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



                                                        S. Hrg. 108-750
 
                    ECONOMIC REPORT OF THE PRESIDENT

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



                                HEARING

                               BEFORE THE

                        JOINT ECONOMIC COMMITTEE

                     CONGRESS OF THE UNITED STATES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                           FEBRUARY 26, 2003

                               __________

          Printed for the use of the Joint Economic Committee












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                        JOINT ECONOMIC COMMITTEE


    [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]


SENATE                               HOUSE OF REPRESENTATIVES
Robert F. Bennett, Utah, Chairman    Jim Saxton, New Jersey, Vice 
Sam Brownback, Kansas                    Chairman
Jeff Sessions, Alabama               Paul Ryan, Wisconsin
John Sununu, New Hampshire           Jennifer Dunn, Washington
Lamar Alexander, Tennessee           Phil English, Pennsylvania
Susan Collins, Maine                 Adam H. Putnam, Florida
Jack Reed, Rhode Island              Ron Paul, Texas
Edward M. Kennedy, Massachusetts     Pete Stark, California
Paul S. Sarbanes, Maryland           Carolyn B. Maloney, New York
Jeff Bingaman, New Mexico            Melvin L. Watt, North Carolina
                                     Baron P. Hill, Indiana



        Donald B. Marron, Executive Director and Chief Economist
                Wendell Primus, Minority Staff Director




















                            C O N T E N T S

                              ----------                              


                      Opening Statement of Members

Senator Robert F. Bennett, U.S. Senator from Utah, Chairman......     1
Representative Pete Stark, U.S. Representative from California, 
  Ranking 
  Minority Member................................................     3

                               Witnesses

Hubbard, R. Glenn, Chairman, President's Council of Economic 
  Advisers, Washington, DC; accompanied by Randall Krosner.......     5
Aaron, Henry J., Bruce and Virginia MacLaury Senior Fellow, The 
  Brookings Institution, Washington, DC..........................    16
Mitchell, Daniel, Ph.D., McKenna Senior Fellow in Political 
  Economy, The Heritage Foundation, Washington, DC...............    18
Engen, Eric M., Resident Scholar, American Enterprise Institute, 
  Washington, DC.................................................    20

                       Submissions for the Record

Prepared statement of Senator Robert F. Bennett, U.S. Senator 
  from Utah, Chairman............................................    33
Prepared statement of Representative Pete Stark, Representative 
  from 
  California, Ranking Minority Member............................    34
Prepared statement of R. Glenn Hubbard, Chairman, President's 
  Council of Economic Advisers, Washington, DC...................    35
Prepared statement of Henry J. Aaron, Bruce and Virginia MacLaury 
  Senior Fellow, The Brookings Institution, Washington, DC.......    49
Prepared statement of Daniel Mitchell, Ph.D., McKenna Senior 
  Fellow in Political Economy, The Heritage Foundation, 
  Washington, DC.................................................    60
Prepared statement of Eric M. Engen, Resident Scholar, American 
  Enterprise Institute, Washington, DC...........................    68
Stark, Representative Pete:
    Notes from testimony of Honorable Alan Greenspan at a Senate 
      Banking hearing, Feb. 12, 2003.............................    72
Prepared statement of Senator Edward M. Kennedy, U.S. Senator 
  from 
  Massachusetts..................................................    72


















                    ECONOMIC REPORT OF THE PRESIDENT

                              ----------                              


                      WEDNESDAY, FEBRUARY 26, 2003

                     Congress of the United States,
                                  Joint Economic Committee,
                                                    Washington, DC.
    The Committee met at 3:35 p.m. in room SD-628 of the 
Dirksen Senate Office Building, the Honorable Robert F. 
Bennett, 
Chairman of the Committee, presiding.
    Members Present: Senator Bennett, Representative Stark and 
Senator Reed.
    Staff Present: Donald Marron, Jeff Wrase, Dianne Preece, 
Wesley Yeo, Gary Blank, Colleen J. Healy, Wendell Primus, Chad 
Stone, Frank Sammartino, Diane Rogers, Matt Salomon, Sean 
McCluskie, Nan Gibson and Daphne Clones-Federing.

        OPENING STATEMENT OF SENATOR ROBERT F. BENNETT, 
                U.S. SENATOR FROM UTAH, CHAIRMAN

    Chairman Bennett. The Committee will come to order. I 
apologize for those who have had their previous schedules upset 
by 
virtue of the delay. We had Secretary Rumsfeld briefing the 
Senate, starting at the hour we would normally have convened, 
and I understand that immediately upon leaving the Senate, he 
will then give a similar briefing to the House, which may mean 
we will have fewer House Members attend this Joint Committee 
than is otherwise the case.
    Nonetheless, I think it important that we move ahead, and I 

appreciate Dr. Kroszner and Chairman Hubbard, your willingness 
to appear. We have a full panel today, and I think we will get 
further insight into the Economic Report of the President.
    The Employment Act of 1946, which created the Joint 
Economic Committee, also created the Council of Economic 
Advisers, and anticipated that the two organizations would work 
very closely together. The one explicitly-mandated task of this 
Committee is to review the one explicitly-mandated task of the 
Council of Economic Advisers.
    That is, the CEA is required to issue a Report each year 
and officially present it to the Congress, and the Joint 
Economic Committee must review that Report and officially 
comment on it. So this is that official presentation by the CEA 
to the Congress, and our comment will come both in this hearing 
and in a formal document that we'll produce later.
    We welcome members of the Council of Economic Advisers 
today, Dr. Hubbard and Dr. Kroszner. We appreciate having 
worked with both of you in the past, and salute you for your 
service to the President and to the country.
    We're anxious to hear your thoughts on the current state of 
the economy, the President's various proposals, and other 
policy proposals that may be included in your Report.
    Now, what stands out in the Report, from my point of view, 
is its sheer breadth. The Administration lays out the current 
state of tax policy, regulatory policy, and the economy, along 
with corporate governance issues and international 
developments, and it does so in some detail. I don't know of a 
similar Report from a Council of Economic Advisers that has 
been quite so sweeping.
    I don't say that in a derogatory sense, but in a 
congratulatory sense. The Administration has taken on an 
amazing array of reforms since the President's inauguration, 
and as I say, I think that is to be congratulated.
    If there is one word that could be used to describe the 
Administration's approach, it would be bold or far-reaching. 
Bite-sized is not an adjective that comes to mind in dealing 
with this.
    Now, the proposals have drawn the ire of a number of 
constituencies, and not only among those who are normally 
thought of as the President's political opponents. The 
Administration has resisted efforts to lard its recent growth 
package with dubious spending programs or temporary tax fixes 
that would produce excitement in one short-term area or another 
or one short-term constituency or another, and, in my view, it 
should be commended on that.
    Nonetheless, the breadth of the Report means that you will 
be getting a number of questions here today, and some of them 
not necessarily friendly, and I think that is not only to be 
expected, but probably is the right way to go at this.
    I feel particularly that the proposed economic reforms 
outside of the Tax Code are bold and far-reaching. The 
Administration's push for the Millennium Challenge Account may 
be a turning point in the efficacy of foreign aid.
    I have had exchanges with Secretary Powell on this point 
and said I want to fund movement and not monuments. Too much of 
our foreign aid has produced a physical monument--``Look what 
the Americans paid for''--but no movement in the economy of the 
country in which it was placed.
    Another interesting policy initiative, bringing greater 
emphasis on rigorous cost-benefit analysis and market forces in 
the regulatory arena, will ultimately result in policy outcomes 
that will help us to meet our common goals of improved 
workplace safety, a cleaner environment, and safe food and 
drugs and lower costs to the Government and the taxpayers.
    And, of course, another policy innovation that we will 
expect to hear about is the introduction of personal 
reemployment accounts, a new approach to the question of those 
who are out of work. They will make it easier, we trust, for 
the unemployed to get training and get back into the workforce 
as soon as possible.
    But, of course, the thing that is on everyone's mind is the 
macroeconomic situation. That is what everybody is talking 
about. I heard one of my colleagues on the Senate floor last 
week describe this as the worst economy in 50 years. I don't 
subscribe to that notion, and I don't know of any numbers that 
would sustain that view.
    But this particular Senator said it, and, presumably, this 
particular Senator's constituents are feeling some economic 
problems, so we would like to talk about the macroeconomic 
view, as well, as we go along.
    I would just note that in a macro way, this economy has 
shown enormous resilience. In the last 3 years, we have 
sustained four major economic shocks.
    The first was the collapse of the high-tech bubble, and 
with it, the entry into a bear market, which has gone on now 
for over 2-and-a-half, going on 3 years. That is something that 
would normally slow down the economy all by itself.
    Then the 9/11 terrorist attacks, with the obvious impact on 
the economy there, and the amount that had to be spent for 
rebuilding and the amount that has had to go for creating 
homeland security and conducting the war on terrorism.
    The third crisis of confidence started with Enron, but hit 
more seriously home with Worldcom, as investors decided they 
suddenly could not trust information they were getting out of 
Wall Street. That was a confidence crisis that would 
significantly damage any economy.
    And then, of course, there is the military showdown in the 
Middle East, which puts uncertainty into the mix. Investors 
always flee uncertainty. Unfortunately that uncertainty is 
heightened by the instability in Venezuela, giving us higher 
oil prices.
    So these four things, the collapse of the high-tech boom 
and the overpriced stock market, the 9/11 terrorist attacks, 
the crisis in confidence, and then geopolitical considerations 
that are beyond our control, hitting us virtually at the same 
time, and still the economy grew at 2.7 percent in 2002, and 
the forecasters say it will grow at a more robust rate in 2003, 
demonstrate the tremendous resilience of the American economy, 
particularly when compared to the rest of the world, where 
those who have not had those kinds of crises have growth 
numbers that are more anemic than our own, particularly those 
two countries in Europe, who shall remain nameless, who are 
constantly lecturing us on how to conduct our own affairs.
    With that, I will turn to Mr. Stark, the Ranking Member, 
for whatever opening statement he might have.
    [The prepared statement of Senator Robert F. Bennett 
appears in the Submissions for the Record on page 33.]

        OPENING STATEMENT OF REPRESENTATIVE PETE STARK, 
         U.S. REPRESENTATIVE FROM CALIFORNIA, RANKING 
                        MINORITY MEMBER

    Representative Stark. Thank you, Chairman Bennett. I 
welcome Dr. Hubbard back again, and Dr. Kroszner, welcome to 
the Committee. The numbers that we have been hearing show that 
the President's latest economic plan doesn't do much to inspire 
our confidence.
    Consumer confidence has slumped to the lowest level in a 
decade. People seem to be worried at home about weak job 
markets, falling stock values, $2-plus-a-gallon gas in 
California, the threat of terrorism, and the war with Iraq.
    Even more astounding is that the Administration's fiscal 
policy has caused this country to go from a 10-year surplus of 
almost $6 trillion, to a projected 10-year deficit of $2 
trillion. By my numbers, that's almost putting us upside down 
by $8 trillion in 2 years. What a job.
    Well, the Administration would like to blame this budget on 
factors it can't control, such as the sagging economy, entropy, 
the war on terrorism, and faith-based economics. The fact is 
that the recent Republican tax cut contributed a third of that 
deficit in 2003 and 2004.
    Making these tax cuts permanent would just make a bad 
situation worse. Moreover, President Bush's recent budget ranks 
right up there with ``Harry Potter'' on that left side of The 
New York Times Bestseller List, rather than the right side.
    The budget costs don't take into account the cost of the 
war. We heard this morning that although your predecessor got 
fired for saying it would be $200 billion, somebody said this 
morning, $95 billion, and if they're still employed at the end 
of the day, I'll take that as the Administration's final word.
    It is clear that the Administration's tax cut proposals are 
irresponsible, inappropriate, particularly in the context of 
future fiscal pressures on Social Security and Medicare, and 
we'll need further extension of unemployment to help those 
currently struggling in this economy.
    When President Bush took office, he proposed an ambitious 
plan to reform Social Security in order to address the 
demographic challenge. This year's Economic Report of the 
President doesn't mention the challenge itself, much less the 
Administration's plans for addressing that. I presume that, 
Chairman Hubbard, you'll explain that to us today.
    But with the retirement of the Baby Boom generation just a 
few years away, we should be taking steps to make sure that we 
have the budget resources to honor our commitment to Social 
Security and Medicare.
    Once interest costs are taken into account, the President's 
new tax cuts will add almost $2 trillion to the national debt 
over the next 10 years. Large increases in public debt are, 
guess what? They're bad for interest rates; they're bad for 
investment; and they are bad for long-term growth.
    So it's no wonder that consumers have a sinking feeling 
about the economy. I look forward, gentlemen, to your testimony 
today, to address these concerns, not only to us, but to the 
millions of Americans whose unemployment insurance just 
expired, and they're just going to get job training and a 
promise, and many of the other people who are worried about 
their retirement plans, educating their children, their 
healthcare, all those things that you have managed to dry up by 
creating this deficit. Thank you very much. Thank you, Mr. 
Chairman.
    [The prepared statement of Representative Pete Stark 
appears in the Submissions for the Record on page 34.]
    Chairman Bennett. Senator Reed.
    Senator Reed. Mr. Chairman, I don't have a prepared 
statement. I think it's probably in order to go to the 
witnesses. Thank you.
    Chairman Bennett. Thank you very much.
    Chairman Hubbard, you may proceed.

