
Low interest rates also allow the monetary authority to be 
patient in changing direction, and that is helpful.
    I think we have got, fundamentally, a low inflation 
economy, which justifies low interest rates. Part of that 
equation, of course, is very high productivity and trade that 
brings in low cost goods from other parts of the world. A 
combination of trade policy that allows low cost goods to come 
in, stretches consumers' income, high productivity, the 
overhang, I would say, of some of the consequences of the late 
1990s, going back to the chairman's question to me, of 
continuing excess capacity. The late 1990s were a period when 
there was overinvestment in a number of industries. That excess 
capacity still is out there and is restraining prices. High 
productivity, of course, holds prices down, makes firms more 
competitive. I think we have a basic low inflation, low 
interest rate environment.
    Mr. Putnam. Do you believe we will be able to sustain the 
types of productivity gains that we have seen over the last 
several quarters?
    Secretary Snow. At some point productivity gains will have 
to come down a little, I would think, because the law of 
diminishing return applies to everything. We have had such high 
productivity for so long; I think it is 4.4 percent for the 
last 3 years. It came in at an astonishing 9 percent in the 
third quarter, clearly not sustainable for the long-term. And 
this quarter we haven't got the number finalized yet, but it 
looks like it was around 3 percent, coming down from that 
average of 4.4. It would be natural to expect some reduction 
over time of these extraordinarily high productivity rates.
    Mr. Putnam. So we have rung a great deal out of our 
productivity. The American worker, with the help of technology 
and education, is doing all they can do. The charts, I think, 
show that we can only grow our way out of the deficit to a 
certain degree. And, of course, we have to constrain spending, 
but we are talking about discretionary, which is a portion of 
the budget, and the non-defense, non-homeland, which is even 
almost a minute portion of the overall budget. So what type of 
a shock to the system will it take, then, to really be able to 
accelerate our deficit reduction measures?
    Secretary Snow. There are only two ways to deal with the 
deficit, I wish there were more but it really comes down to 
two. One is good growth and that generates government receipts, 
so you get that side of the equation working and growth is 
essential to do that. So growth is absolutely critical. It is a 
necessary condition to deal with the deficit but I think we 
have to acknowledge, and the budget does, that it is not a 
sufficient condition. Spending controls are also required. The 
budget reflects that in the non-homeland, non-defense area and 
it reflects it in a way that is pretty tough minded on 
spending, less than 1 percent, half of 1 percent I think if I 
recall the number in terms of growth. So it is a tight budget 
but it is a budget that works in the sense that with the growth 
we see in the economy and the receipts that will come in. There 
is a lag there but will come in and with the tight spending, we 
do come back to cutting that deficit in half both in nominal 
terms and more than half as a percentage of GDP over the 5-year 
period.
    Chairman Nussle. Thank you very much.
    Ms. Baldwin.
    Ms. Baldwin. Thank you, Mr. Chairman.
    I wanted to say something about the Treasury Department's 
use of averages in describing the benefits or more 
specifically, the distribution of benefits of tax relief. I 
raise this particularly because this budget extends certain tax 
cuts, makes permanent certain other tax cuts and proposes 
certain new tax cuts.
    Last year, the Treasury Department issued a release that 
stated that ``91 million taxpayers will receive on average a 
tax cut of $1,126.'' We all know what averages are, I am not 
going to contest that statement. When you peel a little bit 
back, we have to recognize that we are talking to the American 
public about who benefits and how the benefits are distributed 
and who doesn't. So as we peel that away, we learned if you 
just look at middle income, the middle fifth of households, 
their average tax cut of that particular tax package was only 
$217. We learned that 83 percent of households will get less 
than that average amount cited by the administration and your 
department. Some 53 percent of U.S. households, in fact, 74 
million households would receive tax cuts of $100 or less, 
including 50 million households that would receive none 
whatsoever.
    If you just switch to statistics released by the Treasury 
Department on the small business owners and households with 
small business income tax cuts, they were told that 23 million 
wold receive an average tax cut of about $2,209 in 2003. I had 
a chance to speak with many small business owners in my 
district about their benefits under these proposals and I would 
never think of swearing in front of this committee or you, Mr. 
Secretary, but when I spoke with a particular family in 
Stockton, WI, someone who had owned a small gas station, 
automotive repair shop for many years and when asked about 
their tax cut for small business owners, I can tell you they 
did swear about the fact that they didn't receive one. So we 
have to be careful.
    I mention all this as a precursor to my questions about the 
President's new tax favored initiatives, the new tax favored 
savings proposal. I will try to use statistics carefully here 
because I really do want to understand who will really benefit 
and at what cost.
    I recognize the focus and the importance of increasing 
national savings, private savings, but I also note that these 
programs will ultimately drive us deeper and deeper into debt 
and from my examination will disproportionately enrich also the 
very most affluent in our country.
    As I understand the analysis I have read of the lifetime 
savings account, when up and running, fully mature, the program 
would provide the top 5 percent of the population with almost 
50 percent of this account's tax benefits. The top 10 percent 
would secure almost two-thirds of that account's tax benefits. 
I also have information that suggests that the bottom 60 
percent in this country would receive just 4 percent of this 
program's tax benefits. As I read on, I hear that with the 
retirement savings accounts, the results are supposed to be 
even more skewed. I want to dig more deeply into that.
    I also understand that these programs, when up and running, 
the short term costs, the ones we see in the 5 year forecasts, 
are quite affordable and realistic but in the out years, the 
figures I see suggest that this will be $50 billion a year when 
up and running. So I ask you first of all, if those comport 
with your out year estimates of the full cost of these when 
fully implemented and do you dispute or agree with the notion 
that the top 5 percent of income earners will essentially have 
50 percent of these accounts' tax benefits?
    Lastly, we know your own department says that under current 
law, only 4 percent of those eligible to contribute to IRAs 
actually max out per year; 5 percent who are able to do so with 
their 401(k) programs. Who would benefit more under these new 
proposals?
    Chairman Nussle. The gentlelady's time has expired. You may 
respond to those questions.
    Secretary Snow. I will try and make a quick response.
    I haven't actually seen numbers that you have cited. I 
would like to get them and give you our assessment. I just 
haven't seen those.
    Ms. Baldwin. I would be happy to provide you with those.
    Secretary Snow. And we will comment. What I know about the 
jobs and growth bill is--these are numbers we will be happy to 
share--that the burden of the tax bill is higher on high income 
people after passage than it was before. I think the top 5 
percent went from paying something like 50 percent of the 
overall tax bill to paying 52 percent of the overall tax bill. 
I will give you our assessment and then we can have a 
statistician's discussion. I have not seen the $50 billion 
number on these savings plans.
    Our approach to this, our sense of this is, well off people 
have lots of ways to save. They have tax accounts and they have 
tax lawyers and they have disposable income and so on. People 
in lower income categories don't and they are more adversely 
affected by the restrictions in savings plans that limit the 
use of those monies because they are more likely to have a need 
to go in and use $500 for an emergency because they don't have 
the overall liquidity that a person of greater wealth and 
financial attainment would have.
    Our sense of this is it will disproportionately benefit 
poorer people in the sense that they aren't saving today and we 
are trying to give them vehicles to accumulate wealth, be a 
part of the so-called ownership society, and be able to take 
more direct control over their own financial lines.
    We will share our data with you and yours with us and we 
can continue this discussion.
    Chairman Nussle. Mr. McCotter.
    Mr. McCotter. Thank you, Mr. Chairman.
    I have not a brazenly ideological question or a 
philosophical one, but more of a practical question. As one 
thinks about budgeting, budgeting really is a matter of 
priorities. Some budgets will produce operational deficits for 
however long, some will produce structural deficits. It seems 
to me that in both fiscal and most importantly in human terms, 
a budget that produces deficits and retains misplaced 
priorities is what results in the structural deficits and the 
long term negative growth projections in many ways.
    It seems as I am 38 years old, although after serving on 
this committee I probably look like your older brother, I have 
grave concerns about the future myself. I grew up in the 1980s, 
came of age politically. I would like to know the parallels 
that you see between the budget deficit we are running now and 
the budget deficit of the 1980s because I believe there is a 
parallel there in terms of our priorities and how we place 
them.
    In the 1980s, we saw that we won a cold war, we had an 
economy that was struggling in the early 1980s and improved 
over time and created long term structural growth which I think 
resulted in much of the positive economic activity of the 1990s 
and the peace dividend, of course.
    Right now we are waging a war on terror and we have a 
struggling economy that we are trying to get going. Do you see 
parallels in terms of the priorities and the projections that 
you can base upon those priorities?
    Secretary Snow. Yes, Congressman, I think there are some 
striking parallels there. Starting with the cold war, the 
counterpart to the cold war is the war on terror. We have 
really had three major conflicts in the last half the last 60 
years. One was the war on Nazism which caused large deficits as 
you know, then the cold war which reached its culmination in 
the Reagan years and now the war on terror. Each of those was a 
priority for the Nation and took substantial resources. In the 
first two, we were dramatically successful and that is the 
President's intention in the third, to be dramatically 
successful and rid the world of this heinous threat, something 
I think we all agree on.
    The economy in the 1980s, I was early in my business career 
then, was struggling badly. I remember distinctly the 
recessions of the early 1980s and the effects it was having on 
business enterprise. I think those tax cuts clearly had an 
effect. The tax cuts got the economy going but at the price of 
a deficit, a deficit we later were able to work our way out of, 
in part because of the growth that came from my reading of the 
economic history, from the Reagan tax cuts in the Reagan years. 
That 1986 tax cut in particular I think was strikingly good tax 
policy. I wish we could get back to it in many ways, I would 
say aided by some very strong Democratic leadership made that 
possible. Senator Bradley comes very much to mind.
    We also had in the 1980s a phenomenon that is different and 
that is we had low productivity. We had lost the engine of 
productivity of the economy for reasons that economists even 
today can't really pinpoint. Today, of course, we have the 
benefit of good productivity. We also had a difference since 
the inflation rates were a lot higher back then and now we seem 
to have dealt with the demon of inflation pretty well, but 
there are these striking parallels of an underperforming 
economy, tax cut responses that helped and overwhelmingly 
geopolitical engagement, then the war on communism and the cold 
war, now the efforts with respect to the terrorists.
    Mr. McCotter. Thank you, Mr. Secretary. I would just like 
to note that in those 1980s, while I was in high school and in 
college, I heard that my generation would never see the Federal 
Government get out of debt or out of deficit spending and 
because we managed to win the cold war, we managed to get an 
economy going and in my lifetime, we saw a surplus again. I 
think if our priorities are correct in this budget, we will 
again in my lifetime and my children's lifetime.
    Thank you.
    Chairman Nussle. Mr. Moore.
    Mr. Moore. Thank you.
    Welcome, Mr. Secretary. I want to repeat just a little of 
what I said to Mr. Bolton the other day and I am going to 
repeat some numbers I know you know.
    We have a $7.1 trillion national debt in this country, a 
$521 billion deficit, almost $1 billion a day in interest on 
our national debt, and the interest right now in our Federal 
budget is the third largest category of expenditure. It is 
money that could be used for health care for children, for 
education, for anything worthwhile besides paying interest. I 
think all of us would agree with that.
    You said, Mr. Secretary, not quoting exactly but you can 
correct me if I am wrong, that we can afford to keep the tax 
cuts and higher tax cuts would be detrimental to the growth of 
our economy. I think that is close to what you said. I 
generally agree with that. But, Mr. Secretary, I want to ask 
you too, I look around and I see some of my colleagues--Mr. 
Putnam just left but I see some others, who probably don't 
remember the late 1970s. I think you do, Mr. Secretary. We had 
interest rates of 13, 15, and 17 percent. I think you would 
agree with me that would be absolutely devastating to business 
in our country as well real estate, the consumer borrowing, 
everything. It would be devastating to our country if that were 
to happen again.
    This is not an exact quote but I think it is close. I think 
you said in your testimony, ``deficits matter because if we 
don't act responsibly, fiscally, interest rates will or can go 
up.'' In fact, I have heard Chairman Greenspan when he has 
testified before the Financial Services Committee and this 
Budget Committee on which I serve, at least the 5 years I have 
been in Congress, say that several times, if not those exact 
words very close to that. I think you would agree with Chairman 
Greenspan.
    I believe your testimony was that deficits are not large, 
growing, ingrained and entrenched. I guess there I beg to 
differ with you because I am getting very concerned that is 
what is happening in our country. The deficits are in fact 
becoming large. In fact, $521 billion is the largest deficit we 
have ever had, maybe not in percentages but in terms of actual 
numbers, the largest deficit we have ever had, they are growing 
and we can hope that they get smaller next year but I want to 
see that before I will agree. To me they look like structural 
deficits. That is what really concerns me. We have heard Mr. 
Walker and others who are experts as well on the economy warn 
against the dangers of that and I think Chairman Greenspan 
would as well.
    I am going to hazard a guess here and I hope I am wrong, 
but maybe in the next 30 to 60 days, Chairman Greenspan may be 
giving some sort of policy address expressing his concerns 
about the prospect of increased interest rates. I agree with 
you it has been wonderful that we have the lowest interest 
rates in 40 years but I am very concerned, as I said to you, 
Mr. Secretary, that these interest rates--I know you would 
agree--we don't want them to take off but if it does, it is 
going to hurt every American, Republicans, Democrats, and 
especially our children. That is where I want to end and ask 
you a couple of questions.
    I told Mr. Bolton I spoke to a high school class 2 weeks 
ago and said, why should you be concerned that we have a $7 
trillion debt and deficits that are growing instead of going 
down. One senior girl raised her hand, in a government class, 
and said, because we are going to have to pay it off. Her 
teacher said, she gets an ``A'' for today. That is a sad 
commentary on what we are doing because we have a national 
charge card and we are charging new tax cuts, we are charging 
spending on our charge card and saying to our kids and 
grandkids, here, you guys take care of it. I have told high 
school and college classes when I speak to them, you should be 
angry about that and you should contact your Member of 
Congress, your Senators and let them know you don't appreciate 
them spending right now for their own comforts and then passing 
the bill on to you in the future. That is not right. That is 
not morally right and we shouldn't do that to our future 
generations in this country.
    In fact, President Bush said just one year ago on January 
28 of last year, ``This country has many challenges, we will 
not deny, we will not ignore, we will not pass along our 
problems to other Congresses, to other Presidents and other 
generations.'' Especially that comment about we won't pass on 
our problems to other generations, I fear that is exactly what 
we are doing here.
    I guess I want to ask you what can we do. Mr. Moran, Mr. 
Spratt and others have asked you the question. I really want to 
be respect here because I do respect you but I am very 
concerned. Let me ask this question and you can answer it if 
you would. In this budget, there was nothing for Iraq. We know 
it is going to cost somewhere between zero and $50 billion and 
maybe even more. I think we asked businesses when they have 
business plans to make an estimate, a projection or something, 
but we are not getting anything here. So $521 billion could be 
a very low number, it could be over $600 billion or more. How 
do we take comfort in that, Mr. Secretary?
    Secretary Snow. I think you might have had OMB Director, 
Josh Bolton, here yesterday and I think he responded that there 
will at some point be a need for a supplemental, probably not 
in fiscal 2004 as I understand but in fiscal 2005 and it 
certainly will not be zero. I agree with you. I think he 
indicated also it wouldn't be over $50 billion I think that was 
the number he gave. I can't really do any better than that. You 
can fault us for not putting in some number but I think his 
response would be that the number we put in would be a made-up 
number. I wish we had a number but knowing that number is 
impossible at this time. I think if we had a number, we would 
be perfectly delighted to share it with you and put it before 
you.
    On your larger question: I agree with you--we can't pass 
these fiscal issues on to our children and grandchildren. 
Important as it is, and I think Chairman Greenspan would agree 
with me when I say this, as important as it is to get the 
fiscal deficit down to the levels we are talking about, doing 
that is not enough, really isn't enough because Congressman 
Spratt's charts show that the real problem is the unfunded 
commitments we have made to Social Security and to Medicare. 
Medicare is probably two-thirds of the problem, which is driven 
by demographics and rising health care costs.
    The hope is on Social Security that Congress and the 
executive branch can help engender a national dialogue, talking 
to school children, college kids, and build an understanding on 
the part of the country that we need to take some steps to do 
it. I talk to kids all the time and I ask them, are you worried 
about Social Security? These are 20-year-old kids, kids my 
son's age. They say, no, I am not worried at all, why do you 
ask. I say, well, I just thought you might be worried about it. 
They say no, I am not worried about it, I am never going to see 
it, so why worry about it. That sort of flip answer they give 
you is because they have heard it from somebody else but it is 
out there.
    Medicare is really the big one, it seems to me, because it 
drives so many numbers and that chart Congressman Spratt showed 
at the beginning of the hearing has a whole different 
inflection to it if you assume that we control Medicare costs. 
If you assume we can control Medicare costs, put Medicare costs 
at GDP plus one, you get a much better picture. If you assume 
could get Medicare costs growing at GDP, we are in balance. 
That is how big that change in assumptions is in driving those 
numbers.
    I am completely in accord with your sentiments, and, I mean 
this sincerely, I look forward to working with you and other 
members of the committee to find answers both to the short term 
problem which I think is far less pressing than that long term 
problem that really drives the whole fiscal future of the 
country.
    Mr. Moore. Thank you, sir.
    Chairman Nussle. Mr. Gutknecht is next but he has agreed to 
allow Mr. Hensarling to use this slot, so Mr. Hensarling is 
recognized.
    Mr. Hensarling. Thank you, Mr. Chairman. I thank the 
gentleman for yielding.
    Mr. Secretary, to state the obvious, there appears to be a 
fair amount of anxiety by my colleagues to the left over the 
tax relief the administration proposed and which we passed last 
year. I thought I saw a release or a report from Treasury 