          OPENING STATEMENT OF THE HONORABLE R. GLENN 
           HUBBARD, CHAIRMAN, PRESIDENT'S COUNCIL OF 
    ECONOMIC ADVISERS, WASHINGTON, DC; ACCOMPANIED BY RANDY 
                            KROSZNER

    Chairman Hubbard. Thank you very much, Mr. Chairman and 
Ranking Member Stark and Senator Reed. I'll be relatively brief 
in remarks. We have prepared testimony.
    First, I'd like to thank you, Mr. Chairman, for the 
continuing partnership between the Joint Economic Committee 
here in the Congress and the Council in the White House. It's 
not simply our statutory requirement; it's our pleasure and a 
learning experience, and we're grateful.
    You noted that the Report is somewhat sweeping, which 
reflects in large part, the many demands from the President's 
agenda. In my remarks, what I'd like to do is, yes, talk about 
the Economic Report, but in the context of the President's 
here-and-now agenda.
    Following your request, Mr. Chairman, I'd like to begin in 
thinking about the current economic outlook, but look through 
two lenses which I think are useful in thinking about the 
President's economic policies.
    The first lens is risk to the current recovery. The 
dominant role in the most recent recession and playing a factor 
in the nascent recovery is the behavior of business investment. 
Note the sharp decline in investment and equity prices that you 
referred to, Mr. Chairman, in your opening statements.
    This prominent role for investment is not typical of a 
postwar recovery or recession. We believe in the 
Administrations that in the short term, while forecasts in the 
private sector are relatively optimistic for the balance of 
this year, there are important downside risks and those risks 
relate most prominently to investment.
    A recent study from the Philadelphia Federal Reserve Bank 
noted that a key concern in business people's minds, in fact, 
concern greater in that survey than geopolitical risk, is just 
whether the economy's recovery itself is viable.
    But there is a second lens in thinking about the economy, 
and I can be brief here, Mr. Chairman, because you already gave 
the story very well, and that is the flexibility and dynamism 
of the American economy. I often tell audiences, if I sat with 
them 2 years ago and told them that I was clairvoyant and could 
tell them all the events that you spoke of, Mr. Chairman, I 
think we all would have been rushing for the exits. Indeed, the 
economy did much better.
    The secrets there are much the secrets that explain the 
productivity growth performance of the United States. They are 
flexibility in American institutions, which was the theme of 
last year's Economic Report of the President, and the dynamism 
of the American economy, which is the theme of this year's 
Economic Report of the President.
    In a nutshell, the Economic Report of the President tries 
to make the point that public policy, like our economy, can't 
parse the world neatly into short-term and long-term or group 
individuals or classes in our economy on static notions.
    These two lenses, the short-term risks and the long-term 
flexibility, really frame the discussion of public policy. The 
first discussion in the Economic Report is on corporate 
governance, and here, of course, corporate governance isn't 
simply an academic issue.
    We know that it has been an area that has weighed on the 
economy in the short term, and it is also an important part of 
our economy's long-term success, the depth of American 
financial markets remains the envy of the world.
    The Report talks about the ways in which the President's 
original ten-point plan for corporate governance and the 
ultimate Sarbanes-Oxley legislation were based on sound 
economics and on the notion that corporate governance is 
dynamic, reflecting changes in the market for corporate 
control, internal features of boards and so on, and laws and 
regulations.
    You mentioned regulation, Mr. Chairman, in your opening 
remarks. We have a chapter which I think is an interesting one 
on the development of regulation in a dynamic economy. There 
are often unintended consequences of regulation when regulation 
does not anticipate innovation and response in the private 
sector.
    The Report goes through distinctions between good 
regulation, trying to fix market failures in our economy, and 
bad regulation that simply represents rent-seeking from special 
interest groups.
    The CEA and OMB have been involved in the preparation of 
new benefit-cost guidelines, which we hope will impose more 
economic discipline on the regulatory process, and a good case 
study, which is highlighted in the Report is the President's 
Clear Skies Initiative, in which both sound science and sound 
economics have helped shape an important topic in environmental 
policy.
    Analyzing tax policy is also one of the chapters in the 
Report. Here, I might digress a moment. Mr. Stark, as to your 
question about Social Security, we had a major chapter on 
Social Security last year, and I know it is an awful academic 
habit to publish the same thing twice, and so we didn't want to 
do it again, but there is a great discussion last year and I'd 
be happy to talk to you about it.
    The tax policy chapter centers on two things: One is the 
importance of pro-growth policy, but also the importance of 
analytical issues that get at this issue of dynamism.
    One issue comes up in the context of the President's policy 
to remove the double tax on corporate income. The question is, 
who bears the burden of that tax? And there is, of course, much 
discussion about who gets dividends and who gets capital gains.
    Economists, I think, would argue that that is not the right 
way to think of it. Who bears the burden of a tax has little to 
do with who writes a check to the IRS. And who bears the burden 
of the double tax are all of us, whether we get a dividend, a 
capital gain or not, in terms of our wages.
    When you double-tax something, you get less of it. The 
``it'' here is capital, which influences productivity, our 
economic growth, and all of our wages in the future.
    The second issue, analytical issue raised in the chapter is 
the notion of mobility of individuals through income groups and 
tax rates. It's common in the analysis of the distribution of 
tax policy to group people in income classes or tax rate 
brackets where they now are.
    This chart takes a family, just to fix an idea, a two-wage 
earner family with two children, starting at $65,000 in income 
for both workers put together, and follows them through their 
lifetime, if they had a typical wage earnings profile from 
microdata in our economy.
    [Chart appears in the Submissions for the Record on page 
45.]
    You will notice that that couple with children, as their 
children age, as their income grows, as they retire, face very 
different marginal tax rates.
    And as the Report notes, there is a significant amount of 
upward and downward mobility in the income distribution. And so 
in terms of thinking about the distribution of cuts in marginal 
tax rates or the acceleration of marginal tax rates, those 
points are important.
    The Report also has a chapter on designing dynamic labor 
market policies and here again we know from the pretax wage 
data, there is enormous mobility. And one of the President's 
proposals, as noted, was the development of personal 
reemployment accounts.
    These are data on the probability or fraction of workers 
finding work by number of weeks unemployed. The data make a 
simple and a well-known point that periods of expiration of 
unemployment insurance benefits are very closely correlated 
with the finding of a job.
    And the point of the President's personal reemployment 
accounts is to make sure people have an incentive to obtain 
work and that that work is what leads to upward mobility in 
wages.
    The final chapter, as you noted in your opening statement, 
Mr. Chairman, is, I think, in some sense the most exciting, 
even though it's not in the hearing now of the current policy 
debate over the growth package. And that's promoting global 
growth.
    The President is not simply interested in the promotion of 
economic growth in the United States; we're interested in the 
promotion of economic growth around the world. That is, in 
part, of course, because of the concern we all have as 
Americans for our fellow citizens around the world, but, 
frankly, it is also in the economic interest of the United 
States to have more rapid growth around the world.
    Empirical evidence from economic studies suggests that all 
countries can experience faster growth with a better economic 
environment. This chart, taken from the Economic Report of the 
President, plots real income, the log of real income per head 
on an index of the rule of law, making the point that the 
property rights features of an economy, the enforcement of 
contracts in courts, things that we sometimes take for granted 
as the matter of the rule of law, are very closely correlated 
with economic growth. These institutional features are every 
bit as important as endowments a country has as to how quickly 
it grows. There is, of course, the President's agenda for the 
Millennium Challenge initiative that you mentioned, the 
Millennium Challenge account, but also our trade promotion 
initiatives and our attempts to reform the international 
financial institutions.
    [Chart appears in the Submissions for the Record on page 
47.]
    To conclude, Mr. Chairman, in the short term I do believe 
we have a recovery underway. I think there are significant 
risks to the downside that warrant prompt consideration and 
passage of an economic growth package. But for the long term, 
what we must not lose sight of are the underlying flexibility 
and dynamism of the U.S. economy. That is not only our 
distinguishing characteristic among industrial economies. It is 
one to be celebrated.
    Thank you, Mr. Chairman. If you have anything, I have 
nothing further to add at the moment.
    [The prepared statement of Chairman R. Glenn Hubbard 
appears in the Submissions for the Record on page 35.]
    Chairman Bennett. Thank you very much. Could you put the 
first chart back up and explain it to me?
    Chairman Hubbard. The chart plots fixed investment.
    [Chart appears in the Submissions for the Record on page 
44.]
    Chairman Bennett. I understand what the red line is and 
what the black line is, but what is the cause and effect which 
you're trying to show? Does the black line cause the red line 
or does the red line cause the black line?
    Chairman Hubbard. We have a common feature you referred to 
in your opening remarks causing both. We were excessively 
optimistic perhaps about the economy's expected future 
profitability. The realization of that led to a decline in 
equity prices and destruction of wealth to which you referred 
and also to a sharp decline in business investment. That makes 
two points. One that a client in business investment is very 
central, but also these wealth effects are very large and will 
take time to work through. This again is not a typical cycle 
and the design for policy is somewhat more complicated than a 
typical cycle.
    Chairman Bennett. Again the thing I'm trying to understand, 
the red line is the S&P 500.
    Chairman Hubbard. Correct.
    Chairman Bennett. You see the periods of exuberance, 
irrational exuberance.
    Chairman Hubbard. We would expect, of course, from 
economics that equity value changes would be positively 
correlated with changes in investment.
    Chairman Bennett. But the question is, when the bubble 
burst?
    Chairman Hubbard. Then we have a sharp decline in equity 
values and a sharp decline in investment.
    Chairman Bennett. It's the sharp decline in equity values 
that caused the sharp decline in business investment?
    Chairman Hubbard. They are both manifestations of the same 
thing, Senator.
    Chairman Bennett. One does not cause the other, but they 
just track together.
    Chairman Hubbard. The realization that what we thought 
about future profits was likely too optimistic, both depress 
stock prices and tells business people we now have perhaps too 
much capital so we need to go through a period of time with 
lower investment than we had in the past.
    Chairman Bennett. So the black line going up is not meant 
to be predictive that the red line will follow.
    Chairman Hubbard. It may be so, but no, Senator. This is 
just the beginning of a recovery for equipment and software 
investment. The recovery of the red line of course depends on 
expectations about future profits.
    Chairman Bennett. Sure. Chairman Greenspan has said 
repeatedly that the red line's not going to come up until the 
situation in Iraq gets resolved one way or the other. He has 
made it clear that he feels the geopolitical uncertainties in 
Iraq and Venezuela are weighing on the economy, and he repeated 
that again this morning before the Banking Committee. Iraq and 
Venezuela are major depressants.
    Chairman Hubbard. If I may, Mr. Chairman, I think it is 
certainly the fact that geopolitical risks figure prominently 
on business people's minds. I can tell you both anecdotally 
from talking to business people around the country and based on 
surveys like the Philadelphia Fed Survey to which I referred in 
my remarks. Business people cite many factors, sometimes ahead 
of the factors related to geopolitical risk, and those factors 
center on the viability of the recovery itself.
    Chairman Bennett. We might as well get right to it because 
the manner in which the press reports Chairman Greenspan's 
statements is similar to the responses to the Oracle at Delphi, 
and Mr. Greenspan sometimes is just as opaque as the Oracle at 
Delphi. I think people need to try to understand and think it 
through. Republicans and the Administration are taking great 
comfort out of Chairman Greenspan's obvious endorsement of the 
double taxation on a dividends proposal. He says that will make 
the economy more efficient and produce sustained, long-term 
growth in a manner that may get us back to the numbers that Mr. 
Stark referred to in terms of tax revenues coming in as the 
economy recovers.
    Democrats who oppose the President's program take comfort 
in Mr. Greenspan's comment about the fact that the recovery is 
robust enough that it does not need an immediate stimulus. Have 
I summarized it correctly in your view as to how the two have 
been playing off his comments?
    Chairman Hubbard. I think that's correct, Mr. Chairman.
    Chairman Bennett. Let's go to the second question which is 
whether or not the President's proposal would help the economy 
in the near term. Accepting Chairman Greenspan's statement that 
his proposal will help the economy significantly in the long 
term, let's go to the question that has been raised by some of 
my Democratic friends. He says the recovery is robust enough 
that it does not need any help in the near term.
    Now making that argument flies in the teeth of those who 
say this is the worst economy in 50 years, but let's set aside 
that inconsistency and go to the fundamental question.
    How do you answer the criticism that says that the 
President's program is not contributory to a near term recovery 
and that the recovery is, in fact, robust enough that it does 
not need any help at this particular point?
    Chairman Hubbard. You actually raised two questions there, 
Mr. Chairman. On the effects of the President's plan in the 
short run, we've estimated as the council that if you take the 
entire package as a whole, quite substantial effects in 2003 
and 2004 close to a percentage point of extra GDP growth in 
2003, for example, that reflects contributions for accelerating 
the marginal rates and the child credit expending for more 
small businesses as well as the contribution from changing the 
double tax on corporate income. One way to see that is the very 
large cost of capital reductions which is made possible by a 
tax on corporate income. There's a powerful investment 
incentive and the showing up of consumer spending through the 
acceleration in rate cuts. There's a question of, even if it's 
effective, do you need it here. Of course it depends on what 
your counter factual is.
    Think about the downside risk. The downside risk that I 
referred to has to do with the timing of the investment 
recovery. In our estimate, if you looked at conventional 
forecasts of the timing of the investment recovery, and assumed 
a delay of a few quarters, that is, just take the pattern, but 
shift it a little because of the uncertainty in the environment 
and even had very modest increases in precautionary saving by 
consumers in response to uncertainty. That could shave close to 
a full percentage point from GDP growth in the near term, very 
closely call as with the amount of the deposit effect from what 
the President was trying to do.
    We view this in much the same way one views insurance. It's 
very good for downside risks. If you look at the balance of 
risks and whether or not you should act, we believe the balance 
of risks here is very favorable. The action is associated with 
very good long term tax policy at a time when the economy is 
also very weak and inflationary pressures are very, very low.
    Chairman Bennett. Chairman Greenspan has made it clear that 
he believes the tax cuts should be made permanent; indeed he 
has said that the market has already assumed that they will be 
made permanent, and if we allow them to expire, there would be 
a major hit in the market as they change that assumption. So 
the question from his point of view is not should the tax cuts 
be made, but simply a matter of timing, and he is suggesting 
that the timing now is not necessary for the recovery.
    Let me ask you the flip side of that question. If we were 
to move the timing up and have it take place this year, would 
that produce any, either short-term or long-term problems.
    Chairman Hubbard. Making the tax cuts is obviously good tax 
policy. I would assume if Congress voted on something for 10 
years it believed it was good tax policy. It's difficult to 
imagine that it somehow becomes bad tax policy. I think in that 
sense, it makes very good sense. Greater certainty about tax 
policy is very good for business planning and household 
planning.
    Chairman Bennett. But I'm talking about the question. As I 
say, Greenspan agrees with that, but he's being quoted as 
saying we don't need it accelerated to this year; that the 
recovery is robust enough that that's not necessary.
    My question is, is there any downside risk either to the 
deficit long-term to the recovery itself if they are, in fact, 
accelerated to this year.
    Chairman Hubbard. I don't think so, Mr. Chairman. 
Accelerating those rate cuts provides support not only from 
consumption, but for business investment that's done through 
small businesses that pay taxes at individual rates. Ask 
yourself what's the price for that insurance? It's quite low 
fiscally because it's accelerating and they are already talking 
about an up front acceleration in which the many economists 
would argue the economy needs it.
    In terms of additional pressure on interest rates, from 
such an acceleration, we view those, in fact, as being very 
modest compared to the positive effects from the rapid economic 
growth.
    Chairman Bennett. One more question and then I'll turn it 
over to Representative Stark. Again back to Chairman Greenspan, 
as I understand his concern, it is that we accelerate the tax 
cut into this year without making commensurate cuts in 
spending. We would put ourselves on a course that would be 
somewhat destabilizing in terms of the future deficit and/or 
surplus. Therefore he says, okay, the tax cuts are fine, but 
you've got a problem on the expenditure side. Now I've heard 
him say you can set the expenditure level just about anywhere 
you want in Congress, but you can't set the revenue level where 
you want because the revenue level is dependent on how well the 
economy does.
    And if you set your permanent expenditure level--now I'm 
using my words rather than his, but it's his concept--if you 
now set the expenditure level that is unsustainable over time 
in terms of what the economy would yield in terms of revenue 
level, you've built in long-term serious problems. I'm assuming 
that is what has caused him to say don't bring the tax cuts 
forward in this year unless you can find a way to bring your 
expenditures under control.
    Now in a time of building a Homeland Security department 
from scratch and the war on terrorism is not over, in a time 
when in all probability, we will be in a shooting war 
relatively quickly, and in a time when the stock market has 
still not recovered for whatever reasons, geopolitical or 
otherwise, is there value in taking the position that we have 
to pay for within the next year or two the tax cut in terms of 
expenditure control?
    Chairman Hubbard. It's certainly the case that for the 
long-term fiscal health of the country we have to focus on two 
things. One is economic growth, because that is what is going 
to promote revenues for the Federal Government as well as all 
of us as individuals. Yeah, there was spending restraint, no 
doubt about it. But given the short-term issues, the way you 
describe them, I think quite accurately, I just can't see the 
argument for not accelerating the tax cuts. Over the long term, 
it's the size of Government, of course, that will matter. The 
budget constraint must balance over the long term and I think 
we'd be much better as an economy having it balanced with 
smaller Government than a larger one.
    Chairman Bennett. Thank you.
    Representative Stark. Thank you, Mr. Chairman. I have a 
variety of Chairman Greenspan's quotes here and I've been 
looking at some that you paraphrased. The one that I notice, 
and I'm quoting this from his Senate Banking hearing on 
February 12, 2003, is that he supports the program to reduce 
double taxation of dividends as you suggested, but the last 
part of that statement was that, and the necessary other 
actions in the Federal budget to make it revenue-neutral. I 
believe that the tax cut on dividends without any offsetting 
revenue raising would not meet Chairman Greenspan's test, and 
he has a bunch of other statements.
    I ought to correct one other thing. I think that I can 
speak for the Democrats; I'm the only one in the room, but we 
don't think the recovery is very robust and we think a properly 
targeted stimulus is necessary. But that does not mean a 
stimulus targeted at the upper richest 1 percent of American 
individuals.
    So I'll put these notes, if you like, in the record, just 
to try and set the Greenspan--you can interpret them I guess as 
you choose.
    Chairman Bennett. Without an objection, they'll be in the 
record.
    [The notes referred to appear in the Submissions for the 
Record on page 71.]
    Representative Stark. Dr. Hubbard, the Administration and 
President Bush are fond of 92 million Americans who will 
receive an average tax cut of $1,083. I remember suffering 
through some course in economics somewhere, and when the Urban 
Institute or Brookings suggests that half of all the taxpayers 
would only see their taxes drop by less than a hundred dollars, 
then I guess the President could say that the average tax cut 
is $1,000 and change, and I could say the median is $100 and 
we'd both be correct. Would that be a fair statement?
    Chairman Hubbard. I don't think it's exactly a fair 
statement on the numbers, but I take your point that averages 
start that Americans would receive less than $100 benefit from 
this tax cut, then the median is right around $100.
    It depends. We're talking about all Americans in the 
population or all the taxpayers.
    Representative Stark. You're quite correct. I'm referring 
to taxpayers.
    Chairman Hubbard. I don't believe that's the case, Mr. 
Stark, but I can get you the percentages.
    Representative Stark. That's what Brookings says and if you 
want to challenge them, that's okay with me. I'll let you guys 
fight that out.
    Chairman Hubbard. May I respond to the spirit of your 
question Representative Stark? If you take a family of four 
with two children making $39,000, it's not an average, it's an 
example. It would be a $1,100 tax reduction.
    I think the President's plan offers great benefits for 
moderate-income families as well as for upper-income families.
    Representative Stark. Poop, that's all I can say. That's 
nonsense. And I hope you know it and if you don't, it's time 
you learned.
    There was an article by Robert Novak, one of the great 
liberal columnists in the country.
    [Laughter.]
    Representative Stark. On the February 24, 2003, last 
weekend, he said that there's aggravation at the White House of 
Greenspan's comments on the Bush tax cuts. Do you think that 
Dr. Greenspan's comments were inappropriate?
    Chairman Hubbard. Not at all.
    Representative Stark. You weren't aggravated by them?
    Chairman Hubbard. No, Representative Stark. The Federal 
Reserve and its Chairman and all of its representatives are 
independent. As you know, the Administration is both entitled 
to and respected for their opinions
    Representative Stark. You notice that I jumped on Social 
Security. You did have a policy last year. That policy was 
privatizing Social Security, was is not?
    Chairman Hubbard. The policy is the creation of personal 
accounts.
    Representative Stark. Which we referred to as privatizing 
and which you aren't talking about this year, are you?
    Chairman Hubbard. I think that's a sort of inaccurate term. 
There are many ways to do personal accounts.
    Representative Stark. One of the great joys of being an 
economist. You can have inaccurate terms and still be 
economically accurate. But as we liked to say last year and as 
we said it articulately enough so the President dropped it, is 
that his plan of last year was privatization, if only partial 
privatization of the Social Security fund.
    I'd now like to discuss just one more. Could we have that 
chart on unemployment? I love it. Did you ever read Jonathan 
Swift and his solution for welfare, eating little children? Did 
you ever read that story? A modest proposal. I would commend it 
to you because it's the Republicans to a T. And I've always 
said if that doesn't sound like the Bush proposal, I've never 
heard it.
    But what you're telling me there, I think you're trying to 
sell me in fact, is that if there's a cliff that I'm going to 
fall off when I'm unemployed, I'll hurry up and get a job. Is 
that the sense that every time there is an expiration of 
unemployment benefits, people suddenly got jobs?
    Chairman Hubbard. These come from actual----
    Representative Stark. That's what you would suggest to me 
that that chart implies. How about then, Dr. Hubbard, why don't 
you just say if you don't get a job, you go to jail? Wouldn't 
that really get people to get jobs more quickly?
    Chairman Hubbard. I think you're caricaturing, Mr. Stark, 
what's really a very important point for people who are on 
unemployment--that the longer that you remain unemployed, the 
more your skills deteriorate. The question is, what kinds of 
policies get people back to work?
    Representative Stark. That's what I want to get to. I'm 
just going to take an example. You've got a million people who 
are out of work, right? On unemployment. They lost their 
unemployment on December 28th as a Republican Christmas 
present. Now----
    Chairman Bennett. We restored that in the Senate. Didn't 
you pass it in the House?
    Representative Stark. No, we didn't. It was controlled at 
that time by the Republicans.
    Chairman Bennett. It was restored by the Republicans when 
we restored it.
    Representative Stark. The million people who lost their 
benefits are going to get a $3,000 account to do things. 
They're going to get day care, carfare, and training. Isn't it 
correct that to be getting the unemployment benefits for 13 
weeks they had to have had a job for at least six months? I 
think that's the rule, right? It may be longer. So all of these 
million people have had jobs. They were doing something. They 
were plumbers, carpenters, painters, they worked at Home Depot, 
they were chiropractors, lawyers, accountants, CPAs. I bet 
there were a lot of them in there. But all these people had 
jobs.
    So I gather what you're going to do is train the plumbers 
to be carpenters and the painters to be chiropractors and 
that's going to help them along the road, when, in fact, there 
aren't any jobs out there, because these people could all work. 
These are not people who were incapable. They are not 
dysfunctional employees. They're not people who are on welfare 
because they're incompetent to work or they need education. 
They are people who are holding down, one would assume, an 
economically efficient place in our economy and performing a 
task. What kind of training would you suggest they get?
    Chairman Hubbard. Let me start with what I think was the 
thrust of your remarks and questions, Mr. Stark, about jobs not 
being out there. That is precisely the point--that jobs and 
growth package, if I might, Mr. Stark, that the President's 
proposals would in and of themselves lead to the creation of 
1.4 million jobs.
    Representative Stark. That $3,000 for training, daycare and 
carfare are not going to find a job for the plumber when the 
plumbing company closed up. And what I'm suggesting is that if 
he had the $3,000, he would pay his rent, buy clothes for his 
kids, all the things that would stimulate the economy. Instead 
of staying home and reading a book on how to be an economist, 
he would be spending that money. He'd be consuming, which would 
help the economy, and we would be doing something to help that 
family stay together.
    Now the President is going to spend $300 million to promote 
stable families through marriage. These guys are either married 
or they're not, but they're certainly not going to get married 
if they're unemployed. That makes them look very unattractive 
in the matrimony market.
    So what's wrong that two really good, solid, liberal 
Republicans like George Bush Senior and Ronald Reagan, extended 
the benefits for 33 or 36 weeks out of compassion? Why don't 
we?
    Chairman Hubbard. The two-part answer to your questions, 
Mr. Stark. One is, again, the thrust of the jobs and growth 
packages is on the promotion of economic growth so that people 
have jobs. You may have different views on how many jobs.
    Representative Stark. These million people don't.
    Chairman Hubbard. On the personal reemployment accounts, I 
frankly think your question trivializes the problem of the 
long-term unemployed, who as you know well now are eligible for 
Government training programs. What the President is proposing, 
personal reemployment accounts, is a much more flexible 
solution that helps them get a job. What we know is that wage 
growth responds to the time and tenure you have a job, not the 
time and tenure on unemployment insurance.
    Representative Stark. The job market has gone south in 
their particular community, and there aren't jobs even in their 
state. What are you going to train them for? I'm saying these 
are people, and they're a variety of people. Let's say in that 
million people there's probably every skill you can dream of 
and they can't find a job because there aren't any. So what are 
you going to do, daycare?
    Why can't you give them the money in terms of benefits and 
let them have the flexibility to go look for a job? You're 
limiting them, because then they can't pay their rent or keep 
their house or buy gas for their car, and that seems terribly 
arrogant, in my book.
    Chairman Hubbard. The goal of the President's policies is 
to promote people getting a paycheck, not an unemployment 
check.
    Representative Stark. The President may have forgotten 
this, and you may, too, there's an unemployment law in this 
country.
    Chairman Hubbard. If I might continue, Mr. Stark. The 
question in employment policy is how best to promote getting 
people back to work. We can have reasonable disagreements on 
that, but one of the great hallmarks of our labor market in 
this country over the past 20 years is the flexibility. If 
people change industries, change jobs, the kinds of things your 
question precluded are the very factors of success in the 
American labor market.
    Representative Stark. But there aren't any jobs, and you 
can't tell me what you're going to train them to do. People in 
this pool have every conceivable type of skill. I mean, why 
don't you just give them a ticket to where the job is? You are 
begging the question, sir. These people need money to live, and 
you're saying we're not going to give you any money to live, 
we're going to train you. You beg the question. Is it the 
economy is so lousy that there aren't jobs? If you didn't move 
them all to Mexico then for some reason, you got them so that 
they've closed down. Now what do you do with those people?
    Chairman Hubbard. You've given me a lot to work with with 
that question, but I just want to take the part about your 
limiting people's choices. What the President has done in 
personal reemployment accounts is broadened them. There is 
money to use for whatever you want. You're not required to 
simply use this on a particular training program.
    Representative Stark. As I say, I'm glad. I'm sure that a 
million people who have had their benefits expire and the ones 
who are going to come onto it will be happy to learn that they 
can have daycare, although they've got nothing to do during the 
day anyway, so they might as well stay home and get to know 
their kids a little better.
    Carfare. I don't know where they're going to go. And 
training, I know not for what; as I say, they are all currently 
able to hold down a job. The fact that those jobs no longer 
exist, it could be that you've got a few buggy whip makers out 
there, and I'll stipulate that maybe 1 or 2 percent could learn 
to do something else. But it seems to me that toilets still get 
stopped up all over the country and if the plumber is out of 
work, why train him to do something else? You train him to be a 
surgeon, but he'd make more as a plumber. And it seems to me 
that this is an excuse.
    I know that it's compassionate conservatism, and I'm just 
trying to understand how we can get that compassion to some of 
those people in the 98th percentile and down rather than give 
it all to people like the Chairman and myself in the upper 1 
percent where we really don't need it. But thanks for your 
efforts. And read that Jonathan Swift thing. It'll probably 
give you some other ideas for how to help the poor.
    Thank you, Mr. Chairman.
    Chairman Bennett. Thank you. Let's go to the second panel. 
I think we've probably exhausted this one. We're now going to 
hear from Henry Aaron, who is a Senior Fellow for Economic 
Studies at The Brookings Institution; Eric Engen, a Resident 
Scholar at the American Enterprise Institute, and Daniel 
Mitchell, a Senior Fellow in Political Economy at The Heritage 
Foundation.
    Dr. Aaron, I'm sure you are tired of hearing people say 
they think you're a baseball player, but it was too easy a shot 
not to take it. We thank you for being here and appreciate your 
willingness to comment.