stating that tax revenues are up for the last quarter versus 
the same quarter last year. Did I read that report correctly?
    Secretary Snow. That is right.
    Mr. Hensarling. How can that be if we cut tax rates? How 
can we possibly raise more revenue?
    Secretary Snow. The bigger economy helps.
    Mr. Hensarling. Let me ask you this, Mr. Secretary. How 
much tax relief is being proposed by the administration in this 
budget?
    Secretary Snow. The tax relief being proposed in this 
budget primarily has to do with the savings accounts and I 
think that is on the order of $60 billion to $70 billion over 
the 10-year period and permanence, of course, but you said tax 
reductions. Permanence is avoiding a tax increase.
    Mr. Hensarling. How about if we add in the permanence, do 
you have a figure?
    Secretary Snow. Yes, that is around $1 trillion.
    Mr. Hensarling. How much spending is proposed over the same 
10-year period?
    Secretary Snow. Spending over that 10-year period is 
running at over--I think the revenue over that 10-year period 
is $28 trillion.
    Mr. Hensarling. So you are saying, if I understood you 
correctly, making tax relief permanent and any new tax 
reductions is roughly $1 trillion compared to $28 trillion of 
spending. So those who wish to be focused on the Federal budget 
deficit, it would seem that most of the challenge is on the 
spending side. I didn't major in mathematics, but when I 
compare $1 trillion to $28 trillion, it seems like the 
preponderance of the challenge is on the spending side. Would 
that be your conclusion as well?
    Secretary Snow. Yes, I think that is why we said spending 
controls are critical here. We have the growth component going. 
If we can sustain the tax reductions, the economy will growth 
is our view and there will be adequate revenues to fund the 
government if we control spending.
    Mr. Hensarling. I believe earlier one of my colleagues to 
the left said that tax reductions, if I got the quote right, go 
to the deficit bottom line. You said earlier we have had tax 
reductions, and we have actually increased revenue. Having been 
the veteran of one of these budget processes, I recall from 
last year Democrats proposed almost $1 trillion more in 
spending over and above the budget we passed. Would that $1 
trillion of extra spending go to the deficit bottom line?
    Secretary Snow. That is the only place it can go to.
    Mr. Hensarling. We also heard discussions about various 
trend lines in the Federal budget deficit. I am concerned about 
the Federal budget deficit and with the exception of Mr. 
Putnam, I may have the youngest children of any member here, 
having a 23-month-old and a 4-month-old. So I think a lot about 
such things. At the end of the day, the difference between the 
deficit has to do with us paying cash versus us using a credit 
card. A credit card bill that I do not wish to leave to my 
children.
    There is another budget that I am concerned about, the 
family budget. Over the last 5 years, Federal spending has gone 
from approximately $16,000 per household to $21,000 per 
household which I am led to believe is the largest 5-year 
spending spree since World War II. In speaking of trend lines 
and deficits, do you have an opinion about this trend line and 
what it might do the family budget deficit, Mr. Secretary, if 
we don't control spending?
    Secretary Snow. Your question suggests the answer. We have 
to control spending or else those numbers just get worse and 
worse.
    Mr. Hensarling. Thank you very much for your testimony. I 
yield.
    Chairman Nussle. Thank you.
    Let me inform colleagues that we are expecting votes at any 
moment. I am going to do my best to get all the questions in, 
please keep your questions and time for answers as best you can 
within that 5 minutes. When we vote, I am going to let the 
Secretary leave and we are going to move to the second panel. 
It has been a great hearing but I know that we don't want to 
keep him around for the votes.
    Mr. Edwards is recognized.
    Mr. Edwards. Thank you, Mr. Chairman.
    Secretary Snow, I keep hearing that we can continue to have 
trillion dollar tax cuts as long as we are tough on controlling 
spending and everything will be fine for our children's future. 
Let me ask you this question.
    Seventy percent of all the dollars spent by the Federal 
Government, including the tens of thousands of Federal 
programs, 70 cents of every dollar goes into five programs--
defense, Medicare, interest on the debt, Social Security and 
Medicaid. Let me just ask you a yes or no question to these. Is 
the administration in this budget asking for more or less in 
defense spending?
    Secretary Snow. I think it is 7 percent more for defense.
    Mr. Edwards. And I support that increase. Is it asking for 
more or less for Medicare spending?
    Secretary Snow. The Medicare spending is an entitlement and 
it is not really directly in the budget. It will rise.
    Mr. Edwards. But because of the prescription drug bill, it 
is going up, so that is two out of two. Interest on the 
national debt, one of the largest components of Federal 
spending programs is going up dramatically because of 
irresponsible fiscal policies and huge historic national debts, 
are we going to ask in this budget for more or less to pay the 
interest on the national debt this year compared to the year 
before?
    Secretary Snow. I think interest rate is up as the debt is 
up.
    Mr. Edwards. OK. So in the first three out of the five 
largest Federal programs, the administration, despite all the 
rhetoric I hear from the other side of the aisle, is asking for 
more spending and frankly, I don't criticize that, I support 
more defense spending.
    The other two programs, along with the first three, that 
the administration is asking for increased spending are Social 
Security and Medicare. In this year's budget, is the 
administration asking for reductions compared to the previous 
year's spending in Social Security and Medicare or increases in 
spending?
    Secretary Snow. Again, that is a mandatory program but 
numbers will go up.
    Mr. Edwards. So those will go up. After all the rhetoric is 
put aside on the table, the five programs that represent 70 
percent of every Federal dollar spent, this administration, not 
supported in many of those requests, but this administration, 
contrary to the rhetoric, is asking for an increase in 
certainly three, defense, Medicare and interest on the debt and 
most likely in effect, Social Security and Medicaid 
expenditures will go up.
    Let us look at some others. Highway spending, is this 
administration going to ask for more or less in highway 
spending compared to the previous year?
    Secretary Snow. I think it is modestly up.
    Mr. Edwards. That is modestly up. Veterans, the budget 
actually cuts real services to veterans but in terms of actual 
nominal dollars, before you consider health care inflation, is 
the administration asking for more or less in veteran spending 
compared to the previous year?
    Secretary Snow. I think it is a little more.
    Mr. Edwards. So if you take the five programs that 
represent 70 percent of every Federal dollar spent, add 
highways and veterans which represent another significant part 
of the budget, the truth of the matter is, American people need 
to understand, that even these budget hawks that want to be so 
tough and have such a sharp knife on cutting spending, we are 
actually asking for increased spending.
    That is exactly why when President Reagan said in 1981, we 
could have massive increases in defense spending, massive tax 
cuts and balance the budget, he was $2 trillion off in a decade 
and we tripled the national debt.
    I have to talk a little bit about the credibility gap. I 
understand economics is an inexact science and I understand 
these budget annals are beyond the ability of most Americans, 
myself included, to really analyze in great detail. I respect 
the gentleman's economic experience and life work. The American 
people have a right to ask about the credibility of 
predictions, so let us go back historically, 20 years prior to 
2001, 1981. President Reagan did make that promise--increased 
defense spending, massive tax cuts, balance the budget. Guess 
what happened? We didn't balance the budget, we tripled the 
national debt.
    Fast forward 10 years later. Former President George 
Herbert Walker Bush made a campaign promise, ``read my lips, no 
new taxes,'' but to his everlasting credit, probably at the 
expense of reelection, he looked the American people in the eye 
and said, protecting our children and grandchildren's economic 
future is more important than a campaign promise.
    Fast forward 10 years and because of that President Bush 
was part of a bipartisan effort to increase taxes to lower the 
future projected deficits. Come 20 years after President Reagan 
made his promises, which David Stockman said he knew were not 
true, that you couldn't do all three of those things without 
creating massive deficits, President Bush promises in 2001 we 
can increase defense spending massively, cut taxes massively 
and balance the budget. President Reagan was wrong and Congress 
was wrong in 1981. President Bush is wrong this time and 
frankly, I think we have a credibility problem, Mr. Secretary.
    Chairman Nussle. Mr. Gutknecht.
    Mr. Gutknecht. I would let the Secretary respond to that if 
he would like to.
    Secretary Snow. Thank you, Congressman Gutknecht.
    I would simply respond that the Reagan years produced 
phenomenal benefits for the world and the country in ending the 
cold war and bringing the wall down, reuniting Germany. I don't 
think anyone wants to quarrel with the extraordinary success of 
what was accomplished on Ronald Reagan's watch.
    The deficits, and you have probably studied this more 
recently than I have, but as I recall during the Reagan years, 
he did propose fairly tight spending controls and Congress 
didn't give him the spending that he wanted and that 
contributed very much to the deficit that occurred. I don't 
want to go back and argue history with you. It is a combination 
of good tax policy and good spending policy. You get them 
right, you get good results. I think the President's budget 
reflects good policy on taxes and I think it reflects good 
spending.
    I wish we weren't in the situation we are with the war on 
terror and homeland security because that drives this budget. I 
don't think you are criticizing it so much, as you are just 
pointing out that the spending goes up and it does. It is 
regrettable but it is for a cause that I think is awfully 
important and I think you will agree.
    Mr. Gutknecht. Reclaiming my time, and since everyone is 
engaging in a little bit of historical revisionism, now it is 
my turn and maybe I can put our spin on the story.
    I was first elected in 1994 and when I came here, I will 
never forget, the first meeting we had with some of the CBO 
economists. They told us we were looking at a minimum of $250 
billion deficits for as far as the eye could see. They were 
wrong. About 3 years ago, we were told by some of the same 
economists that we were looking at $4.5 trillion worth of 
surpluses over the next 10 years. They were wrong. The only 
thing we can honestly say about the projections we are looking 
at today is they are wrong. We don't know if they are high or 
low but we know they are wrong. I do agree with you on this, 
that we have to keep our eye focused on the spending side. 
Frankly, some of the criticism you have heard today is not that 
the administration is being too tough, the criticism I think 
really is are you going to be tough enough.
    Ultimately, it seems to me we have to get hold of some of 
these big entitlements--health care costs. The bottom line is 
this, and my biggest employer is a little medical practice 
started by two brothers named Mayo and they are a very 
important part of our economy. Health care is extremely 
important to every single American. The bottom line is we can't 
have a health care delivery system that is taking 15 percent of 
our gross domestic product and going up. At some point, we are 
going to have to get our arms around that.
    The same is true of Medicare and ultimately, let us not kid 
ourselves. Those kids are right. We have to get some kind of 
real Social Security reform. Frankly I think the budget you are 
presenting is, in my opinion, a little bit too timid.
    I do want to come back to another issue. I will help you 
all I can on the budget issues to get control of Federal 
spending, both on the entitlement and on the other side of the 
budget equation, but I want to come back to something you said 
that I think is important. I apologize, this is a bit parochial 
but it affects an awful lot of people. You said something about 
making pensions stronger in your opening remarks. I would like 
to know more about what you are saying. More importantly and to 
the point, I really want to know more about the 
administration's position on this whole issue of pension 
conversions. This is a very big issue. I have 6,000 current and 
former IBM employees in my district and it affects a lot of 
Americans and there is a lot of angst out there.
    I would like to work with you, I think I have offered a 
very reasonable compromise on this issue but it is a big deal 
and affects everybody. If the administration is serious about 
making pensions stronger, I have a couple of very specific 
recommendations.
    While you think about your answer, Secretary Snow, I do 
want to welcome, for the benefit of all the members in the back 
of the room, we have several members of the German Parliament 
who are here with us today, including a member of the Hungarian 
Parliament who are here in Washington. Perhaps we can give them 
a welcome. [Applause.]
    And you have 20 seconds left.
    Secretary Snow. We will look forward to working with you on 
the pension issue. I think you are referring to the cash 
balance pension plans and the conversions to cash balance 
pension plans. I think we have sent up by now a proposal or we 
are in the course of doing it, I have signed off on it. It is 
in the budget, good, that deals with that issue by providing 
for continuation of cash balance pension plans but only where 
the employer treats the older workers equitably. We deal with 
the wear away problem that you are referring to and in effect, 
hold older workers in the same position they would have been if 
they had stayed with the employer, with their old DB plan for 5 
years.
    Mr. Gutknecht. Not having seen that, that sounds like a 
very fair compromise. Again, I look forward to working with 
you.
    Chairman Nussle. If we are quick about it, we can get two 
more questioners in.
    Ms. Capps.
    Ms. Capps. Thank you.
    Mr. Secretary, I would like to turn to the topic of tax 
credits for the uninsured. In testimony before the Committee on 
Ways and Means last year, Jonathan Gruber, a professor at MIT, 
presented an analysis which showed that the tax credit proposal 
would only reduce the number of uninsured by 1.9 million, out 
of 44 million uninsured. In addition, of the 4 million who will 
take advantage of the tax credit, according to the 
administration, almost half or around half already have some 
form of insurance.
    My question is, why would the administration tout a policy 
that only helps 5 percent of the uninsured, many of whom have 
insurance and call this the centerpiece to its uninsured 
agenda? I am wondering, in addition, is it really cost 
effective to spend $70 billion for such little effect?
    Secretary Snow. We would have little different numbers than 
the professor. I think our number is somewhere between $4 
million to $5 million, so we would see our program being a 
little more effective.
    Ms. Capps. Still, 4 million out of?
    Secretary Snow. Out of 444 [million].
    Ms. Capps. Maybe it is appropriate to focus on what this 
tax credit could buy on the insurance market. This is according 
to the GAO. In 1998, the mid range premium for family insurance 
in the individual market exceeded $7,300. It is probably higher 
now. Further, a Commonwealth fund study that looked at 
individual health insurance policies found that the median 
annual premium for a single, healthy adult aged 55 was $6,100. 
Keep in mind in this budget, the President is proposing tax 
credits of $1,000 for individuals and $3,000 for families. 
These tax credits, I submit, will do little to make health 
insurance more affordable for eligible families.
    My question again is how would this tax credit help low 
income families buy health insurance when they are still left 
with such a large premium that they can't afford?
    Secretary Snow. I have looked at this question and I am not 
as knowledgeable as you are with your background in health 
care, but I don't think there is any silver bullet that deals 
with all 44. It is a complex issue. This only deals with a 
piece of it, there are other proposals we have, the 
deductibility, above the line, high deductible plans, the HSAs 
that the Congress approved should help but I think it is a 
problem we have to keep coming up with tailored solutions 
because there isn't a one size fits all sort of answer.
    Ms. Capps. I grant you this is not a silver bullet. I 
haven't even brought up and maybe we should that it is really 
difficult for older individuals and those in less than perfect 
health to buy health insurance. If any of us in this room have 
ever tried to buy health insurance on the individual market, in 
the rare instances that people can do it, affordable premiums 
and deductible are out of reach. There is no silver bullet but 
in this budget, you are proposing $70 billion for tax credits 
for health insurance that won't help many of the 44 million 
insured. This is not only cynical but a tremendous waste of 
resources. I submit that we should be looking and I wonder if 
you have other ideas for more effective ways to address the 
needs of the uninsured?
    Secretary Snow. I think there is one effective way to deal 
with it and that is only one. This won't surprise you but it is 
to narrow the gap between the path health care costs are on and 
the path which disposable income is on. You do that two ways. 
You lift the path for disposal income and you reduce the path 
for health care costs.
    Ms. Capps. How do we reduce the path for health care?
    Secretary Snow. I would suggest right away that we go after 
malpractice abuses. Medical malpractice abuses are having a 
disastrous effect on health care quality and health care costs 
in the country. That is where I would start.
    Ms. Capps. I yield back.
    Chairman Nussle. I thank the gentlelady.
    Mr. Diaz-Balart. You can see the time on the screen as well 
as I can.
    Mr. Diaz-Balart. I will be brief, Mr. Chairman.
    Mr. Snow, you are probably as amazed as I am, I haven't 
been here that long either, of hearing from our dear friends on 
the minority side on one hand that the deficit is too high, 
therefore we are spending too much more than we are bringing on 
and on the other hand, that we are not spending enough. I guess 
the answer to that is well, they say we have to reverse the tax 
cuts, i.e., increase the taxes on the hardworking Americans.
    My question, to be brief, is what do you think the outcome 
would be if in fact we reverse those tax cuts of the past few 
years, in other words if we raise taxes, what would be the 
adverse effects on the economy, if any, and to what degree?
    Secretary Snow. I think the consequences of that would be 
very serious on economic growth, on the incentives to save and 
invest, unemployment levels. There just can't be any doubt 
about the fact that the tax cut you approved last year has put 
the economy on a much, much stronger path. We wouldn't have 
seen 8 percent growth rates in the third quarter if it hadn't 
been for the tax cut. We wouldn't have seen 4 percent in the 
fourth quarter. We wouldn't have had the 26 percent growth in 
the equity markets. We wouldn't have manufacturing coming back 
and exports coming back as they are and they clearly are, 
without the effect of those tax cuts. It would be a shame to 
reverse that course.
    Mr. Diaz-Balart. Thank you, sir.
    Thank you, Mr. Chairman.
    Chairman Nussle. I thank the gentleman.
    With that, Mr. Secretary, we are going to go to a vote. We 
have three votes on the floor and we appreciate the access we 
have to you and for your valuable time and attendance at these 
meetings. If I could put I none final pitch, Mr. Smith knows my 
passion in this regard, we need better revenue forecasts. My 
understanding is there have been some ideas floating in 
Treasury for ways that we can help you help us with those 
forecasting measures. If you would give a proposal, I can tell 
you that myself and many others are interested in helping you 
help us with the revenue forecasting issue. We stand ready to 
serve in making sure we can get better numbers.
    Secretary Snow. Mr. Chairman, maybe with that admonition to 
us, Secretary Olson will reconsider her decision to retire.
    Chairman Nussle. That would be nice, but your entire team 
knows our passion for that and we appreciate your work in that 
regard.
    With that, we will stand in recess. There is a second 
panel. We will reconvene after the final vote in this series.
    [Recess.]
    Mr. Shays [assuming Chair]. I would like to call this 
hearing to order and to thank you, Mr. Aaron, for your patience 
on the day that members go home and after a Secretary has come, 
sometimes the room is somewhat sparse but your message is very 
important. The advantage we have is that we don't have to 
follow the 5-minute rule and we can make sure what you have to 
say is out, the story is out. So we are going to hear your 
testimony and welcome that and I will start with Ms. Baldwin.

   STATEMENT OF HENRY J. AARON, BRUCE AND VIRGINIA MAC LAURY 
            SENIOR FELLOW, THE BROOKINGS INSTITUTION

    Mr. Aaron. Thank you very much, Mr. Shays. I appreciate the 
invitation to come here and perhaps there are advantages to a 
cozy setting. At least I hope so.
    You have a copy of my testimony and I am going to try to go 
through all of the points I covered in it but I would like to 
hit a couple items and there are a few other issues that arose 
either yesterday or today that I would like to spend a bit of 
time on.
    The first point which I covered in my testimony is that I 
think most informed observers would agree that official 
projections grossly understate the size of the budget problems 
the Nation faces. The current conventions incorporate 
assumptions that directly contradict stated policy of the 
administration, including extension of the 2001 and 2003 tax 
cuts, relief for the alternative minimum tax and as we just 
heard from Secretary Snow and you heard yesterday from OMB 
Director Bolton, a supplemental for national defense.
    The official projections also treat the temporary cash flow 
surpluses in the retirement programs as if they were available 
legitimately to finance current activities of government and I 
believe they conceal the size of the imbalance between revenues 
and outlays in the rest of the budget. If one takes those 
adjustments into account, the proper measurement of the 2005 
deficit is well over $600 billion and will not decline but will 
increase in the years ahead under stated administration 
policies reaching close to $1 trillion a year and an annual 
rate in 2014 despite of the assumption of full economic 
recovery, a return to full employment and a continuation of the 
rapid productivity growth we have enjoyed since the late 1990s.
    Affirmation of the tax cuts enacted over the past 3 years 
represents a decision, an explicit priority decision as one of 
the members noted earlier today, and it is a decision that we 
should use funds that we need to pay for public assumption 
instead to go back to individual pockets to finance private 
consumption.
    Over the long haul, the revenues sacrificed through these 
tax cuts are more than sufficient to deal with urgent problems 
that I believe all Americans want to see solved. The revenues 
foregone by the tax cuts are three times as large as those 
needed to close the entire projected deficit over 75 years in 
the Social Security Trust Fund.
    Mr. Shays. Could you repeat that?
    Mr. Aaron. The size of the tax cuts enacted in 2001 and 
2003 calculated over the next 75 years are three times as large 
as the entire projected deficit in the Social Security system. 
To put it in other terms, you could if you wanted retain two-
thirds of the tax cut but not all of it, divert the rest of it 
to correcting the shortfall in Social Security and be no worse 
off than if you would under administration policy. This raises 
a question of priorities squarely. Which do we want? Do we want 
to finance that much more private consumption or do we want to 
at least use part of that to help deal with recognized national 
problems?
    An additional point I stressed in my testimony I would like 
to repeat here is that I believe the proposed reforms in budget 
procedure that the administration advances are unbalanced and 
are not likely to work as intended. The administration would 
place procedural obstacles in the way of any increase in 
entitlement spending or in refundable tax credits but there 
would be no procedural obstacles to further tax cuts in the 
positive income tax..
    The old pay go rules that Congress worked under during the 
1990s were far more even handed. The same rules, in my view, 
should apply both to entitlements and to tax reductions of any 
kind.
    In addition, the baseline that the administration proposes 
for discretionary spending amounts to a 15 percent reduction in 
real per capita spending for domestic discretionary activities. 
It would represent a 20 percent cut in the share of national 
income devoted to this function. Again, limits are necessary 
and I am not in any way arguing against them but they should 
not be so far outside the range of policies that both Congress 
and the administration have clearly embraced. I include not 
just the previous administration but this administration and 
this Congress.
    Reducing the deficit is important as I think everyone 
agrees because it frees up private saving for productive in 
investments, adds to national income, increases earnings and 
reduces the share of the budget that has to go to pay off 
interest on the national debt. A balanced program is going to 
include both spending cuts and tax increases. To be sure 
raising taxes increases associated economic distortions as I 
think members of both parties generally agree but there is 
ample room to raise taxes in ways that actually reduce economic 
distortions.
    Furthermore, some economists, rather shrilly in my view, 
said after the tax increases enacted in 1993 that they would 
cripple economic growth. What in fact ensued was the longest 
economic boom in U.S. history and large increases in the rate 
of productivity growth. Furthermore, cutting spending carries 
costs too. For example, a failure to provide health care for 
the disadvantaged or a failure to clean our environment. There 
are losses suffered either by raising taxes or by cutting 
spending but in both cases, they are necessary to help restore 
fiscal discipline for the Nation's budget.
    Finally, some have defended proposals to make the tax cuts 
permanent by saying that doing so would reduce uncertainty. 
With all due respect to the people who have made this argument, 
I believe it is laughable. Does anyone here really think that 
American workers are seriously deterred from looking for work 
or improving their skills by the prospect that tax increases 
might rise in the year 2010? In the case of businesses, there 
is more substance to the concern. Businesses do depend on a 
stable environment to make long term plans.
    You can best reduce uncertainty for business by assuring 
them that exploding government deficits will not produce 
financial market meltdown and one effective way to do that 
would be to state clearly that the tax cuts will, for the most 
part, be allowed to expire, no question about it, no 
uncertainty, you can count on it. It would be even better if 
that announcement were part of a comprehensive program 
including sensible spending cuts and sensible tough budget 
rules.
    I would like to just mention two points that came up in 
Secretary Snow's testimony and in the questioning thereafter. 
In responding to Ranking Minority Member Spratt's reference to 
the charts from the special analysis volume of the budget which 
showed steady deterioration of the budget in the future, 
Secretary Snow said, ``but if we could only bring health care 
spending down for example, so that it would not be faster than 
the growth of GDP plus 1 percent, things would look a great 
deal better.''
    In fact, those projections incorporate precisely that 
assumption. That assumption indeed is over optimistic. It is 
over optimistic because the growth of health care spending for 
decades has proceeded at a faster rate than that. The message 
is that we already have in the projections graph in the special 
analysis volume a picture that is unduly optimistic, serious 
and threatening though it appears.
    The second point referred to the question of the source of 
our current budget deficit problem. Is it attributable 
primarily to revenue issues or is it attributable primarily to 
spending excesses? Here are the key facts. In the last 4 years, 
the budget has moved from surplus to deficit for a total shift 
of 6.6 percentage points of GDP. Of that shift, 5 percentage 
points is attributable to declining revenues, 5 percent; 1.6 
percent is attributable to increased spending. Of that 1.6 
percent, all but 0.4 percentage points is attributable to 
defense and homeland security and only four-tenths of 1 percent 
of the deterioration of the budget is attributable to increases 
in non-defense discretionary spending. Spending in fact for the 
Government as a whole is running below the average of the last 
20 years.
    I think for that reason, it is a mischaracterization to 
attribute our current deficit problem to spending that is out 
of control. We have serious revenue problems. To balance the 
budget we will need to cut spending but on balance, if there is 
indiscipline, it has occurred more on the revenue than on the 
expenditure side of the budget.
    Thank you very much, Mr. Chairman.
    [The prepared statement of Mr. Aaron follows:]