        OPENING STATEMENT OF HENRY J. AARON, BRUCE AND 
        VIRGINIA MacLAURY SENIOR FELLOW, THE BROOKINGS 
                  INSTITUTION, WASHINGTON, DC

    Mr. Aaron. Thank you very much. If you don't take it out of 
my time, I could tell you some stories about being asked to 
sign baseballs and submit items to some celebrity auctions, 
even once being invited to a celebrity golf tournament by 
Phyllis George. Unfortunately, I don't play golf.
    Thank you very much, Mr. Chairman, for the opportunity to 
testify today. This Economic Report, like most, is the product 
of first rate professionals, good economists. It contains a 
good deal of solid and very sophisticated analysis. In my 
opinion, however, no Report can be better than the Presidential 
program that it's defending. And in this case, the Economic 
Report fails to address the central fiscal challenge of the 
Federal Government, the central challenge for this decade and 
probably some more to come. That challenge is the need to 
prepare now, not later, for the fiscal burden that will be 
imposed on us by the retirement of the baby-boom generation.
    In fact, the President's program aggravates that problem 
very significantly. I have tables in my testimony to try to 
document that specific point. The Economic Report itself 
largely skirts this question. In fact, I was hard pressed to 
find any specific reference to it.
    The Congressional Budget Office projects that over the next 
decade, the Federal budget will run a surplus of a bit more 
than $1 trillion. If one factors into that estimate the impact 
of the program contained in this budget as a whole, the 
projection reverses and becomes a projected deficit of 
something more than $1 trillion. That estimate itself is based 
on extraordinarily optimistic and unrealistic assumptions. In 
fact, if one builds in corrections for those unrealistically 
optimistic assumptions, the deficit balloons to something in 
the vicinity of $5 trillion.
    Chairman Bennett. Unfortunately, we all understand what 
you're saying.
    Mr. Aaron. The program that the President has put forward 
in this budget is touted as a pro-growth program. I believe 
that is flatly the opposite of its actual effect on the 
economy. You're quite right in the questions that you were 
asking Mr. Hubbard. Some fiscal stimulus in the near term could 
add to demand and help provide us insurance that our current 
economic capacity will be fully utilized rather than 
underutilized as it is today.
    Over the medium and long term, however, budget policy that 
results in sizable deficits simply subtracts from national 
savings. Private saving that could have been used to invest in 
productive capital gets used to finance current activities of 
Government. Higher math is not needed to calculate the 
consequences of deficits as large as those that will occur 
under the President's program.
    Based on published estimates of the productivity of 
capital, we can look forward to national income in the end of 
the 10-year projection period nearly half a trillion dollars 
smaller than we could have had if we had balanced the budget 
apart from the funds that are being accumulated for retirement 
purposes: Social Security, Medicare and Federal employees. If 
we balanced the rest of the budget, the Federal Government 
would be adding to capital formation rather than subtracting 
from it, and we could look forward as a nation to roughly half 
a trillion dollars a year more in gross domestic product in the 
year 2013 than we can do under the President's program.
    Various people have been discussing, and I think correctly, 
the balance of the benefits and harm that would flow from the 
tax cuts that are proposed. I want to be quite up front. If you 
cut taxes, benefits always flow from that. But tax cuts are not 
free. One has to pay for them in some fashion. That realization 
was implicit in some of the questions in the preceding session. 
Either one has to raise taxes later on to make up for the 
revenue sacrificed currently, or one has to sacrifice public 
services that those taxes otherwise could have financed. It's a 
mathematical identity, as Mr. Hubbard said, the budget has to 
balance over the long run. You pay now or you pay later.
    The final table in my testimony tries to give some 
indication of what we could have purchased with the revenues 
sacrificed by the tax cuts Congress has already enacted and 
those that the President's budget currently requests. It would 
have been possible over the long haul and over the next 10 
years both with the revenues embodied in the tax cuts to do the 
following specific items:
    There is enough money both to close entirely the projected 
long-term deficit in Social Security and to cover the entire 
projected deficit in the Medicare Hospital Insurance trust 
fund. In addition one could double the budget for biomedical 
research, an area where scientists from the National Institutes 
of Health agree that they are rejecting solid research 
proposals that would have been funded in the past.
    We can try to reverse the downward trend in access to 
higher education by families from middle and lower 
socioeconomic groups if we doubled higher education assistance. 
We could do those things and still have money left over besides 
after those steps.
    We could also enact a program to improve life chances for 
America's children. My colleague at Brookings, Isabelle 
Sawhill, together with a group of scholars, has put together 
such a program.
    The reason I put this menu before you is not because I 
think each of these items is necessarily how revenues should be 
spent. Rather, I want to illustrate in specific form the size 
of the tax cut that has been enacted and that the President is 
now seeking.
    Many people are duly impressed and quite concerned about 
the magnitude of the cost of funding Social Security and 
Medicare. I think they should be. My point is very simple, 
though. If you're concerned about those problems you should 
recognize that the revenue loss from the tax cuts enacted and 
proposed, are even larger.
    [The prepared statement of Mr. Aaron appears in the 
Submissions for the Record on page 49.]
    Chairman Bennett. Thank you very much.
    Dr. Mitchell.

  OPENING STATEMENT OF DANIEL MITCHELL, Ph.D., McKENNA SENIOR 
     FELLOW IN POLITICAL ECONOMY, THE HERITAGE FOUNDATION, 
                         WASHINGTON, DC