   Prepared Statement of Henry J. Aaron, Bruce and Virginia MacLaury 
                Senior Fellow, the Brookings Institution

    Mr. Chairman, thank you for the invitation to testify today before 
this committee on the current state of the U.S. Government's budget and 
on the proposals contained in the administration's proposed 2005 
budget.
    Presidents often begin State of the Union messages with some 
variation on the phrase ``The state of the Union is strong.'' In the 
same spirit, I shall begin my testimony with the statement ``The state 
of the Federal budget is perilously weak and getting weaker. It is on 
its way to becoming a threat to national economic and political 
stability.'' To this I would add that the administration's proosed 2005 
budget would make that situation worse, not better.
    I understand that these are strong words and that not all respected 
economists would agree with them. I also realize that disagreement 
among supposed experts puts those who depend on expert testimony in a 
difficult situation. When experts disagree, why not just wait and see 
if time clarifies matters? Mr. Chairman, you and your colleagues do not 
have that luxury. You are in the position of a jury judging a difficult 
case of transcendent importance. You will hear the evidence, and you 
must reach a verdict, a verdict of action.
    In my testimony, I shall try to make the following points:
     The deficit in calendar year 2004 is large, but not 
unprecedented for a recession year. It is not a serious problem and 
should absorb little of your attention. Indeed, any belated effort to 
reduce this year's deficit is neither likely to succeed nor desirable 
to undertake, as it could hinder recovery from the recession.
     The deficit projection over the next 10 years is 
distressingly bad. Official statistics do not come close to 
representing how bad it is for two reasons: official projections are 
based on conventions that everyone understands to be misleading; those 
projections focus on the unified budget, which misrepresents the long-
term implications of current budget policy.
     The budget situation has deteriorated catastrophically 
over the past 3 years. Events beyond the control of economic policy 
makers account for much of this deterioration, but persistently bad 
fiscal policy has aggravated the damage from these unfortunate external 
events.
     Although budget prospects for the next decade are bad, 
they become far worse in later years as retiring baby-boomers push up 
pension and health outlays.
     The time to begin repairing the fiscal damage inflicted on 
our economy is now. For economic reasons a program of fiscal 
rehabilitation should and for political reasons must, include both 
spending cuts and tax increases. The mix will depend on the priorities 
of the American public, but no responsible cure for America's fiscal 
problems can exclude sizeable tax increases.
     The program outlined in the administration's 2005 budget 
fails distressingly to meet the challenge. Rather than calling for 
needed tax increases, it calls for still more tax cuts. It focuses on 
the wrong target, the unified deficit, which badly understates the size 
of the deficit problem the nation confronts. Simply maintaining current 
services would reduce spending more than the administration's budget 
would do. Furthermore, spending will almost certainly be higher and tax 
collections lower than stated in the budget if administration policies 
are adopted.
     The changes in budget procedure that the administration 
proposes to control deficits would constrain nondefense spending 
increases, which account for little of the deficit problem over the 
next decade, and do nothing to forestall cuts in revenues, erosion of 
which accounts for most of the problem.

                I. THE CURRENT DEFICIT IS NOT A PROBLEM

    The Congressional Budget Office estimates that the unified budget 
deficit for fiscal year 2004 will total $477 billion, somewhat below 
the administration's estimate of $521 billion. This number is 
misleadingly small because it includes as revenues available to cover 
current spending $170 billion in revenues counted as additions to 
Social Security and Medicare Hospital Insurance Trust Fund reserves. 
All of these cash flow surpluses and more besides will be needed to 
honor currently promised benefits. A better indicator of the size of 
this year's fiscal shortfall would exclude these accumulations. If 
these trust fund additions are not included, the CBO estimate of the 
budget deficit balloons to $647 billion and the administration's 
deficit is approximately $685 billion.
    These deficits, 5.7 and 6.0 percent of projected GDP, respectively, 
are about as large as were the unified budget deficits in the 1980s, 
when Social Security and Medicare cash flows were about in balance. 
Pointing to the unified deficit, some people pooh-pooh this year's 
deficit as much smaller than those from which the nation suffered 
during the 1980s. Those claims are misleading because they disregard 
the fact that the nation was in the 1980s suffering from a much more 
serious and persistent recession and because they treat funds that are 
being collected and will be needed to meet future obligations as 
available for current use.
    That said, this year's deficit is not a major concern. Revenues 
fall during recession, and the recession is not yet clearly over. The 
very fast growth during the third quarter and the slower, but still 
encouraging, growth during the fourth quarter of 2003 have not sufficed 
to produce job growth. The small drop in the unemployment rate is due 
more to discouraged workers giving up and leaving the labor force than 
to job creation. Workers continue to exhaust unemployment benefits at 
record and increasing rates. And auguries for the sustainability of the 
current recovery remain mixed. In this situation fiscal managers, in my 
view, should follow a strategy similar to that announced by the Federal 
Reserve's Open-market Committee of continuing to allow highly 
stimulative policies to remain in effect until the recovery is 
undeniably under way.
    Current policy remains flawed. The stimulative tax cuts of the past 
3 years could have been designed far more effectively to combat the 
recession. Reductions in dividend taxes, in capital gains rates, and in 
marginal tax rates applicable to high-income recipients, who spend a 
relatively small fraction of their incomes, do far less to stimulate 
the economy than would tax cuts of equal size directed to recipients of 
low and moderate incomes, who spend virtually all of their incomes on 
current consumption. But that legislation is on the books, and Congress 
should, in my view, look ahead, not back. As I shall argue presently, 
most attention should be devoted to the long-term budget situation. But 
in looking ahead, Congress should not leave unattended two urgent near-
term problems.
    The first is the plight of the unemployed who are exhausting their 
benefits at record levels an estimated 2 million during the first half 
of 2004 and whose job prospects remain cloudy. The situation is not 
equally serious everywhere, but the number of unemployed exhausting 
their benefits is higher than average in every state in the union and 
higher than it has been for decades in nine states.
    To pick just two states not entirely at random, an estimated 
seventeen thousand Iowans (the third highest number for any 
corresponding period in the last twenty-nine years) and nearly 28,000 
South Carolinians (the highest number for any corresponding period in 
the last thirty-two years) will exhaust their benefits.
    The second is the fiscal problem confronting state and local 
governments. Because of a recession states did not cause and cannot 
fight, state revenue growth has fallen far behind projections an 
estimated $57 billion less in 2005 than if the recession had not 
occurred. The result has been 2 years during which balanced-budget 
requirements have forced large reductions in public services. 
Additional deficits are projected for 2005 of roughly $40 billion, more 
than 8 percent of baseline general fund spending.
    In those same two not-randomly selected states, the projected 
deficits are 7 percent of general fund spending in Iowa and 6-10 
percent in South Carolina.
    Nor is profligate spending the cause of state fiscal problems. Over 
the decade from 1989-99, real spending by states grew at an annual rate 
of only 2 percent. From 2002-05 Federal policies have imposed net costs 
on the states collectively of an estimated $165 billion. The states at 
first tried to maintain public services by running down rainy day 
funds, then cut spending and raised taxes.
    The result has been stark: loss of health benefits for more than 1 
million low-income people, more than + million of whom are children, 
cutbacks in day care that is necessary to make effective the work 
requirements under TANF, cutbacks on funding of primary and secondary 
education, and reductions in support of higher education, resulting in 
double-digit tuition increases.
    Rather than helping the states, however, the administration's 
proposed budget would add to their burdens. It reduces the real value 
of grants to the states by about $3 billion.
    Constituents should ask for an explanation from those Members of 
Congress who supported tax cuts for high income families, but who 
refuse to support extending unemployment benefits for the long-term 
unemployed or additional fiscal support to enable states to provide 
health benefits for poor children, books for school children, and day 
care for children of mothers required to work. Even if one rejects any 
spending that would further increase the deficit, one can still ask 
what value system would lead an elected official to put tax cuts that 
add to the disposable income of the wealthy ahead of grants that would 
maintain health care for poor children and education for all because 
those are the priorities that policies advocated by this administration 
and passed by this Congress have expressed.

II. OFFICIAL BUDGET PROJECTIONS SERIOUSLY UNDERSTATE THE NEXT DECADE'S 
                                DEFICITS

    Between 2005 and 2014, the Congressional Budget Office anticipates 
cumulative unified budget deficits totaling $1.893 trillion. According 
to CBO projections, large early deficits give way to a small surplus in 
2014. This projection follows well-established conventions and, based 
upon those conventions, is done with complete professionalism.
    The CBO and the corresponding administration projections of the 
unified budget deficit are, however, a misleading guide to the fiscal 
challenges that the nation faces. To base current economic policy on 
those projections would be a serious error. The problem is that the CBO 
unified budget projections focus on the wrong target and are based on 
implausible assumptions.
    The Wrong Target. In fiscal year 2005, the CBO's projected unified 
budget deficit consists of three components:
     Social Security cash flow surplus of $171 billion,
     Medicare Hospital Insurance cash flow surplus of $18 
billion, and
     non-Social-Security-non-Medicare-Hospital-Insurance 
deficit of $551 billion.
    Every nickle of the cash flow surpluses in Social Security and 
Medicare and much more besides will be needed to pay for future 
benefits, as both programs confront projected, long-term deficits. 
Furthermore, every nickle of the payroll tax collections that make 
those surpluses possible is justified on the grounds that it will help 
pay for future benefits. Excluding those cash flow surpluses in 
computing the current budget balance of the nation provides a more 
accurate indicator of the nation's fiscal shortfall than does the 
unified budget deficit. Using that measure, the CBO's projected 
cumulative deficit from 2005-14 is not $1.893 trillion, but $4.438 
trillion.
    Implausible Conventions. But even that measure is far off any 
reasonable projection of what is likely to occur, as shown in several 
papers by my colleagues William Gale and Peter Orszag (alone and with 
various co-authors). Because Peter Orszag testified before you 
yesterday, I shall only summarize the major points.
    The official projections of both the Congressional Budget Office 
and the Office of Management and Budget are based on the following 
assumptions: that expiring tax provisions (including all of those 
enacted during the last 3 years with sunset dates) are allowed to 
expire on schedule, that nothing is done to soften the effect of the 
spreading reach of the alternative minimum tax, and that real 
discretionary spending (defense and nondefense combined) will be 
unaffected by either population or income growth.
    Dropping these assumptions produces disturbingly higher projected 
deficits:

 
------------------------------------------------------------------------
                                                 Projected Deficit, 2005-
                    Concept                                2014
------------------------------------------------------------------------
Unified Budget.................................          $1.893 trillion
Excluding Social Security and Medicare.........           4.438 trillion
Adjusted for expiring tax provisions and AMT              7.451 trillion
 adjustment....................................
Adjusted to hold real discretionary spending              8.035 trillion
 per person constant...........................
Adjusted to hold discretionary spending/GDP               9.002 trillion
 constant......................................
------------------------------------------------------------------------

    The starting point for discussions of the nation's fiscal challenge 
should not be $1.893 trillion, but somewhere between $4.438 and 9.002 
trillion. Since the administration has made clear its desire to make 
the tax cuts permanent and, presumably, would not want the minimum tax 
to deny filers the tax cuts that it deems so beneficial, the starting 
point is well over $7 trillion. If one supposes that spending on 
national defense will not sink materially and that some increase in 
real, per capita nondefense discretionary spending will occur, the 
budget problem is somewhere in the $7-$9 trillion range. In other 
words, over the decade from 2005-14, the budget challenge is roughly 
four times as large as the CBO's projection of the unified budget 
deficit would suggest. Furthermore, the deficit with these adjustments 
does not diminish, but increases steadily, approaching $1 trillion in 
2014 alone.
    False Hopes. Some observers downplay the significance of 
prospective budget deficits by claiming that past deficit projections 
have been widely off the mark and that we can grow our way out of the 
current mess. This position is dangerously irresponsible.
    That budget projections are unreliable is well established. It was 
not only the courageous bipartisan deficit reduction programs enacted 
in 1990 under President George H. W. Bush and a Democratic Congress, in 
1993 by President William Clinton and a Democratic Congress, and in 
1997 by President William Clinton and a Republican Congress that 
eliminated the deficits spawned in the late 1970s and early 1980s. The 
economic boom of the late 1990s and the revenue bonanza it produced did 
much of the work. Why couldn't we get lucky again?
    Well, we could. But three considerations warn that we should not 
count on it.
    The first is that the budget projections of the Congressional 
Budget Office and the administration already build in faster 
productivity growth than was assumed or achieved throughout the 1980s 
and the early and mid 1990s. These higher productivity assumptions 
reflect the improved economic performance of the United States since 
the late 1990s and are fully warranted. Still higher sustained growth 
is conceivable. Based on historical trends, however, it is unlikely. 
Furthermore, even if higher growth were realized, the administration's 
own calculations, shown on page 194 of the Analytic Perspectives 
chapter, ``Stewardship,'' indicate that modest increases would not 
solve the nation's long-term budget problems.
    Second, the last productivity surprise followed two decades of 
courageous and far-sighted economic policy, beginning with The Tax 
Reform Act of 1986 enacted during the administration of President 
Reagan, and continuing with the three deficit-reduction packages passed 
in 1990, 1993, and 1997. To count on even higher productivity growth 
than is already built into budget projections following budget policies 
that studies carried out by the Congressional Budget Office and outside 
analysts indicate are more likely to lower productivity growth than to 
raise it, is neither prudent nor responsible.
    Third, it is simply irresponsible to count on good luck to bail us 
out of clearly foreseeable problems. Yes, productivity growth could be 
higher than currently assumed. It could equally well be lower. 
Economists still do not fully understand why productivity collapsed in 
the 1970s, and they cannot fully explain why it rose in the late 1990s. 
To blithely invoke a jump in economic productivity as a budget savior 
when there is no good reason to foresee it is foolhardy.
 iii. events and bad policy have combined to create this fiscal problem
    When CBO made its 10-year unified budget projection in 2001, 
covering the period from 2002-11, it foresaw a cumulative surplus of 
$5.6 trillion. It now foresees a cumulative deficit for the same 10 
years of $2.9 trillion. The total budget deterioration is $8.5 
trillion.
    Of that deterioration:
     27 percent is attributable to the tax cuts,
     19 percent to increased spending on defense and homeland 
security,
     15 percent to increased spending, and
     39 percent to changed economic and technical assumptions.
    This apportionment of causes of the deficit shows clearly that the 
recession contributed in a major way to the deterioration of the budget 
situation, principally because it has led to a huge and still 
incompletely understood reduction in revenues. The uninvited, but 
necessary, increases in spending for defense and homeland security also 
contributed to the budget turn-around. But the various tax cuts 
accounted for $2.4 trillion of the red ink and will add far more in the 
years after 2011 when recession plays no part in projected deficits.
    To argue, as the administration does, that the budget would be in 
deficit even if taxes had not been cut, makes no sense, because that is 
not the issue. The question, rather, is whether, given the difficult 
hand that economic events and the terrorist threat have dealt us, it 
makes sense to make an already bad deficit situation worse by cutting 
the taxes needed to pay for government services Congress has approved.
    The answer is that imprudent tax cuts have made a difficult 
situation worse. This characterization is fair because opponents to the 
tax cuts specifically warned that the economic weather could 
deteriorate in the future as it had in the past. Disregarding such 
warnings, the administration relentlessly and rashly insisted on 
cutting taxes and Congress unwisely concurred. We are now reaping the 
consequences of this improvidence.
    It is also misleading to argue that the source of budget problems 
is ``out of control'' discretionary spending. Between 2000-04, 
government spending rose by 1.6 percent and revenues fell by 5 percent 
of gross domestic product, a total swing from surplus to deficit of 6.6 
percent of GDP. Of the increase in spending, about three-quarters was 
for defense and much of the remainder was for homeland defense. 
Nondefense discretionary spending rose by about 0.4 percent of GDP, 
thereby accounting for about 6 percent of the deterioration in the 
budget. Whether those increases were wise or foolish, I leave to others 
to debate, but anyone who claims that explosive spending growth is the 
source of our current deficit problem or the one that the nation will 
face over the next decade should not be taken seriously. The deficit 
problem, overwhelmingly, is attributable to declining revenues, which 
have fallen in part because of the recession and in part because of tax 
cuts that Congress has enacted.

                          IV. THINGS GET WORSE

    As is well known, budget prospects over the next several decades 
deteriorate dramatically. CBO projections indicate that Social 
Security, Medicare, and Medicaid spending as share of gross domestic 
product will rise by 3 percentage points of GDP between 2010-20 and by 
an additional 5 percentage points between 2020-40 under current policy, 
a total of 8 percentage points of GDP over the three decades from 2010-
40.
    Despite irresponsible rhetoric to the contrary, it will be 
impossible to offset this increase solely by program cuts, program 
redesign, or improved efficiency. As the recently enacted Medicare 
amendments demonstrate clearly, pressures to liberalize health benefits 
for the elderly and disabled are strong. And with good reason. Even 
after the drug benefit is implemented, Medicare will continue to 
provide far narrower coverage than does the health insurance enjoyed by 
the majority of the non-elderly. Retrenchments in private retiree 
health benefits and skyrocketing Medigap premiums, as well as 
inadequacies in Medicare coverage will sustain pressures to liberalize, 
not curtail government-sponsored benefits. It will take great effort 
and substantially increased cost sharing by upper-income elderly and 
disabled simply to stay within current frightening projections.
    Some cuts in Social Security benefits are possible and desirable as 
part of a program to restore long-term financial balance, but total 
spending is bound to increase as a share of GDP as the baby-boom 
retires.
    Against this background, it is fair to enquire whether making the 
tax cuts permanent is the best possible use of the funds that higher 
rates would generate. The long-term cost of the tax cuts enacted in 
2001 and 2003 is three times the cost of closing the seventy-five-year 
deficit in Social Security and more than sufficient to close not only 
that deficit but also that in Medicare Hospital Insurance. Given the 
choice, the American public might well prefer to devote at least some 
part of the revenues that will be generated as the tax cuts expire to 
reforming and restoring balance in Social Security and Medicare. In 
addition, it is quite odd that an administration which has emphasized 
the importance of taking account of the size of the multi-trillion 
dollar long-term shortfall in Social Security and Medicare fails take 
account of the even larger multi-trillion dollar long-term cost from 
making tax cuts permanent.
    The demands on the public sector over the coming decades confront 
the United States with a challenge that few democracies have been able 
to handle. Congress and the American public will be forced to choose 
among three broad options:
    The first is to raise total tax collections by 40-50 percent from 
the current level of just under 16 percent of gross domestic product to 
roughly 25 28 percent of gross domestic product.
    The second is to slash pension and health benefits for the rapidly 
growing numbers of elderly and disabled and to withdraw the safety net 
under the poor. Please note that privatizing these services offers no 
fiscal relief whatsoever. Either benefits must be cut or dedicated 
revenues must be increased; those are the only options.
    The third is to run huge deficits that would quickly destroy the 
willingness of financial markets to lend to us and amount to economic 
suicide for this nation.
    None of these choices is palatable, but there are no others. The 
nation is likely not to rely on any single one of these options. If it 
behaves responsibly, however, it will not use the third, but will 
choose some combination of tax increases and reductions in pension or 
health benefits and not rely at all on the third option. I am not here 
today to embrace any particular approach, but rather to point out that 
the stress of choosing among what may now seem unthinkable alternatives 
will be enormous and that poor choices will threaten the nation's 
economic stability. Cutting deficits now will ease those problems 
later. Cutting taxes and raising deficits as the administration's 
announced policies will do will only intensify the problems.
    It is tempting to try to wave off such unpleasant projections, for 
example by pointing to the well-documented inaccuracy of forecasts. But 
the current deficit problem is not a forecast, but a reality. The 
imminent retirement of the baby-boom generation is rapidly becoming a 
reality. This nation is rich enough and its institutions are flexible 
enough to cope with both problems, but not by ignoring them, not with 
currently legislated taxes, and certainly not by cutting taxes still 
more.

 V. A CURRENT ACTION PROGRAM: DOES THE ADMINISTRATION PROGRAM MEET THE 
                                 TEST?

    Against this background, does the administration's program as set 
forth in its 2005 budget begin to meet the challenge? The answer, alas, 
is that it does not. The budget claims that it will reduce the budget 
deficit, projected to be $521 billion in 2004, to $237 billion in 2009, 
a reduction of more than half. There are several problems with both the 
target and with the claimed achievement toward it.
    When is a cut not a cut? The heralded halving of the budget deficit 
is actually an increase in the deficit relative to what the 
administration projects will happen if it doesn't do anything other 
than fund current services. Table S-14 (p. 388) of the budget reports 
that the unified budget deficit will fall from $527 billion in 2004 to 
$211 billion in 2009. Thus, the budget's actual commitment to reach 
$239 billion amounts to a $28 billion increase in the deficit.
    Furthermore, the choice of 2005-09 as the period over which to 
measure progress toward deficit reduction is grossly misleading. The 
first baby-boomers become eligible for Social Security in 2008 and for 
Medicare in 2011. Extension of the expiring tax provisions of the 2001 
and 2003 tax acts that the administration seeks to make permanent will 
affect revenues only in years following 2010. Thus, the administration 
claims credit for deficit reduction, while actually increasing it, over 
a period 2005 2009 conveniently before its own deficit-increasing 
policies take effect and before the commitments of past legislation 
inexorably drive up projected budget deficits.
    The program. The administration is on record with commitments that 
make achievement of even this remarkably unambitious objective highly 
improbable.
     The administration has indicated that it will propose 
relief from the alternative minimum tax in 2005. Just how much such 
relief will lower revenues depends on how much relief is given. 
Sufficient relief to hold constant the number of filers subject to the 
AMT could lower revenues as much as $200 billion cumulatively from 
2005-09 and more than $600 billion over the succeeding 5 years. The 
absence of any specific minimum tax relief from the 2005 budget means 
either that tens of millions of filers will not receive the tax cuts 
that the administration proposes to make permanent or that the tax 
collections will be lower and the deficit larger by the amount of such 
relief. The administration cannot have it both ways.
     Even the deficit reduction that is promised is partly 
phony. The administration has asked once again for a variety of new 
saving ``incentives.'' Within the 5-year projection period they are 
scored as revenue increases, but they would reduce revenues by hundreds 
of billions of dollars in later years because all investment earnings 
and withdrawals would be exempt.
     Nor despite promises dating back to the 2000 campaign to 
restore balance to Social Security does the budget contains any 
specific proposal to reform Social Security. The budget does put in a 
good word for the recommendations of the president's own Social 
Security commission. Unfortunately, all the commission's three plans 
would aggravate the budget problem, adding approximately $4 trillion 
each to the public debt by 2040, according to official estimates the 
Commission reports.
    A better way. In confronting a deficit problem of the size American 
faces, the first requirement of good policy is honesty about the size 
of the problem and of the steps that it will take to deal with it. 
Staff of the Brookings Institution tried to meet that challenge in its 
recent report, Restoring Fiscal Sanity: How to Balance the Budget. It 
starts by presenting an honest measure of the unified budget deficit 
over the decade from 2005-14. Next, it explains why closing that 
deficit is a vital first step to dealing with the nation's long-term 
fiscal challenge. Finally, it lays out three programs to achieve that 
objective.
     One of the programs relies primarily on spending cuts to 
close the deficit. It is a program designed to represent how an 
advocate of small government could simultaneously pursue that objective 
and fiscal balance.
    Although this option entails expenditure cuts that many would 
regard as draconian elimination of all Federal spending for elementary 
and secondary education, housing and urban development, manpower 
training and related programs, environmental protection, and law 
enforcement, for example, as well as many other cuts spending 
reductions are insufficient to restore fiscal balance by 2014. It is 
still necessary to boost taxes by $134 billion a year, relative to a 
baseline in which all of the 2001 and 2003 tax cuts are extended.
     Another program expands government spending and raises 
taxes enough not only to pay for that spending but also to close the 
deficit. It is a program that implements an activist and fiscally 
responsible vision of government.
     An intermediate program, which most of the authors of the 
study embrace, would restore fiscal balance with a combination of 
spending cuts and tax increases.
    This study demonstrates that one need not plunge the nation into a 
fiscal morass in pursuit of any particular vision of government. It 
also underscores that it will take courage and patience to restore 
fiscal sanity to a policy trajectory that is badly astray. The 
administration's proposed 2005 budget does not meet any of these tests.