    Dr. Mitchell. Thank you very much, Mr. Chairman, for the 
opportunity to testify. With your permission, I'm just going to 
go through some of the highlights of my testimony, specifically 
Chapter 5, Tax Policy for a Growing Economy, then I'll comment 
very briefly on Chapter 6.
    Chapter 5, the Tax Policy chapter, covers some very 
important issues that I think paint a road map for policymakers 
in terms of tax policy, including important issues such as the 
need to improve distribution analysis, as Dr. Hubbard talked 
about, when we take these snapshots of where people are today 
and look at the impact of tax policy, we're missing the upward 
and downward mobility that we see in our economy, and that 
gives policymakers I think a very incomplete and inaccurate 
picture of the potential benefits or lack thereof of different 
changes in tax policy.
    The focus of the chapter, of course, is on what at least I 
would call tax reform. The Administration doesn't really phrase 
it that way, but obviously they're looking at what are the key 
guidelines for good tax policy, and there's a number of lessons 
that are in that chapter:
    Lower tax rates to encourage more work and 
entrepreneurship.
    Neutral tax treatment of savings and investment will 
increase capital formation.
    Elimination of tax preferences will mean decisions are 
based on economic rather than tax-minimization factors.
    Simplicity will free up resources for more productive uses.
    These are all things I think are very good criteria for 
policymakers to decide tax policy. But then the chapter also 
focuses on, well, what are some of the practical issues that 
are raised when you look at these criteria? Should America 
shift to a consumption-based tax system? This could be a flat 
tax system where income is taxed once when it's earned. It 
could be a sales tax or VAT system, where income is taxed once 
when it is spent. What we're really talking about, though, is, 
should there be double taxation of income that is saved and 
invested?
    The chart I have up shows that under current law, when a 
taxpayer earns money and then, of course, pays tax on that 
money, they then have a choice of what to do with their after-
tax income. If they spend it, with a few rare exceptions, 
there's no additional tax liability from the Federal 
Government. But if you save and invest that money, depending on 
the circumstances, that same dollar of income can be taxed over 
and over and over again: Capital gains taxes, corporate income 
taxes, the double tax on dividends, the death tax. And these 
things, of course, are changing the price of current 
consumption relative to future consumption.
    [Chart appears in the Submissions for the Record on page 
64.]
    They're punishing people who would save and invest. Every 
economic theory of which I'm aware, even Marxist, they all 
believe that capital formation is necessary to long-run 
economic growth.
    Some of the other specific aspects of the chapter that I 
think are worth looking at, should businesses expense new 
investment or depreciate new investment? Under current tax law, 
we treat some investment expenditures as if they were taxable 
profit, because businesses aren't allowed to fully recognize 
the costs in the year they occur. That chapter I think has a 
very important contribution to the international tax debate, 
looking especially in light of what the WTO has ruled on our 
FISC law.
    The chapter looks at whether it might be better to replace 
worldwide taxation with territorial taxation, something that I 
think would be a pro-growth way of dealing with corporate 
inversions, instead of treating companies as if they were 
permanent captives of the Federal Government.
    Let me go ahead and shift really briefly to Chapter 6. This 
is the Pro-Growth Agenda for the Global Economy. I think the 
Administration has done some very good work looking at how to 
transfer foreign aid programs, which right now oftentimes 
subsidize economically unworthwhile activities and instead 
reward the countries that actually get some of the basic 
policies right in terms of everything from rule of law to 
fiscal policy, openness to trade and investment. These are all-
important things.
    But one sin of omission, I guess I would phrase it, in that 
chapter, is the failure to address what I see as a very 
important long-run issue, which is the battle between those who 
want tax competition between jurisdictions and those who want 
tax harmonization. You have international bureaucracies such as 
the OECD, the EU and even the UN, who are trying to work with 
high tax governments in Europe to try to hinder the flow of 
jobs and capital from high tax governments to low tax 
governments. We saw beginning 20 years ago with the Thatcher 
and Reagan tax cuts that when nations had to compete, good 
policy in one nation triggers good policy in another nation.
    We look at the facts that tax rates, both personal and 
corporate tax rates, have dramatically come down in the last 20 
years. I think that would not have happened had it not been for 
fiscal competition between nations. So when I look at some of 
these international tax harmonization initiatives and the fact 
that they would in effect lock up the factors for production 
inside high tax countries that will both remove the incentive 
for the high tax countries to reform--we should want more 
countries to do what Ireland did when they lowered their tax 
rates. They had an economic boom. We want countries to do what 
Russia has done, implementing a low flat tax, which has led to 
30 percent revenue increases in the first 2 years it's been in 
effect. But if countries aren't allowed to benefit from good 
tax policy, and if they're not punished for bad tax policy, I 
fear that we're not going to see the kinds of positive economic 
changes we've seen in the last 20 years.
    So I think it would be very important to give some further 
consideration to some of these international issues. I say that 
recognizing that the Administration by and large has done a 
very good job in rejecting a lot of these tax harmonization 
initiatives. But I think any discussion of international 
economic growth is incomplete without some recognition that 
fiscal competition is one of the most powerful forces for 
economic liberalization we have today. We see it between U.S. 
states, we see it between national governments, and it's 
certainly something I think is necessary for international 
economic growth.
    Thank you very much.
    [The prepared statement of Dr. Mitchell appears in the 
Submissions for the Record on page 60.]
    Chairman Bennett. Thank you, sir.
    Dr. Engen.

         OPENING STATEMENT OF ERIC M. ENGEN, RESIDENT 
            SCHOLAR, AMERICAN ENTERPRISE INSTITUTE, 
                         WASHINGTON, DC

    Mr. Engen. Thank you, Mr. Chairman. I too will also just 
cover some of the main highlights out of my written testimony 
that I submitted to you.
    In that I focused on essentially the proposals for tax 
relief for corporate earnings and the tax-free savings accounts 
that were both in the President's recent budget and discussed 
those in the context of the tax reform that was discussed in 
the Economic Report.
    At the very end, I'd like to briefly discuss the issue of 
long-term fiscal imbalances.
    My principal conclusions are as follows. First, the 
taxation of capital income, sometimes at very high marginal 
rates in the U.S. tax system, stands in marked contrast to the 
implications of optimal tax theory in the economics literature, 
which has generally concluded that the optimal tax on capital 
income is zero. As well, what is oftentimes not understood is 
that the costs of having high capital income taxes are not just 
borne by capital owners. Indeed, they are borne very much by 
workers who have less capital to work with, and thus have lower 
levels of productivity, and their wages reflect that also, and 
thus lower wages.
    So the proposal to remove the double taxation of corporate 
earnings would lower the cost of investment for firms and 
increase the after-tax returns to savers that hold corporate 
equity, thus stimulate capital formation, and very importantly, 
boost the productivity of workers and raise their wages. As 
well, there are other benefits that I think are very timely, 
particularly at this point, looking at the events of the last 
couple of years in the economy.
    First of all, exempting corporate profits from personal 
income taxation reduces the tax incentives for corporations to 
retain earnings instead of paying dividends. Higher dividend 
payouts would not only help improve the allocation of corporate 
capital amongst its different uses, but also help stockholders 
in monitoring corporate managers. Indeed, everyone is aware of 
the corporate governance and accounting problems that have 
manifested in the last year or so. If companies no longer can 
hide behind the tax reason for why they have to retain 
earnings, and if they need to pay them out in dividends, then 
they need to have real earnings. They can't just have paper 
profits.
    As well, another benefit from exempting corporate profits 
from the personal income taxes is it reduces the tax incentives 
for corporations to finance investments with debt instead of 
equity. Less corporate debt reduces the possibilities of 
default and bankruptcy in an economic slowdown and thus would 
lower the risk premiums that are included in the cost of 
financing corporate capital, so it makes it easier for firms to 
weather the type of economic slowdown that we had.
    As Dr. Mitchell mentioned as well, the United States is 
also in the midst of a tax competition in terms of the 
corporate income tax with Europe and the rest of the world 
whether we like it or not. The United States currently has the 
second highest corporate tax rate among its economic 
competitors, second only to Japan, and is one of only three 
countries in the OECD that does not provide dividend tax 
relief. The other two are Ireland, which has a corporate rate 
of 12.5 percent, and Switzerland, which has a corporate tax 
rate in the low 20s, both quite lower than in the U.S. So 
although the corporate tax rate is not an issue that is being 
dealt within the current tax policy discussion, at least 
limiting the double taxation of dividends would help improve 
some of these competitiveness pictures for U.S. firms in the 
global economy.
    The second issue is the other major tax proposal that's in 
the President's budget that deals with saving and investment. 
That is, proposals for expanding tax-free savings accounts. 
This would continue the kind of trend that we've seen for more 
than 20 years now when IRAs were first made universal and 
401(k) plans came on board in the early 1980s. That 20-year 
trend has been toward moving the personal income tax more 
toward a consumption tax base, which I think many economists 
agree would have positive growth outcomes, and it's the basis 
for the optimal tax literature assigning a zero tax on capital 
income.
    However, this would still not yet bring the Tax Code at the 
personal level to a full consumption tax treatment. That's very 
important to realize when we're looking at the potential 
effects of these accounts. In general, I think the important 
thing to realize here is that an important component of these 
tax-free savings accounts is that there still would be 
contribution limits. So particularly with some of the new 
accounts being potentially offered, the Lifetime Savings 
Account, in addition to the type of plans that are merely an 
extension of current Roth IRAs and 401(k) plans, one of the 
benefits is that this does raise the contribution limits and 
thus would affect more savers at the margin in terms of 
possibly gaining new saving.
    However, there still are those contribution limits, and for 
very high savers, they could get the tax benefits of these 
accounts by shifting assets into the new accounts or for 
existing ones, merely putting in saving they would do 
otherwise.
    So an important thing that is limiting the positive savings 
effects of these accounts relative to a consumption tax is that 
there are still these contribution limits. The lower the 
limits, the more that would have a stifling effect on the 
savings effect. So raising the limits does help that, but those 
limits are still there.
    Another important thing in this context is that for a full 
consumption tax treatment at the personal income level, not 
only would all capital income not be taxed, but interest paid 
should no longer be tax deductible to have full consumption tax 
treatment. So the benefits to net saving come not only from 
encouraging saving, but also not from subsidizing borrowing in 
the Tax Code, which counts against the net saving of 
households, and indeed that feature is not something that's 
being dealt within current tax policy proposals, which is not 
surprising.
    The main tax deductible interest component to personal 
income is the mortgage interest deduction. That's very popular, 
and so no one wants to touch that, but that is a very important 
issue when we're thinking about moving the tax system more 
toward a consumption tax. That is a point I'd like to 
highlight.
    The final thing I'd like to briefly talk on is just the 
issue of long-term fiscal balance. Whereas I generally support 
the tax proposals that are being offered by the President and 
the type of tax reform shifting to a full consumption tax that 
is in the Economic Report, one of the things that is of concern 
is the long-term fiscal balance. When I look at what would be 
the effect of even putting in all of the tax proposals that are 
in the current budget proposal, what that would do is leave 
over the foreseeable horizon tax revenues at the Federal level 
in the range of 18 to 19 percent of GDP. I have estimated those 
using earlier figures by the CBO and adjusting them for the 
more recent tax cut proposals that those tax figures would be 
in the range of 18 to 19 percent of GDP.
    The average over the postwar period is 18 percent. So 
Federal revenues are not running at historically low levels. 
And indeed, what we're doing is coming off the historically 
high level of Federal revenues that we saw a few years ago. So 
in a sense, the revenue reductions that are taking place are 
pulling us back closer to the historical average.
    The long-term fiscal imbalance is, in my view, a spending 
problem. What we see is because of the promised retirement and 
health benefits that all spending is going to grow primarily 
because of those programs, and indeed, with very conservative 
estimates going to the future on other spending, that spending 
is projected, which right now is currently in the range of 18 
to 20 percent of GDP, close to taxes, would rise to 35 to 40 
percent of GDP.
    I don't see how we could balance that gap by raising taxes 
without having extremely detrimental effects on the economy. So 
I think in looking at the long term fiscal imbalance problem, 
it's not a tax problem, it's a spending problem.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Engen appears in the 
Submissions for the Record on page 68.]
    Chairman Bennett. Thank you very much. Thanks to all of 
you, because we have some interesting dynamics now among the 
three of you, some of which I'd like to explore.
    First, Dr. Aaron, purely parochial and a single little 
item, you made reference to NIH making less money available 
than they had in the past.
    Mr. Aaron. No, I did not.
    Chairman Bennett. That's what I understood, and I wanted to 
clear that up.
    Mr. Aaron. Thank you very much for the opportunity. NIH has 
committees of scientists who review applications. They assign 
them point scores, and then they work down from the highest to 
the lowest until the money is gone. The quality of scientific 
proposals has been getting better. As a result, even with the 
growing budgets that NIH has enjoyed, its cutoffs have been 
rising. So scientific proposals of a quality that would easily 
have been funded in the past are now being rejected.
    Chairman Bennett. That's because other proposals are 
better?
    Mr. Aaron. That is exactly right.
    Chairman Bennett. That was not the impression I got.
    Mr. Aaron. I appreciate the opportunity to set it straight. 
The fundamental point is that this is a period of extraordinary 
opportunity for marvelous advances in science, and in my own 
view--this is not as an economist, but as somebody who reads 
this literature--as a society, we would do well to exploit 
these opportunities rapidly, because they promise enormous 
benefits in terms of extending life.
    Chairman Bennett. I'm glad to get that cleared up, because 
the impression I got was that you were claiming that NIH didn't 
have enough money, and I've been part of the Republican group 
that has demanded that NIH's budget be doubled over a 5-year 
period, and we held to that and succeeded in that even though 
some in our conference, after we had done the first couple of 
years, said ``Look, we've given NIH a 30 percent boost last 
year, why do you have to give them another 25 percent? Why 
can't we hold them to 6 or 7 percent like everybody else?''
    We said, no. We made a commitment to double their funding 
over a 5-year period, and we are on track to do that. And we 
succeeded in doing that. Frankly, I feel very strongly about 
that. So I'm glad to get that one----
    Mr. Aaron. I'm entirely on your side on that one.
    Chairman Bennett. Maybe the only thing you're entirely on 
my side, but----
    Mr. Aaron. I hope not.
    Chairman Bennett. I hope not. I am on your side on another 
issue, the fundamental issue which you raised in the beginning. 
That the most serious long-term economic problem we have is 
when the baby boomers hit retirement and then have the temerity 
to live longer than was designed into the system when it was 
designed in the 1930s for Social Security or the 1960s for 
Medicare, thereby upsetting all of the actuarial tables that 
would have made those things viable if people had just been 
compliant and cooperative and dropped dead at 67, so that the 
retirement age of 65 would make economic sense.
    Now I'm well past the 67 mark myself and running for 
reelection in 2004, hoping to extend a career as long as my 
parents. My father was 95, my mother 96, and I have better 
health care than they did. I am genetically programmed to live 
into triple digits. That is not good news for the Social 
Security system that has started already paying. So a 
recognition of the size of that problem is something that 
should be highlighted as often as possible. And I agree with 
you absolutely that it should be highlighted as quickly as 
possible.
    Because every day that goes by that we don't address it 
here in the Congress is a day that multiplies in difficulty for 
some future Congress when they finally get around to finding 
themselves in the midst of it and say, why didn't those people 
in the 1990s have the political courage to deal with it? Or 
those people in the early years of the 21st century have the 
political courage to deal with it? Why have they just kicked 
the can down the road and left us with the problem when it's 
upon us?
    I see that happening in the Congress. I see that happening 
in the political arena, and it upsets me a great deal, and I 
agree with you that that should be the number one thing we talk 
about.
    Having said that, I get the feeling from the projections 
you gave us of what would happen if the tax cuts were restored, 
how much money we would have, that you are almost viewing the 
circumstance as a sum-zero game, and that a tax cut that takes 
place now--and it can be calculated, the impact 10 years, 20 
years from now with enough certainty for you to give us the 
numbers that you're giving us, is a straight matter of math, of 
addition and subtraction. You subtract here and it isn't there. 
I have a problem with that.
    Mr. Aaron. I do, too. I think forecasts of specific levels 
of spending and revenues are fraught with dangers, to put it 
mildly. The Congressional Budget Office obligingly now includes 
a chart at the beginning of each of its baseline annual 
Reports, a fan chart that shows the range of uncertainty.
    Nobody who looks at that chart can have anything but a 
clearer understanding of the dangers of long-term forecasting.
    What can be forecasted, I think, with a much higher degree 
of reliability, although still not with certainty, are the 
consequences on the level of the deficit with specific policy 
changes.
    If tax rates are reduced----
    Chairman Bennett. We're talking about rates, not revenues.
    Mr. Aaron. Revenues will be lower than they otherwise would 
have been. That fan, the entire fan, moves.
    Chairman Bennett. I'm not sure I agree with that statement, 
that if rates are lower, revenues will be lower.
    Mr. Aaron. This is a debate that's been going on for about 
25 or 30 years. Many years ago, it was called supply-side 
economics. And supply-side economics got, I think, an unfairly 
bad name, because it failed so dismally when applied in the 
1980s.
    As you know, we cut tax rates, and it was anticipated that 
revenues would boom as result. What boomed were interest 
payments on the explosively growing public debt.
    But there is no question that when tax rates are reduced, 
economic distortions are reduced. If tax rates are reduced on 
labor supply, on balance, there is some increase in the amount 
that people will work. I think that economists, both 
conservative and liberal, tend to agree on that.
    There is a range of disagreement, but its professional 
disagreement about technical issues. But I don't know that 
there is any responsible economist at work today now who thinks 
that if you cut rates, the supply-side effect will be large 
enough to restore revenues. And, in some cases, the supply-side 
effects can aggravate problems.
    Let me give you a specific example here: Mr. Engen referred 
to the savings incentives that are contained in the President's 
budget. Readers of the journal of record for taxation these 
days, Tax Notes, have been welcomed to a barrage of articles 
discussing the consequences of such an increase in individual 
tax incentives on the willingness of employers to continue to 
have qualified pension plans.
    If I'm a small employer and I want to shelter my personal 
savings from taxes, the way I do so is to create a qualified 
pension plan, if I want to save more than the amount currently 
deductible under IRAs. To get qualified pension plan coverage 
for myself I have to bring in my employees, because of, so-
called non-discrimination rules.
    But if I can put in $7500 for myself and my wife and for 
each of my two kids, and can shelter even more through the 
other elements of this program, I probably can dispense with 
the qualified pension plan and avoid the cost of spending money 
to support pensions for my employees.
    What I'm worried about are the kinds of dynamic effects 
from this program that could actually go counter to the shared 
objective of the Administration and of the opposition, which is 
to increase national savings.
    National saving is important. We want to encourage private 
saving. We, I think, should also encourage public saving. It 
was the public saving side of the ledger that I focused my 
testimony on, but not because that's the only thing that goes 
into national saving. Private saving counts, too.
    Chairman Bennett. I want to come back to that, but if 
either of the other panelists want to comment at this point, go 
ahead.
    Dr. Mitchell. I can't resist defending the Reagan 
Administration.
    Chairman Bennett. I was prepared to do that, but go ahead.
    Dr. Mitchell. The Reagan budget forecasts were almost 
insignificantly different from the CBO forecasts. They used 
traditional static revenue scoring for their tax cut.
    What caught both the Reagan Administration and CBO by 
surprise were the economic conditions, the rapid disinflation 
that nobody foresaw. And even after all that happened, we did 
wind up with revenues in 1990 being almost 100 percent larger 
than they were in 1980, and that was during a decade when I 
think we had about 55 percent inflation.
    As someone who still considers myself a supply-sider, I 
don't think that many of my colleagues would ever claim that 
all tax cuts pay for themselves. As a matter of fact, supply-
siders go out of their way to distinguish between tax rate 
reductions that will encourage additional productive behavior, 
versus tax credits and exemptions and deductions that don't 
have any effect on people's willingness to work, save, and 
invest.
    And depending on which of those pro-growth tax policies 
you're looking at, the revenue feedback, it may be 20 percent; 
it may be 40 percent. The revenue feedback can be bigger, 
certainly, in the long-term, rather than the short-term, but 
that, in some sense, is a separate question from what is good 
tax policy at the end of the day.
    Is it to have low rates? Is it to have a consumption base? 
And then if it turns out that you get some additional economic 
growth, which almost certainly is the case, there will be some 
supply-side effect. And I think it's very worthwhile for some 
revenue feedback. It's very worthwhile for policymakers to have 
a better understanding of what that effect might be.
    Chairman Bennett. Dr. Engen, did you want to get into this?
    Mr. Engen. Yes, sure. I guess, first, on the issue of 
forecasts, yes, they're uncertain, but we need them. We can't 
fly blind.
    Having done this type of fiscal and economic forecast at 
the Federal Reserve before I went to AEI, although even on a 
shorter-term framework--typically, our forecasts are out only 2 
years--it's easy to criticize forecasts. It's very difficult to 
actually do them, once you're in the trenches.
    I think we need to keep in mind, in terms of forecasts, 
that they're better than nothing.
    On the issue of tax cuts paying for themselves, I agree 
with the general sense of Dr. Aaron's comments that typically 
when we are looking at saving and investment by households 
within the U.S. and labor supply responses to tax cuts, that 
oftentimes the consensus of the economic literature is that 
they don't necessarily pay for themselves.