               VI. PROPOSED CHANGES IN BUDGET PROCEDURES

    Many observers warned that the expiration of the Budget Enforcement 
Act would remove a useful device for constraining spending and tax 
cuts. They have urged Congress to adopt new procedures that would 
promote fiscal prudence. The 2005 budget contains proposals to alter 
the budget process. Unfortunately, they would be neither effective nor 
fair and Congress should adopt quite different rules.
    The administration proposes that Congress adopt rules under which 
any legislated increase in entitlement spending or refundable tax 
credits would have to be offset by cuts in other entitlement spending 
or other refundable credits. No restriction would apply to cuts in 
positive taxes. This rule contrasts with the old pay-go rules under 
which entitlement spending and tax changes of all kinds were grouped.
    The proposed rule is not worthy of serious consideration, in my 
view. It is hard to conceive a rationale that would place greater 
procedural burdens upon spending and tax credits that primarily benefit 
the elderly, disabled, and households with low or moderate incomes the 
primary beneficiaries of entitlements while creating no obstacle to 
deficit-increasing cuts in positive income taxes paid primarily by 
upper-income households. As Alan Greenspan has stressed, one must deal 
both with tax and spending entitlements. By embracing such budget 
procedures, the administration has surrendered any right to accuse 
opponents of its policies of class warfare.
    Under the administration's proposed budget rules, any increase in 
discretionary spending above the administration's baseline would 
require a super-majority. Some target is surely necessary. But the one 
that the administration proposes is not reasonable. It proposes as a 
baseline to hold non-defense discretionary spending constant in nominal 
dollars between 2004-09. This target amounts to a drop in real per 
capita spending of approximately 15 percent over this 5-year period. 
Nondefense discretionary spending would fall from 4 percent of GDP in 
2005 to 3.2 percent of GDP in 2009, lower than any other year published 
in OMB's Historical Tables. If this trend reflected the demonstrated 
intent of either the administration or Congress, it might make sense, 
but it does not. The administration has proposed and Congress has 
approved gradual increases in non-defense discretionary spending. There 
is no indication that either wants to reduce per capita services by 
one-fifth. The implausibility of this projection is yet another reason 
why the administration's claims of reducing the Federal deficit are not 
to be taken seriously.