    But the gains in economic growth are not inconsequential. 
They are debatable, and so the amount of revenue that is lost 
if we do cut rates, can be quite different, depending on what 
those responses are.
    And I think Dr. Mitchell makes a very good point that's 
very relevant; that not all tax cuts or tax increases are the 
same. Some have incentive effects, and some do not.
    One area where I think this issue is quite important, where 
it may be more responsive in terms of reduction in rates 
actually lifting revenue, is this area of international tax 
competition.
    In Tax Notes, I had a recent article with my colleague, 
Kevin Hassett at AEI, looking at this issue of what has 
happened over the last couple of decades in terms of the 
corporate tax competition between the U.S. and its major 
economic competitors.
    One of the things you tend to see is, because of this 
competition and because of the fact that it's now easier to 
move corporate profits across different tax jurisdictions, you 
don't have to do it by physically moving a plant from one 
country to another. You can now, through various financial 
arrangements, teams of accountants and tax lawyers all have 
figured out very well that you can move profits around.
    So what oftentimes you're seeing now is that countries that 
are lowering their corporate tax rates are actually seeing 
increases in corporate revenues because they're getting more of 
that activity, either in their country or actually moving in.
    Ireland is an example. They reduced their corporate tax 
rate from 50 percent down to 12.5 percent. Over that same 
period, their corporate revenues went from 1 percent up to 4 
percent of GDP.
    Chairman Bennett. The Prime Minister of Ireland told me it 
was 10 percent. Is he wrong?
    Mr. Engen. My information is 12.5 percent.
    Dr. Mitchell. Originally, it was a dual rate of 30 percent 
and 10 percent. The high-tax governments in Europe took them 
before the European Court of Justice, saying that was 
discriminatory, under, I guess, the Treaty of Rome.
    Ireland--and, of course, as expected--France and Germany 
wanted to force Ireland to bring the 10 percent rate to 30 
percent. Ireland pulled the rug out from under them and said, 
fine, we'll have one uniform low rate at 12.5 percent.
    Chairman Bennett. I see.
    Mr. Engen. That 10 percent was for manufacturing, but it's 
now unified at 12.5. But that is an area that I think tax 
policymakers need to be very aware of, because we're in this 
tax competition with other countries, as I said before.
    Whether we like it or not, it's not one that we can sit on 
the sidelines and say, well, we're not going to worry about it. 
This is a problem that has a number of different symptoms, 
issues about the ETI and FISC are related to the high corporate 
tax in the U.S., issues of corporate inversions, issues of 
transfer pricing concerns.
    A lot of these are symptoms of this issue that over the 
last decade, as our competitors have been lowering their 
corporate rates, the U.S. has maintained the same high rate.
    Chairman Bennett. I could continue this seminar and learn a 
great deal from it, but I want to--and I sincerely thank you 
all three for helping add to my education--but I want to come 
back to what I consider to be the main focus of where we ought 
to be going, and get your reactions and comments on it.
    Specifically, with respect to the President's plan, 
because, after all, this is a hearing about the President's 
Economic Report, not a seminar on educating Senator Bennett in 
his areas of ignorance, which are vast. My take, after a career 
in business, as well as exposure now to the activities in 
politics, is that the most important thing we can do for the 
future is to increase the efficiency of the economy.
    Productivity figures are important. Productivity means a 
more efficient economy. As you look around the world--and the 
international issue has been raised--you see inefficiencies 
built into many economies in most countries of the world, to a 
degree that Americans simply do not comprehend.
    One of these fundamental inefficiencies is corruption. 
Corruption is a form of inefficiency and a very high form of 
taxation. If you have to bribe someone to get anything done, it 
slows everything down and, as I say, it's a high form of 
taxation. It adds to your costs.
    So, we want to get the most efficiency we possibly can into 
the system. Unfortunately, our tax system right now is not 
built on that philosophical basis.
    Our tax system right now is a relic of the thinking of the 
1930s, which says we use taxes as incentives or punishments in 
order to drive behavior. And, yes, a byproduct of that is, we 
get enough money to run the Government.
    But we get all excited, as Mr. Stark does, about, quote, 
``fairness,'' unquote, and we get all excited about who is 
benefitting and who is not. There are people he wants to 
punish; there are other people he wants to benefit, and he 
wants to use the tax system to do it.
    My philosophy is that the tax system should be structured 
solely for the purpose of raising however much money you need 
to pay for NIH and the other things you need to do, and it 
should not be used to have those of us in Government making 
decisions that the free market would make better.
    So, I want the system to be as efficient as possible, the 
economy to be as efficient as possible, which means it's as 
low-cost as possible, which means it produces the most money 
that it possibly can.
    If you can clear its arteries out, it will produce the most 
revenue for the American people. I made the comment to the 
first panel and repeat it here, in my conversations with Alan 
Greenspan, he said you can set the level of expenditure 
anywhere you want. You can't set the level of income, because 
the level of income is a factor of what's going on in the 
economy.
    So if the level of expenditure goes too high by virtue of 
Congressional action, you become an African nation where they 
will adopt a budget that has something in the budget for 
absolutely everybody. They just don't have any money with which 
to pay for it.
    So, with that philosophic underpinning, we come back, for 
my benefit, please, and analyze the key points of the 
President's program against that question. Will the economy 
become more efficient or less efficient if we end the double 
taxation on dividends? Will the economy become more efficient 
or less efficient, if we advance the effective date of the 
marginal tax rates?
    Or, tip of the hat to Dr. Aaron, would the economy become 
more efficient or less efficient if we repealed the reduction 
of marginal rates, and went back to the levels that we had in 
the Clinton Administration?
    Would the economy become more efficient or less efficient 
if we adopted child tax credit, elimination of the marriage 
penalty, savings activities, depreciation activities? Don't go 
into each on in specifics, but address the general categories 
of the President's tax program, without regard to forecasts.
    I have never seen a Government forecast, including those 
that were favorable to the position that I took, come true. I 
agree you have to do it; you have to go through the exercise, 
and it's a very useful exercise, but be a little humble when 
you get the results.
    So that question is for each of you, and we'll start with 
you, Dr. Engen, and go back and give Dr. Aaron the last word. 
How do you feel about the key components of the President's 
program, measured against the matrix of does this make the 
economy more efficient or less efficient? Does this increase 
productivity or decrease productivity? Will this clear the 
arteries or clog the arteries in terms of the structural nature 
of the impact on the economy as a whole?
    Mr. Engen. I think the two key elements of the President's 
proposal that are the most efficiency-enhancing are: One, as I 
touched on in my testimony, the reduction in the double 
taxation of dividends proposal. I think that has a number of 
different efficiency-enhancing aspects, as I went through, not 
just in terms of investment, but also in terms of the 
allocation of that investment, in terms of corporate 
governance, in terms of corporate financial policy.
    One thing, though, that we see, even in the discussion 
about the dividend tax proposal, is the issue that you brought 
up of all of the different social policies, if you will, that 
have been undertaken within the Tax Code.
    One of the things that's been used to criticize the 
dividend proposal is that it changes the relative prices, if 
you will, between using deductions and tax credits within the 
code. Some people like that because it reduces incentives to 
tax shelter. Other people don't like it. Those are people that 
put in the credits and deductions to start with.
    But what it shows is that once you have a lot of these 
targeted tax credits and tax deductions, it makes tax reform 
more difficult because you run up into these various policies 
that people have put in for social reasons, that maybe in years 
past, were done on the spending side and are now in the Tax 
Code and make tax reform more difficult.
    The other thing is the tax rate cuts. I think the lowering 
of marginal rates increases economic incentives, and I think 
those are the two most important components of the President's 
proposal that are the most efficiency-enhancing.
    I would though like to touch on just one thing that I would 
have liked to see better proposals, so to speak, in the budget. 
That is on the side of spending restraint. It's obvious to most 
the need for increased spending for Defense and Homeland 
Security, but a lot of other spending programs and the growth 
in spending that I see on that part of the budget, looking at 
the long-term imbalance that I talked about before in my view 
that's a spending program. I view that as a concern with the 
President's proposal on how to restrain spending both on 
existing programs of various new programs such as the 
prescription drug benefit that is a big part of the spending 
increase as proposed.
    Chairman Bennett. Thank you. Thank you for your being here.
    Dr. Mitchell.
    Dr. Mitchell. Mr. Chairman, there are sort of two competing 
theories. One theory says that fiscal balance drives everything 
and that if you have an increase and the deficit rates go up, I 
don't think there's evidence for that. We live in world capital 
markets that are immense. Even a big shift in U.S. Government 
fiscal balance is unlikely to have a significant effect on 
interest rates even more than I go dump a glass of water in the 
Potomac River that I'm going to significantly affect the water 
level of the river.
    That's why I think we need to focus on good tax policy. I 
agree with you completely. We want a Tax Code that raises 
whatever amount of money we have to raise with the minimum 
distortions possible. That means a low-rate consumption-based 
system. If you look at the President's agenda, lower tax rates, 
lower marginal tax rates, he presumably eliminated the death 
tax last year. If we ever make that permanent, he's eliminating 
the double tax on dividends. He has asked for the lifetime 
savings account Dr. Engen talked about. Those are all things 
that in an incremental fashion are moving us in the direction 
of tax reform. I don't think the Administration likes to 
characterize it that way, but I'd like to think of it that way.
    Those things I think are good policies. There are other 
things, the child credit, that's not going to do anything for 
the economy. It doesn't mean it's bad policy, but it's not 
along the lines of supply-side policy to work, save and invest 
more.
    So I think the Administration's policy is good tax policy 
and it's good economic policy, because I think the need to get 
the Tax Code right trumps the very insignificant evidence about 
fiscal balance. Plus I think there's an interconnection. 
Government spending grew a lot more rapidly when we had a 
surplus in the late 1990s, and it was free money. There was a 
lot of blood in the water with hungry sharks around. In some 
sense, I almost harken back to what Senator Moynihan accused 
the Reagan Administration of, which was deliberately running a 
deficit to get Government spending to grow smaller. I don't 
know whether that was the secret plan of the Reagan 
Administration, but that probably does work.
    We do know that spending certainly grew very, very rapidly 
when we did have a surplus, so I view it almost a serendipity 
that we now have a bit of a deficit because: (1) I don't think 
that it has any real significant negative impact and; (2) it's 
probably going to promote some much needed expense and 
frugality in Washington. Thank you very much.
    Chairman Bennett. Dr. Aaron, you have the last word.
    Mr. Aaron. Thank you very much. First of all I want to 
point out that the Administration's program is not moving us to 
a consumption tax, it is moving us to a wage tax. I can go into 
more detail if you would like subsequently. But it has been 
mislabeled seriously and that's not a minor question.
    [The additional information as referenced appears in the 
Submissions for the Record on page 48.]
    Chairman Bennett. If you want to send us something on that, 
we'd be happy to receive it.
    Mr. Aaron. The second point is I was not advocating here 
that we go back to the tax schedule that existed before 1981. 
My point was only to underscore that one is making social 
choices with far reaching implications when one chooses to use 
one's revenue generating capacity for tax cuts rather than to 
deal with other problems. These are matters on which honest 
people can and do disagree.
    But one should not focus only at the tax side and say, 
``Gee, tax cuts are nice.'' You've got to pay something for tax 
cuts. And what we have done with the tax cuts we've enacted is 
use up all of the fiscal elbow room that we would have had to 
deal with the problems in Social Security, Medicare hospital 
insurance, and other areas besides.
    Maybe the tax cuts are a better way to go; maybe they're 
not. That's a debate for another day. My point is simply put 
both items on the scale. When one considers the virtues and 
flaws with respect to your specific question, I believe it's 
not even a close question. This is an efficiency reducing 
proposal for the following very specific reason.
    As a Nation, we're saving too little. The most important 
element contributing to efficiency is the intertemporal 
distribution of our capacity to consume and our capacity to 
take advantage of the productive opportunities that we have. 
Prudence suggests that we should be saving more now because we 
are going to face some difficult fiscal challenges in the 
future. Whether we do so through public programs or private 
programs, there are going to be more retirees that active 
workers are going to have to support.
    The way to get ready for that future burden is to build up 
capital stock and worker productivity today so that future 
workers can produce more and sustain their own standards of 
living while producing a surplus that will go to support health 
and pension benefits for retirees and the disabled.
    The second reason why I think the evidence is pretty clear 
that we're saving too little is one of the points you 
mentioned; namely the productivity opportunities that the 
Nation faces. There has been a flowering of opportunities for 
productive investments. We talked about biotechnology for which 
your support is firm and clear.
    The Nation had a bubble in computers and in technology, but 
there is a new world out there as a result of those 
technologies. To deprive ourselves of the capacity to invest 
and increase output by not saving enough today, is first-order 
inefficiency. Everything that the gentlemen to my left have 
been talking about are second-order questions.
    Chairman Bennett. I wish we could continue the seminar. 
This has been very helpful. I thank you all for your 
presentations. I guess I can exercise one last prerogative of 
the Chair.
    I was the CEO of a company that was founded and flourished 
in what The New York Times has labeled the ``decade of greed,'' 
when the top tax rate was 28 percent. This was an S 
corporation, so that all of the money that we earned in the 
corporation flowed through our individual tax returns and 
therefore was taxed at 28 percent. When the corporation was 
founded in 1984, I joined it as the CEO. They had four full 
time employees. The amount of taxes those employees were paying 
was very, very small.
    The amount of taxes the corporation was paying was zero 
because the corporation wasn't earning any money. We funded the 
growth of the corporation entirely from internally generated 
funds. We did indeed have a line of credit at the bank. But it 
was what was known as a 30-day clean up, which means that every 
12 months, you have to bring it to zero and leave it at zero 
for 30 days before you can go back into it.
    That was the kind of credit we had and those 30 days were a 
hard 30 days. But we were able to do that. Today that 
corporation has over 4000 employees. You figure the income tax 
of those 4000 employees and what it is, you figure it has over 
$500 million in sales. You figure the supplies it purchases and 
the corporate taxes paid by its suppliers, not to mention the 
corporate tax that it used to pay. It's now in a deficit. 
That's the sole cause and effect because I left.
    [Laughter.]
    Chairman Bennett. Let the record show that's a facetious 
remark.
    [Laughter.]
    Chairman Bennett. You figure in the employees of the 
suppliers and their tax payments. You figure in the sales taxes 
that are paid off of $500 million in sales, you figure the 
property taxes that are paid off of the excess of the 100 
different stores that are operated there plus the corporate 
headquarters plus the manufacturing plant, plus all the rest of 
that.
    I think the country got a pretty good return on the 
investment it represented in cutting the effective tax rate 
down to 28 percent in the decade of greed. As I look back on 
it, if the company were founded in 1994 as opposed to 1984, 
when the effective tax rate on us would have been 42.5 percent, 
following the Clinton tax increase, I can't be sure, you can 
never be sure, but my guess is that we would not have been able 
to fund the growth of that company. We could very easily not 
have survived. Now, that is a single example. I recognize there 
are all kinds of other circumstances around it. But in my gut, 
having lived through that circumstance, I have to say that 
there was something to the Laffer curve.
    I understand that the Laffer curve was not invented by 
Arthur Laffer. I learned it in Econ 1. I'm old enough that it 
was before the days of 101 and it was called the Law of the 
Optimum price. I learned it in Econ 1, and I saw Arthur Laffer 
build a whole career on something that was a question on my 
first midterm back as a college student.
    But having had the experience I just described to you, my 
bias is that a lower marginal tax rate over time will produce 
really good things for long-term forecasts.
    With that again, I thank you all for coming. I would be 
happy to receive any additional papers that you want to send 
either to corroborate me or to correct me. Both will be equally 
welcome.
    The hearing is adjourned.
    [Whereupon, at 5:25 p.m., the hearing was adjourned.]
                       Submissions for the Record