    Mr. Shays. I am going to give Ms. Baldwin the first chance 
but just to clarify, what level of spending are you suggesting 
has taking place in the last 4 years?
    Mr. Aaron. I am saying the share of gross domestic product.
    Mr. Shays. The increase. What is the increase in spending?
    Mr. Aaron. 1.6 percentage points of GDP of which three-
quarters of that is attributable to national defense and 
homeland security.
    Mr. Shays. The growth in spending has been what, on the 
average of about 8 or 9 percent?
    Mr. Aaron. It has varied. During the first years of the 
Bush administration, it was much higher than that. During the 
last year, there was a significant slowdown, virtually no 
increase in domestic discretionary spending in the last year, 
but continued as a number of members have stressed legitimate 
increases.
    Mr. Shays. I will do it when I have my time but it strikes 
me that we are way off on our numbers, so it would be good to 
nail them down.
    You have the floor. Why don't we do 10 minute rounds and 
then I will go to you, Mr. Scott.
    Ms. Baldwin. Thank you, Mr. Chairman.
    I will jump in where you left off because I have seen the 
graph that was referred to comparing 2000 and 2004 revenues and 
expenditures as a percentage of GDP. The figures you used at 
the end are somewhat difficult to wrap one's brain around but 
let me see if you agree with this contention and then perhaps 
we can share this graph with committee members.
    If you ask what share of the swing from surplus to deficit 
is attributable by changes in revenue policy, tax breaks versus 
spending, what I saw, and it doesn't matter whether you use OMB 
numbers or CBO numbers, it is 76 percent of the swing 
attributable to the change in revenue as a percentage of GDP?
    Mr. Aaron. I believe that is approximately the same numbers 
I have. The swing in revenues should be divided into two 
categories. We have gone into a recession. Revenue collections 
have collapsed for reasons that nobody clearly understands as 
yet. In addition, we have cut tax rates so it is a combination 
of the two. Actually more of it is attributable to the changed 
economic assumptions and revenue collections, about 40 percent 
of the deterioration in the budget is attributable to that, 27 
percent to tax cuts and the rest to spending.
    Ms. Baldwin. I don't actually have that chart in front of 
me but will share with the chairman and make sure we are all on 
the same page with regard to these numbers.
    I guess I couldn't agree more with your assessment and sort 
of over arching statement that this truly is about priorities. 
I think you were here earlier when I had a chance to ask some 
questions of Secretary Snow about the distribution of benefits 
of the tax cuts previously imposed, the impact of their 
extensions, making permanent the 2001 and 2003 tax breaks and 
also the new proposals, specifically the life savings account 
and the retirement savings account.
    I believe it may have been some of your colleagues who took 
a closer look at these proposals. They have been offered before 
and I know the administration has made a few changes to the 
proposals but there are essentially things that we have seen 
before and have been analyzed before.
    Once concern I have as I stated to Secretary Snow is that 
some of the short range costs are quite manageable, quite 
affordable, but when you look at a fully mature, up and running 
lifetime savings account and retirement savings account program 
as currently proposed, I have seen cost estimates as high as 
$50 billion a year or more. I also have seen very disturbing 
analyses of who really benefits in our population from those 
programs once they are up and running, specifically the top 5 
percent of the U.S. population would get 50 percent of the 
account's tax benefits, that the top 10 percent could secure 
two-thirds of the tax benefits. Additionally, that was with the 
lifetime savings account, that the retirement savings account 
might be additionally skewed.
    Lastly, if you can address this in response, the Treasury 
Department has looked at current law and who gets to fully reap 
the benefits of contributions to IRAs and to 401(k)s. The 
Treasury Department said recently that only about 4 percent of 
those currently eligible to contribute to IRAs actually max out 
in any given year. Only about 5 percent of 401(k) participants 
actually contribute the maximum. I am wondering whether there 
is a belief that any greater percentage of people would be able 
to reach these maximum limits if we were to convert these two 
or have greater reliance on the savings programs that are being 
proposed in this President's budget?
    Mr. Aaron. I would like to make three points in response to 
your question. The first is I think encouraging saving is a 
good thing, particularly for lower income Americans. With that 
in mind, it is particularly distressing that the 
administration's budget does not call for an extension of the 
saver's credit which is targeted to lower income Americans. 
They are the ones not saving enough, who need encouragement.
    The second point is that the administration and many 
private analysts have taken pains to emphasize the importance 
of looking at the long term budget challenge posed by social 
insurance. This is not irrelevant to your question. They look 
many years into the future and in effect calculate the present 
value of our obligations. That is an illuminating thing to do. 
I am not decrying it in any way.
    What is sauce for the goose is sauce for the gander. If one 
should do that with respect to social insurance, one should 
also do that with respect to proposed changes in the tax code. 
If one does that with respect to the savings proposals that 
have been advanced, they represent truly enormous tax 
reductions. The reason they represent enormous tax reductions 
is that they encourage saving in a forum where the deposits are 
not in any way tax favored but all investment earnings are 
exempt and withdrawals are tax free, sort of the reverse of 
normal IRAs, just what Roth IRAs do.
    Furthermore, the proposals would allow people to convert 
from the traditional IRAs which backloaded benefits into these 
alternative accounts counting the revenues that are collected 
on conversion as net additions to revenue during the 5 year 
budget window. As a result, they don't look like they cost 
much. In fact, they cost on a properly accounted basis hundreds 
and hundreds of billions of dollars and represent an enormous 
increase in the deficit burden that we will face in the future.
    I think the first step is to do a proper accounting of the 
cost of these programs and then ask whether this is a use of 
the Government's tax raising capacity that meets the standards 
of Congress. Like you, I share the view that the benefits are 
skewed unevenly toward upper income households but that is 
where the money is and I can understand somebody arguing on the 
other side that if you really want to promote saving, that is 
the way you want to do it. If you want a net addition to 
national saving, however, it is important that the proposal not 
reduce Federal revenues dollar for dollar for any increase in 
private saving that occurs. That doesn't add to national 
saving.
    The first step is to account honestly for the cost of these 
proposals. The second, in my view, is to pay for them. I think 
the general idea of pay go rules is something we ought to 
adhere to now and then we can have a debate about whether this 
is something that we think is in the national interest.
    Mr. Shays. Thank you.
    Mr. Scott.
    Mr. Scott. Thank you, Mr. Chairman.
    Mr. Shays. I just want to say, Mr. Aaron, except for your 
last words, I have been listening to you closely because I have 
some real problems with what you are saying. You may be right 
on some of it but I need to sort it out.
    Mr. Scott, you have the floor for 10 minutes and Ms. 
Baldwin if you want to come back and I will take 10.
    Mr. Scott. As Ms. Baldwin pointed out, and you can see on 
the chart, we have had a swing of approximately $750 billion 
from the surplus down to the deficit we have now. The last time 
I checked on the Federal budget under revenue, the line item 
individual income tax, everybody's individual income tax 
brought in less than $800 billion. We have had a $750 billion 
swing in 3 years. How would you describe that kind of 
deterioration in the budget?
    Mr. Aaron. Much of the deterioration in the budget that has 
occurred in the last 7 years is attributable to the causes that 
Secretary Snow and some of Shays' colleagues have emphasized. 
We have gone through a very difficult period, a terrorist 
attack, a need for military build-up, a need to invest in 
homeland security, a recession that has lowered revenues. The 
bulk of the deterioration in the specific budget numbers we are 
looking at is attributable to those causes.
    My concern is that confronted with these adverse events, it 
would seem to me this is not an opportune time to weaken the 
Federal Government's revenue raising capacity for the long 
haul. I agree with Secretary Snow that the tax cuts we have 
enjoyed in the last 3 years have softened the recession. It 
would have been worse had tax cuts not occurred. It could have 
been better than it was if the tax cuts had been better 
designed, targeted more toward people who would have spent a 
larger proportion of the tax cuts that were given to them than 
the actual legislation did but there is no doubt that the tax 
legislation enacted in 2001 and 2003 have softened the 
recession.
    Virtually all of the increase in disposable income that has 
occurred in the last couple of years can be traced to tax cuts 
rather than to increases in wages and salaries.
    Mr. Scott. Mr. Aaron, as you know, different tax cuts have 
different effects on the economy.
    Mr. Aaron. Yes.
    Mr. Scott. Different spending, if you are faced with the 
challenge that we are presented, the first thing the House did 
right after 9/11 was to pass legislation that dealt with the 
alternative minimum tax to corporations. Those corporations 
that are profitable sent out dividends every year that we 
notice weren't paying any taxes. A few years ago we passed the 
alternative minimum tax for corporations. Right after 9/11, we 
elected to repeal the alternative minimum tax for corporations 
and made the repeal retroactive 15 years, giving billions of 
dollars in tax cuts and several corporations got about $1 
billion. Enron got about $250 million.
    Mr. Aaron. And a lot of good it did them.
    Mr. Scott. It seems to me that kind of cash would do 
nothing for the economy. It might mean that the corporate 
executives get their bonuses, it means the dividends might go 
out but there is no new demand for product, so anybody who 
works for the company is no more likely to have a job after 
that than before.
    There are other things you can do. Extend unemployment 
compensation, earned income tax credit, tax credits to families 
that would have a much more stimulative effect. On the ones 
that we selected, could we have gotten a substantially bigger 
bang for the buck in terms of the economy than we did?
    Mr. Aaron. I believe the answer to that is yes and I would 
add an item to your list of places where I think the use of 
Federal revenues could have much produced a much bigger bang 
for the buck and that is greater aid to State governments. They 
have been confronting very large deficits for the past 3 years 
as a result of which they have had to do something you don't 
want to have to force a government to do during a recession 
which is to raise taxes, and they have been forced to cut back 
on services, many of which flow to those who are most directly 
affected by the economic slowdown and to dependent populations 
more generally.
    The most important failing in my view of the tax policy of 
the last 3 years is of a different kind, however. It is the 
fact that the clear intent is to make these cuts permanent. As 
Mr. Spratt emphasized with his chart, the Nation faces enormous 
spending challenges in the future. There is much talk about 
reducing entitlement spending, the net action in the past year 
was to raise entitlement spending.
    The likelihood that we are going to reduce entitlement 
spending materially moving into the future is not very great. 
In fact, the three proposals advanced by the Commission that 
President Bush appointed to examine Social Security all would 
add approximately $4 trillion to the national debt over the 
next three and a half decades. As I say, Congress acted last 
year to increase not decrease Medicare spending. In this 
environment to make permanent tax cuts seems to me to be rash.
    Mr. Scott. One of the problems I have noted is it appears 
to me that there is no one sounding an alarm. If you look at 
this chart, it just goes out to about 2014 where you have with 
reasonable assumptions, listening to the President and what he 
wants done, including making the tax cuts permanent, you have 
deficits in the $450 billion to $500 billion range out to 2014. 
At the last hearing, I reminded people of the joke about the 
guy who jumps off the 20 story building and at the eighth 
floor, he says, so far no problem.
    In 2014, you have a $502 billion deficit. That year you 
have a $275 billion surplus in Social Security. Three years 
later, as we know, the Social Security surplus will evaporate 
and then it goes into deficit. Even there you are on the brink 
of a $275 billion hole in the budget that has to be filled 3 
years from there. Nobody seems to be alarmed by the fact that 
unless we have a profound change in direction, we are not going 
to be able to pay Social Security.
    Mr. Aaron. I am more optimistic about being able to pay 
Social Security. Actually the cash flow surpluses in Social 
Security will continue until the later part of the 2020s. The 
date to which you refer, which is about 2014 is the one at 
which payroll tax revenues cease to be sufficient to cover 
outlays of the problem, but Social Security has other revenues 
including from the income tax and from interest paid on the 
bonds which are held in the Social Security reserve.
    Mr. Scott. Where does that money come from?
    Mr. Aaron. Let me continue because I think the fundamental 
point you are raising is absolutely right and I would like to 
put in a plug for an effort to respond to precisely the concern 
you are expressing that I was part of at the Brookings 
Institution. We recently put out a study which attempted to 
form a realistic estimate of what budget deficits would be 
stretching out to 2014 under the assumption the tax cuts are 
indeed made permanent, all of them enacted in 2001 and 2003.
    It did included some relief in the minimum tax but not full 
relief from the minimum tax, and it included growth of domestic 
discretionary spending at the rate of inflation on a per 
capital basis. Given those assumptions which are not 
extraordinarily bullish, the projected deficit in 2014 was 
close to $1 trillion.
    What we did was try to ask how--I will use political 
labels--a responsible conservative, a responsible liberal and 
by that I mean a small government conservative and a big 
government liberal and somebody who was in between could 
respond to that deficit problem in a serious way. How could 
they close the deficit by 2014? We presented three different 
programs, one of which relied almost entirely on spending cuts 
but not entirely, one of which raised government spending and 
raised taxes enough to pay for that and the deficit, and one 
that cut spending and raised taxes, all of which balanced the 
budget.
    The job is tough, that was the message of the book. The 
second message was it can be done if Members of Congress from 
both sides get together and do the job but we concluded that 
there was no way even with a small government mentality of 
doing the entire job without some tax increases.
    Mr. Shays. Mr. Aaron, you are a very respected and I view a 
somewhat centrist economist, you are not on the fringe on 
either side, certainly not on the fringe on the supply side, 
but I view you as being somewhat centrist, maybe leaning a 
little to the left side. You are about as respected as they 
get. I just want to not knowing exactly how this is explained, 
I would like you to look at two charts and let me first take a 
look at chart No. 3 in the President's budget request and just 
walk me through the first four 3 years, 2001 to 2002, and then 
2003 and 2004.
    We are looking at basically what we think is a 9.7 percent 
spending increase in discretionary spending. You would agree 
that is admittedly discretionary is only about one-third of the 
budget but you would basically accept we have been doing that?
    Mr. Aaron. I would and I would like, as a former luncheon 
companion of yours at Brookings, return the compliment. It is a 
genuine pleasure always when you come because one has a 
productive and honest interchange of views.
    Mr. Shays. We have an interesting time, don't we?
    Mr. Aaron. Yes, we do.
    Mr. Shays. How about looking at chart No. 2.
    Mr. Aaron. Before we leave, that includes--as I 
understand--it both non-defense discretionary and defense.
    Mr. Shays. Correct, and it includes the supplemental. That 
is why you see the $875 billion and it is what distorts what 
you read later. It says, the next 5 years total discretionary 
spending would grow at 1 percent.
    Mr. Aaron. No, the 1 percent, yes, you are quite right. The 
non-defense discretionary actually is projected to be flat in 
nominal dollars between 2004 and 2009. That is the same number 
in each year, plus or minus $1 billion.
    Mr. Shays. That is if we accept the viewpoint that the $86 
billion supplemental doesn't repeat itself.
    Mr. Aaron. No. I am referring to non-defenser discretionary 
right now.
    Mr. Shays. Right. You are on one level and I am on a 
different level. Can we just stay with this a second?
    Mr. Aaron. Sure.
    Mr. Shays. I just want to know if total discretionary, if 
you basically look at those numbers and say it was 664, 735, 
849, 875, those look more or less like they were in 
discretionary?
    Mr. Aaron. Yes. There are some timing issues as to what 
goes in what year but fundamentally, we are talking about 
rounding.
    Mr. Shays. And all I am doing is admitting to you that in 
2005, 2006, 2007, 2008, 2009, it looks like somehow we are 
getting spending under control but that makes some assumptions. 
We have this balloon in the 2004 budget with the $86 billion 
supplemental, for instance.
    Mr. Aaron. Yes.
    Mr. Shays. But what I am asking is when I look at those 
numbers and I do see a 9.7 percent increase in terms of 
historic in discretionary spending?
    Mr. Aaron. Yes.
    Mr. Shays. Let us take a look at chart No. 2 in the budget. 
This is all spending. When you talk about it growing, I see it 
growing at 6.2 percent and I have historically believed anytime 
it grows historically greater than 4 or 5 percent, we are 
clearly outpacing the natural growth in revenue.
    When I look at that and see a 6.2 percent over the last 3 
years from 2001 to 2002 from 2002 to 2003 and 2003 to 2004, 
what am I missing that you see because that to me is a 6.2 
percent growth in overall s pending?
    Mr. Aaron. I think we are talking about the same numbers in 
a mutually consistent way but from a different standpoint. You 
are pointing out, correctly in my view, that government 
spending has risen faster than gross domestic product, 6.2 
percent per year is faster than the actual growth in gross 
domestic product.
    Mr. Shays. Particularly in those years.
    Mr. Aaron. Yes. What I was saying is that government 
spending has risen as a share of total national income by 1.6 
percentage points. That means, just to pull a number out of the 
air and I don't think these are necessarily right, if it was 19 
percent in 2001, it is 20.6 percent in 2004 or 2005. Given the 
fact that gross domestic product has been rising in nominal 
dollars, and this is shown in nominal dollars, is entirely 
consistent with a 6.2 percent per year growth as you have shown 
in this chart.
    Mr. Shays. I would love to be in one sense in the minority 
right now because I do think there is a lot you can rail about 
this budget and the budgets that have proceeded, so there is a 
bit of envy on my part but I do want you to know that in this 
room there is no much discussions about solutions on either 
side. Maybe we have to say uncle and then maybe both sides will 
start to talk about solutions. I do realize since we have 
excluded Democrats from the solution in some ways, we can't 
then say we want to hear your solutions. I am more than willing 
to put that on the table. We basically had to pass our budgets 
on our own and in part because there is a disagreement about 
taxes.
    When I look at the information that comes to us, the 
biggest contributor to the deficit has been the slow down in 
the economy.
    Mr. Aaron. Yes, that is correct.
    Mr. Shays. In fact, if we had no tax cut, we would still 
have a deficit?
    Mr. Aaron. Yes.
    Mr. Shays. But it wouldn't be as great, is that your point?
    Mr. Aaron. My point is that a tax cut at this time is 
useful in maintaining demand and in preventing unemployment 
from having risen faster and further than it did. I think we 
need to be concerned about the fact that the tax cuts under 
administration policy would become permanent in the face of 
expenditure demands that will result in potentially 
catastrophic deficits.
    Mr. Shays. You have concluded that the President's $518 
billion deficit, you believe will be over $600 billion. Is that 
because you have made the assumption that we will still have to 
have the same additional supplemental in defense? The reason I 
question that is we are adding 7-plus percent to the defense 
budget and my logic is, that has to be going to pay for some of 
what we have been involved in. Otherwise, why the heck are we 
putting it in there?
    Mr. Aaron. My adjustment was not for the supplemental. I 
left that out entirely. My adjustment was not for the 
supplemental. It was simply on the basis that I think it is not 
wise to count the cash flow surplus in Social Security and in 
Medicare hospital insurance as legitimately used to pay for 
current government consumption.
    Mr. Shays. Surplus is something I need to have you define.
    Mr. Aaron. It is the difference between total revenues and 
total expenditures in Medicare and Social Security, Medicare 
hospital insurance.
    Mr. Scott. We pay more into Medicare than we pay out.
    Mr. Aaron. Let me put it this way. The unified budget has 
three pieces. It has a surplus in Medicare, a surplus in Social 
Security, admittedly in both cases temporary, and Medicare 
hospital insurance, and a deficit in everything else that 
government does.
    Mr. Shays. And you are saying it is disguising the deficit?
    Mr. Aaron. What I am saying is if you really want to look 
as you would in a business at sort of what current operations.
    Mr. Shays. I understand you now. You are basically saying 
we are counting Social Security reserves and Medicare reserves 
and we disguise the deficit and I think that is legit.
    Mr. Aaron. Yes. Let me say, I found your previous remarks 
very heartening. I think that the message that has gone forth 
to the Nation and that is still going forth from many quarters 
is there is a deficit, don't need to worry about it, the long 
term will take care of itself, we can't trust forecasts, they 
are wrong all the time, why worry.
    The message that I was trying to convey in my testimony 
that the Brookings project to which I referred earlier was 
trying to emphasize and I think I am hearing more and more in 
statements from journalists and I think abroad when I hear 
people interviewed, and I think it will come to be heard from 
the halls of Congress, is that we face a very serious long term 
fiscal challenge. It is a challenge to both parties, it is 
going to take spending cuts, it is going to take tax increases. 
The longer we deny it, the harder the problem will be. We 
don't, and here is where the partisan disagreements come in, we 
don't begin the process of dealing with it by making permanent 
and enacting yet additional tax decreases at this time.
    I fully understand that Congress is probably not going to 
roll back all of the tax cuts.
    Mr. Shays. On either side of the aisle.
    Mr. Aaron. On either side of the aisle, I understand that. 
I listen to the Democratic candidates for nomination and I hear 
the same thing you do but I think it is important to begin to 
understand that the Nation faces fiscal challenges for 
pensions, for health, for national defense, for everything else 
that government does that cannot be satisfied on a tax base in 
which all of the tax cuts that have been put on the books in 
2001 and 2003 are fully renewed and more tax cuts are enacted 
besides. The numbers don't add up.
    Mr. Shays. I just want to ask you this. There are some on 
my side of the aisle who think that the logical compromise is 
to restore, I am not saying this is unanimity, but to deal with 
the tax cuts that are coming due in 2005, extend those and wait 
and let the next Congress and whoever is the next President 
deal with that issue. It may be then we continue on our route 
but we will have a clearer picture.
    Mr. Aaron. The Hippocratic oath is ``primum no nosari,'' 
first, do no harm.
    Mr. Shays. Right. Let me ask you this. I will wait for my 
second round but I would be asking which tax cuts do you think 
are the most healthy and helpful. My biggest challenge is 
understanding the total elimination the inheritance tax. My 
constituents who are very wealthy, many of them, have argued to 
reduce the tax rate from 55 to 25 and increase the threshold 
from say $1 million say tenfold or twentyfold but they have 
never argued for total elimination, never, at least not mine.
    Mr. Aaron. There is a case where current law returns us to 
the situation in 2001.
    Mr. Shays. But that is pretty absurd, total elimination, 
then total continuation.
    Mr. Aaron. Absolutely.
    Mr. Shays. Mr. Scott, you have the floor.
    Mr. Scott. Thank you, Mr. Chairman.
    I agree with you that when you talk about cuts can help, it 
is not any tax cut, the right tax cuts can help the most. Any 
tax cut might help or might not but you have to make sure you 
are doing them in an intelligent way. If you are talking about 
stimulating the economy now, a backloaded, permanent tax cut is 
not the right thing to do. Is that right?
    Mr. Aaron. In my opinion, no. I am agreeing with you. No, 
it is not the right thing to do.
    Mr. Scott. We had a chart that showed that in terms of job 
creation, this administration is the worst. The chart went back 
to Harry Truman. Everybody created jobs during their 
administrations, nobody left office with fewer jobs than they 
came in with and that period of time, included the Korean War, 
the Vietnam War, the cold war, hostages in Iran, Kosovo, 
Grenada and everything else. This administration is not doing 
as well as anyone in the last 50 years.
    It seems to me that when you talk about 9/11, an argument 
in my judgment could be made that was an opportunity to 
stimulate the economy and if you did it right, in fact, you 
could have stimulated the economy. Instead, we gave cash to 
airlines, alternative minimum tax and that kind of thing. If 
you had taken the money we spent for 9/11 in hiring police 
officers, port security and construction in ports, and that 
kind of thing, you could have actually increased the national 
security and created jobs at the same time. Is that right?
    Mr. Aaron. Mr. Scott, I do not want to disagree with that 
characterization of history but personally I believe the really 
important thing is to look ahead. Right now, American workers 
are exhausting their unemployment benefits at the highest rate 
in recent decades. I think it is imperative if this is a 
jobless recovery which, so far, it has been, it may turn around 
and I pray that it does, but if it is a jobless recovery so 
far, then I think it is important as part of the program of 
combating the effects of the recession and at the same time 
putting purchasing power in the hands of the American public to 
fight the recession itself to provide extended unemployment 
benefits that are not being offered, will now expire.
    Mr. Scott. What would that do for the economy?
    Mr. Aaron. It does two things. First, and I think most 
importantly, it helps the people who are exhausting 
unemployment benefits maintain their payments on home mortgages 
and payments on automobiles and be able to continue a normal 
pattern of living. In addition, it maintains consumption at 
large and that creates additional jobs.
    Mr. Scott. In terms of bang for the buck, putting money 
into extending unemployment benefits, what kind of bang for the 
buck do you get for that compared to eliminating the tax on 
dividends?
    Mr. Aaron. The evidence on that is that eliminating the tax 
on dividends will have some modest positive effect on 
consumption. It is not zero but the bulk of those benefits 
accrue to individuals who consume a much smaller proportion of 
their income than do those who are scraping against budget 
limits because they don't have a job.
    Mr. Scott. So in terms of bang for the buck and stimulating 
the economy, we ought to do unemployment compensation 
extensions before we think about dividend cuts if our goal is 
to stimulate the economy?
    Mr. Aaron. I would certainly do the unemployment extension. 
The issue of dividend cuts I think raises much more complicated 
issues of tax policy. The way in which we tax dividends and 
corporate source income is a mess. Some income is taxed twice, 
some is not taxed at all and some is taxed once. The objective, 
in my view, should be to tax all corporate source income once, 
not twice, but not zero times either. What I think is needed is 
a different form of reform of the taxation of corporate source 
income than the one that was enacted but not no action at all.
    Mr. Scott. One of the problems you mentioned, me worry kind 
of thing, I view it as the Alfred E. Newman approach to the 
budget, I do not get the sense that there is an alarm. I 
mentioned the fact that the swing in the deficit we see is 
equivalent to the entire take on the individual income tax and 
it is an easygoing kind of response to that. When you look at 
521 deficit and getting worse and you have the Social Security 
coming around the corner, it is a kind of lackadaisical 
response. Then you have people wanting to cut spending a little 
bit. You saw the last chart where the discretionary spending 
was $800 billion to $900 billion. Half of that is defense. If 
you just talk about non-defense discretionary spending, you are 
talking about $400 billion to $500 billion. In other words, if 
the Appropriations Committee did not meet after they funded 
defense, did not appropriate a dime after that, you still would 
not be in balance.
    Mr. Aaron. What you are characterizing is the size of the 
deficit. What disturbs me most right is what I think is a 
mischaracterization of views on the deficit. I was on a radio 
program yesterday with another economist who said, opposing the 
deficit is a job for the minority party. Whoever is out of 
office, they complain about the deficit because it is a problem 
of those who are in office.
    I thought about that and I think that is wrong. Back in the 
1980s, as I recall, it was both Republicans and Democrats that 
were badly worried about the deficit. They thrashed around for 
a while trying to find budget procedures which did not work; 
they talked about various cuts; they did not really belly up to 
the bar and take the necessary actions to deal with it, 
although there were some tax increases and domestic 
discretionary spending was reduced significantly during 
President Reagan's term in office. We had as bad a problem at 
the end of the decade but both parties agreed that there as a 
problem, the ins and the outs.
    I believe that consensus persisted throughout the 1990s and 
ultimately it bore fruit, a combination of courageous 
bipartisan policy and good luck gave us budget surpluses and 
now, in my view, a combination of very bad luck and unwise 
policy has given us large and indefinitely projected deficits. 
I would like to see a return to this bipartisan consensus that 
deficits are a problem and that we need to deal with them.
    Mr. Scott. I would just take issue with your view of 
history and we can debate it. Let me just give you another 
version. When President Clinton came in for 2 years there was 
no Republican vote on the budget. All that was heavy lifting 
was done without a Republican vote. When the Republicans came 
in, the first thing they did was pass a trillion dollar tax cut 
that President Clinton vetoed, they closed down the Government 
because he wouldn't sign the bills, but because he kept vetoing 
irresponsible budgets from the majority, that kept the fiscal 
responsibility and that allowed that green line up to 236. It 
is only because President Clinton kept vetoing their 
irresponsible tax cuts. When President Bush came in, they 
passed the same thing, it wasn't anything new and you see what 
happened.
    Let me ask, do you know how much the Nations saves, if you 
add up all our savings, what it amounts to?
    Mr. Aaron. The national savings rate is in the vicinity of 
five to 6 percent of gross domestic product of which only a 
very small part is done by households, most is done by 
business.
    Mr. Scott. What number is that?
    Mr. Aaron. You mean in billions of dollars? It would be 
$700 billion to $800 billion. I would like to correct that 
number for the record.
    Mr. Scott. We are trying to borrow $500 billion this year. 
So if everybody put every dime of their savings into government 
notes, we wouldn't make it. The fact is much of the Government 
borrowing is borrowed from foreign governments?
    Mr. Aaron. That is exactly right. We are incurring 
additional debt by importing more than we are exporting, that 
we owe abroad, and we are diverting private saving that could 
go into new factories to increase worker productivity into 
paying for current Government services.
    Mr. Scott. China buys a lot of our debt. My question is, 
does that create a national security problem?
    Mr. Aaron. I think the only national security problem that 
the Nation faces is if the amount of debt outstanding becomes 
so large--there are two ways. If the amount of national debt 
outstanding becomes very large so that the interest burden 
begins to represent such a large drain on current spending that 
we cannot responsibly afford other things the National needs, 
national defense, pensions, health and the like without highly 
distorting tax rates. The other danger is if the share of 
American assets held by foreigners, not just government debt 
but private securities as well becomes so large that at some 
point a change in foreign sentiment about holding U.S. debts 
could create a very serious crisis in financial markets in 
which that debt is traded. The larger our debt held abroad, the 
greater that risk becomes.
    Mr. Scott. Mr. Chairman, if I could say the problem there 
is that if we are trying to negotiate something with China and 
they hold billions of dollar of our paper, part of the 
negotiation could be to our negotiators, if you don't accept 
our last offer, we are going to start selling our paper, that 
could affect the negotiations. When we continued the war in 
Iraq at $87 billion, we had to borrow $87 billion to continue 
the war and in 2009, interest on the national debt, if that 
green had continued as we projected, would have been zero, will 
be according to CBO approximately $300 billion. Three hundred 
billion dollars at $30,000 apiece could have hired 10 million 
people working--talk about stimulating the economy. For $300 
billion, you can hire 10 million people, only 9 million are 
unemployed. Borrowing has had a devastating effect on our 
ability to meet our needs and the amount of debt we are piling 
up and the rate we are piling it up and the direction in which 
this red line goes ought to result a different response than 
kind of business as usual.
    Mr. Shays. I am finding this very interesting. One of the 
things I do want to put on the record, because I was part of 
the Budget Committee during the 1990s, is I always felt that 
the President basically wanted to spend more, basically the 
equivalent of what we wanted in a tax reduction, so I always 
took the view that it really was pretty much a wash. We wanted 
a tax cut and he wanted to spend more and it was a difference 
in philosophy.
    Some of the spending I actually liked but I do want to put 
on the record, Mr. Aaron, that in 1997 we had a significant tax 
cut but we also slowed the growth of spending to 1 percent for 
1 year. We then worked on a slower base. My view was that the 
market looked at this and said, they had a tax cut that was 
significant, a long list, many, many pages, the Taxpayer Relief 
Act of 1997, child tax credit, education tax incentives, the 
savings and investment tax, the alternative tax provision, the 
estate gift and generations gifting tax provisions, extension 
of certain expiring tax provisions, miscellaneous provisions, 
the capital gains, the welfare to work tax, it goes on, but it 
wasn't an insignificant tax cut. My recollection is that when 
we wanted to get to of town, we always had to spend a little 
more than we wanted.
    What we did do was we had a tax cut and we slowed the 
growth in spending. I thought the market responded to that and 
said, these guys are serious. What I have heard you and others 
say is you almost feel like we are oblivious to this and you 
need to see a message that we are aware of the future 
implications.
    One of the things we didn't want to be was like President 
Hoover, cut spending, raise taxes. We weren't going to fall 
into what we think was the traditional Republican trap and that 
may have scared some folks. It was obviously made easier by the 
fact that we had some very real spending on national security. 
Did that tax cut not exist or am I inventing it or did it?
    Mr. Aaron. Let me be clear on the history as I was trying 
to explain it. I think the United States for about a decade and 
a half, allowing for politics and for pulling and hauling and 
perhaps some irresponsible intents on both sides of the aisle, 
was blessed by unusually good overall economic policy. I would 
date the beginning the enactment of the Tax Reform Act of 1986 
which was put forward under President Reagan, supported by him, 
and passed by a Democratic Congress.
    Mr. Shays. That was pretty much a tax cut though.
    Mr. Aaron. No, it was basically revenue neutral. That was 
the goal, to make the bill revenue neutral, so it was not a tax 
cut.
    Mr. Shays. I know that was the goal but was it actually a 
tax cut?
    Mr. Aaron. It ended up reducing taxes somewhat as I recall 
on businesses--pardon me, erased slightly on businesses and 
reduced them slightly on individuals but I believe in the end 
it was close to a wash.
    Mr. Scott. Mr. Chairman, didn't it do something about 
Social Security at that time too?
    Mr. Aaron. In 1983, there was major legislation on Social 
Security following the Greenspan Commission which made 
recommendations for change. We could date it from that if you 
will as well, but then in 1990, President Bush and a Democratic 
Congress passed the first of three important deficit reduction 
measures.
    Mr. Shays. Let me make a point there. I regret voting for 
that tax increase because I remember I voted for the luxury tax 
and truly your point, there are some taxes that bring in less 
revenue when you increase them. They just stop spending and we 
put the boat industry out of business.
    Mr. Aaron. I think that was in historical view and perhaps 
it should have been in prospect, a mistake but it was a small 
element of what was overall a beneficial package for the 
economy. Then in 1993, President Clinton with a Democratic 
Congress, and as Mr. Scott says, with no Republican support, 
enacted a second deficit reduction package. Then in 1997 
through whatever process of pulling and trading actually 
occurred, a Republican Congress enacted a major deficit 
reduction package that was signed by President Clinton with 
some tax cuts but with significant spending restriction and it 
contributed to deficit reduction.
    What I am saying is that over that period, from 1986-97, 
not necessarily in an eager, attractive way, it is like making 
salami and you don't want to see it but the product that came 
out of the end of that sausage maker for that 11-year period 
was a set of important economic pluses for the United States. 
What I am mourning is the loss of the bipartisan agreement that 
moving on the deficit was important. Until that is restored, 
and it is going to take presidential leadership that is not in 
evidence at the present time, until that is restored, I think 
the lack of concern that Mr. Scott has deplored, that you have 
clearly I believe indicated you are concerned about the deficit 
and the need for action on it, until that bipartisan consensus 
is restored, we have a very serious problem.
    Mr. Shays. Let me just tell you though, I had finished what 
had happened from my view from 1997-2000 and that was we had 
these incredible surpluses, we started to actually have 
balanced budgets without counting Social Security reserves, and 
we started to go on somewhat of a spending binge.
    Mr. Aaron. That was I believe in part because the budget 
procedures were allowed to expire and were not extended. For 
that reason, I think extension of a balanced set of procedural 
rules to help stiffen the back of those who are interested in 
fiscal responsibility should be a high order of congressional 
business.
    Mr. Shays. That gets me to kind of my last point. One of 
the views of some members, and I am one of them, is that before 
we increase the debt ceiling, that the only way we agree to it 
is if we see some of those pay go kinds of provisions that we 
used to have. Would that be something you would want to 
encourage?
    Mr. Aaron. Very much so. I think it is very important how 
they are designed and as I said in my testimony, I do not 
believe the specific proposals put forward by the 
administration are worthy of support but a sensible set of 
rules to restrict both spending and tax cutting of all kinds in 
an equitable and balanced way would be of great assistance in 
my opinion.
    Mr. Shays. This is to be continued. I appreciate you being 
here. You may have liked more people here but frankly, I am 
kind of happy it was just the few of us.
    With that, I will adjourn this hearing. Thank you so much.
    Mr. Aaron. Thank you.
    [Whereupon, at 5:34 p.m., the committee was adjourned, to 
reconvene at the call of the Chair.]

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