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

           Prepared Statement of Senator Robert F. Bennett, 
                    U.S. Senator from Utah, Chairman
    Good afternoon and welcome to today's hearing. The Employment Act 
of 1946 created the Joint Economic Committee and Council of Economic 
Advisers, or CEA, and explicitly mandated one task for each: That the 
Council of Economic Advisers issue an Economic Report every year and 
officially present it to the Congress, and that the Joint Economic 
Committee issue a response to the Report. Today's hearing is the 
official presentation of the Economic Report to the Congress by the 
CEA.
    We welcome the members of the CEA to Congress today. Dr. Hubbard 
and Dr. Kroszner, we have enjoyed working with you and your team and we 
look forward to continued cooperation between the CEA and our 
Committee. The other members of the Committee and I are anxious to hear 
your thoughts about the current state of the economy, the President's 
various tax reform proposals, and the numerous other policy reforms 
presented in the Economic Report of the President, or ERP.
    What stands out the most about the Economic Report of the President 
is its sheer breadth. In the Report the Administration lays out the 
current state of tax policy, regulatory policy, the current state of 
the economy, corporate governance issues, and international development 
in great detail. What's more, in the Report the Administration clearly 
signals its short-term and long-term goals in each individual area.
    The Administration has taken on an amazing array of reforms since 
the President's inauguration, and for this it ought to be commended. 
While political sensibilities suggest that an Administration focus on a 
small number of bite-size, stage-manageable reforms that play well to 
swing voters, the Administration rejected any thought of this early on 
in the term. Its efforts in the area of tax reform bear testimony to 
that; it has moved to lower the marginal tax rate for all workers, 
reduce the tax on capital income, expand and reform tax-preferred 
savings accounts, eliminate the death tax, remove tariffs on goods 
imported from developing countries, and has signaled its intention in 
upcoming months that it will attempt to introduce personal accounts to 
supplement Social Security. ``Bite-sized'' is not the adjective that 
comes to mind when looking at these proposals. ``Bold'' or ``far-
reaching'' are more appropriate.
    Politically, every single proposal draws the ire of a substantial 
constituency, and not just on the left. However, the tax reforms 
proposed by the Administration all contribute to higher savings and 
investment, the necessary ingredients for increasing growth in the long 
run. The Administration has resisted efforts to lard its recent growth 
package with dubious spending programs or temporary tax cuts designed 
to produce a short-run impetus to the economy, and for that it should 
be commended. When the Bush plan is enacted I believe that it will 
usher in an extended period of exceptional growth, not just here but 
abroad as well. And as I've said before, economic growth is a wonderful 
elixir that can cure a wide array of problems.
    The proposed economic reforms outside of the Tax Code are just as 
bold, in my mind. For instance, the Administration's push for the 
Millennium Challenge Account may prove to be a turning point in the 
efficacy of foreign aid. To cite another interesting policy initiative, 
bringing a greater emphasis on rigorous cost-benefit analysis and 
market forces to the regulatory arena will ultimately result in policy 
outcomes that allow us to meet our goals of improved workplace safety, 
a cleaner environment, safer food and drugs, and less government 
intrusion into the market, with a lower cost to the government and the 
taxpayers. A third policy innovation worthy of mention is the 
introduction of personal re-employment accounts, a tool that should 
make it easier for those out of work to get new training and re-enter 
the work force.
    We also eagerly anticipate your discussion of the macroeconomic 
situation. My personal thoughts on the state of the economy are well 
known. In the last three years the U.S. economy has sustained a number 
of economic shocks, any one of which should have been enough to send 
the economy into a tailspin. The collapse of the internet bubble, 
corporate malfeasance, the 9/11 terrorist attacks, wildly oscillating 
oil prices, and a military showdown in the Middle East more than offset 
the relatively sanguine decade following the Persian Gulf War. Despite 
the massive uncertainty, fear, and caution injected into the economy we 
still managed to grow at a rate of 2.75 percent in 2002, a feat that I 
believe bears testament to the amazing resilience of our country and 
its people. Dr. Hubbard and Dr. Kroszner, again welcome to the Joint 
Economic Committee. We also extend a welcome to our second set of 
panelists, who will testify on the Administration's Economic Report and 
the current state of the economy following the testimony of Drs. 
Hubbard and Kroszner. Our second panel consists of Dr. Henry Aaron of 
the Brookings Institution, Dr. Eric Engen of the American Enterprise 
Institute, and Dr. Dan Mitchell of the Heritage Foundation. We look 
forward to your thoughts as well.
                               __________
           Prepared Statement of Representative Pete Stark, 
      U.S. Representative from California, Ranking Minority Member
    Thank you, Chairman Bennett. I also want to thank you for holding 
this hearing, which continues a JEC tradition of having the Council of 
Economic Advisers present and discuss the Economic Report of the 
President. I want to welcome Dr. Hubbard, who testified before this 
committee last month, and Dr. Kroszner. I look forward to continuing 
our discussion about the Administration's latest economic plan. Our 
second panel of witnesses will also provide useful perspectives.
    Yesterday it was reported that consumer confidence has slumped to 
the lowest level in nearly a decade. Consumers are worried about the 
weak job market, falling stock values, rising gas prices, the threat of 
terrorism, and war with Iraq. I think it's fair to say that the 
President's latest economic plan does not inspire confidence.
    Instead of a plan that would put money into the hands of those who 
need it and would spend it immediately, the President has proposed to 
eliminate the individual income tax on dividends paid by corporations 
and to speed up the rate cuts that go to a relatively small number of 
high-income taxpayers. The Administration is proposing something that 
doesn't help in the short-term and undermines budget discipline in the 
long run.
    The President's latest budget, released earlier this month, shows 
the startling effects of the Administration's fiscal policy agenda. In 
January 2001, the President inherited a 2002-11 surplus of $5.6 
trillion. The latest Congressional Budget Office (CBO) projections show 
that even if no further policy actions are taken, this surplus has 
shrunk to $20 billion. The Administration's own projections show that 
if the President's policies are enacted, there will be a cumulative 
deficit of $2.1 trillion over that period--an astounding $7.8 trillion 
reversal in only two years.
    The Administration continues to argue that the deterioration is due 
almost entirely to events beyond its control--mainly the economic 
recession and the war on terrorism. But the facts are that the tax cuts 
already passed are responsible for a third of the deterioration in the 
budget outlook for 2003 and 2004. If the 2001 tax cut were to be made 
permanent, this share would only increase over time. In addition, the 
budget ignores the cost of deploying troops and the cost of a war with 
Iraq, which the Administration continues to push upon us. Today's Wall 
Street Journal reports that the President will request supplemental 
spending totaling as much as $95 billion for war, its aftermath, and 
new terrorism expenses.
    The budget situation is actually much worse, because these 
projections contain glaring omissions, such as the cost of extending 
other tax breaks that are scheduled to expire but which Congress has 
repeatedly extended; the cost of fixing the alternative minimum tax; 
understating the growth in discretionary spending, particularly for 
defense and homeland security; and the cost of a war with Iraq. These 
factors could easily add more than $2 trillion in costs over the next 
ten years.
    The Administration's tax cut proposals seem especially large and 
inappropriate in the context of the future fiscal pressures on the 
Social Security and Medicare systems. Permanently extending the 2001 
tax cut alone would cost 1.3 percent of GDP by 2012 and the President's 
other new tax proposals would add another 0.6 percent, for a total 
taxcutting agenda worth 1.9 percent of GDP. By comparison, the 75-year 
shortfall in the Social Security trust fund is currently 0.72 percent 
of GDP, and the 75-year shortfall in the Medicare (HI) trust fund is 
0.96 percent of GDP, adding up to less than 1.7 percent of GDP.
    When President Bush took office, he touted ambitious plans to 
reform Social Security in order to address the demographic challenge. 
But this year's Economic Report of the President does not mention the 
challenge itself, much less the Administration's ideas for addressing 
that challenge.
    With the retirement of the baby boom generation just a few years 
away, we should be taking steps to make sure that we have the budget 
resources to honor our Social Security and Medicare commitments. During 
the Clinton Administration, growing budget surpluses were considered 
prudent preparation for the looming demographic change. But the Bush 
Administration has squandered the Clinton surpluses at a time when the 
certain demographic change is ever closer, and when new pressures and 
uncertainties associated with the war on terrorism and the possible war 
with Iraq are before us.
    The President's plan is stunningly irresponsible. It drains budget 
resources that could be put to better use--such as really improving 
Medicare--and it increases the deficit. Once interest costs are taken 
into account, the President's new tax cuts would add almost two 
trillion dollars to the national debt over the next 10 years. Large 
increases in the public debt are bad for interest rates, investment, 
and long-term growth. It's no wonder that consumers have a sinking 
feeling about the economy.
    I look forward to Dr. Hubbard and Kroszner's testimony, and l hope 
they address these concerns:
                               __________
 Prepared Statement of R. Glenn Hubbard, Chairman, Council of Economic 
 Advisers and Randall S. Kroszner, Member, Council of Economic Advisers
    Chairman Bennett, Vice Chairman Saxton, Ranking Member Stark, and 
members of the committee, it is a pleasure to appear before you to 
discuss the release of the Economic Report of the President, along with 
the economic outlook for the United States and the Administration's 
policy agenda.
    The events of 2002 brought new challenges for the U.S. economy and 
for America's economic policy. Efforts to strengthen homeland security 
and prosecute the war against terrorism placed new demands on the 
economy. The recovery from the 2000-01 economic slowdown continued, but 
with an unsatisfactory pace of job creation. These developments make it 
all the more important to undertake policies that promote growth, both 
in the United States and in the global economy.
    Reliance on markets is key to enhancing growth. Thanks to the 
flexibility of markets, consumers, businesses, workers, and investors 
can continuously adapt to changing economic circumstances. Markets 
constantly reshape and redirect economic activity and economic output 
in response to changes in producers' supplies and costs and in 
consumers' incomes, demands, and the prices they face. In turn, the 
market itself evolves, as new information, new technologies, altered 
supplies, and other changes in the economic and physical environments 
pose new problems and open up new opportunities. Put simply, markets 
are dynamic.
    The Report emphasizes the importance of dynamic markets in the U.S. 
economy and the need to design public policies so as to preserve and 
build on this dynamism. In particular, it discusses recent developments 
and policies in the areas of corporate governance, regulation, 
taxation, labor markets, and international economic development. It 
describes the lessons that have been learned from recognizing the 
dynamic flexibility of the U.S. economy, and how the President's policy 
initiatives are putting those lessons into practice.
    A fundamental theme in this year's Report is the need to craft 
short-run economic policy with a long-term perspective. An example is 
the President's Jobs and Growth Package, which is designed to assist 
the recovery of 2002 in gaining momentum in 2003. A key feature of this 
package is ending the double taxation of corporate income. In the short 
run, the positive effect of this policy on equity-financed equipment 
investment would be equivalent to an immediate investment tax credit of 
4 to 7 percent, according to CEA calculations. Higher investment will 
raise job creation and insure continued economic growth in the next few 
years. In the long run, the additional investment encouraged by the 
proposal would raise the nation's stock of productive capital, which in 
turn would increase the productivity and wages of the nation's 
workforce. Another important component of the President's plan is the 
acceleration of marginal tax rate reductions that have already been 
approved by Congress. In the short run, these reductions will support 
consumption by bringing forward permanent tax relief. In the long run, 
marginal rate cuts reduce disincentives to risk-taking and 
entrepreneurship and thereby help the economy grow. The package also 
includes two other important components: an expansion of expensing 
allowances for small businesses and an innovative program ``Personal 
Reemployment Accounts,'' which will give workers money to fund job 
search or job training expenses, as well as a cash incentive to find 
work quickly.
    In my testimony, we will first discuss the economy's performance in 
2002 and discuss both the short-term and long-term outlooks. We will 
then discuss specific areas in which the Administration's approach to 
economic policy promises to foster economic growth and prosperity in 
the United States and around the world.
                  assessing macroeconomic performance
    The U.S. economy solidified its forward progress in 2002, with the 
fourth quarter of the year marking the fifth consecutive quarter of 
economic growth. (GDP data from the fourth quarter of 2002 were not 
available as the Report went to press, but will be referenced in this 
testimony.) This progress followed a contraction in 2001 that was 
deeper and longer than initial data suggested, but still mild by 
historical standards. Real gross domestic product (GDP) declined by 0.6 
percent during the first three quarters of 2001, about one-fourth the 
average percentage decline over the previous seven recessions. Growth 
resumed in the fourth quarter of 2001--despite the terrorist attacks in 
September--and real GDP rose 2.8 percent over the four quarters of 
2002. Although economic activity weakened in the fourth quarter 
relative to the other three quarters of the year, ongoing improvement 
in productivity growth, together with lean inventories, foreshadows a 
return to more normal levels of production and job growth in the 
quarters ahead.
    The economic recovery of 2002 resulted from a constellation of 
factors, including the resiliency of the economy after the terrorist 
attacks and the lagged effects of stimulative monetary and fiscal 
policy in 2001. Although the Federal Reserve lowered the Federal funds 
rate only once in 2002--by half a percentage point on November 6--the 
475-basis-point reduction over the course of 2001 continued to 
stimulate the economy throughout the year. (A basis point is 0.01 
percentage point.) Monetary stimulus was complemented by fiscal 
stimulus, in the form of the tax rate reductions included in the 
Economic Growth and Taxpayer Relief Reconciliation Act of 2001 (EGTRRA) 
and the investment incentives in the Job Creation and Worker Assistance 
Act (JCWAA) of 2002. In the long run, EGTRRA's reductions in marginal 
tax rates will raise potential output by increasing labor supply and 
encouraging the entrepreneurial activities that are the building blocks 
of economic growth. In the short run, the tax cuts also buoyed 
disposable income and helped maintain consumption. Robust consumption, 
in turn, was a crucial locus of strength in the overall economy, 
contributing an average of 1.8 percentage points to real GDP growth 
during the four quarters of the year. Additionally, the tax incentives 
in JCWAA, which the President signed in March, provided needed support 
to investment at a time when stability in this component of final 
demand was especially important.
    In 2002, discussions of both economic activity and economic policy 
paid particular attention to the valuation of the economy's stock of 
productive assets. One of the more favorable developments for many 
Americans in 2002 was the continued appreciation of their most 
important investment: their home. Housing prices rose 6.2 percent from 
the third quarter of 2001 to the third quarter of 2002, following an 
8.7 percent increase in the same period a year earlier. As discussed 
below, housing values were buoyed not only by low mortgage interest 
rates, which reached levels not seen in more than a generation, but 
also by rising demand, continuing strength in purchases of second 
homes, and ongoing improvements in mortgage finance. Strength in 
housing values contributed to robust increases in residential 
investment, providing another important impetus to final demand in 
2002.
    In the aggregate, however, the appreciation in housing wealth was 
overshadowed by continued losses in the stock market. Like those for 
all of the world's major equity exchanges, U.S. stock indexes lost 
ground in 2002, continuing a general slide that began in the spring of 
2000. From the market's high point in the first quarter of 2000 to the 
fourth quarter of 2002, stockholders lost nearly $7 trillion in equity 
wealth. These losses continued to weigh heavily on economic growth and 
job creation in 2002, by reducing the wealth of consumers and raising 
the cost of equity capital for investing firms. The precise reasons for 
the bear market of 2000-02 are subject to debate, but the market's 
three-year decline was probably influenced by two general factors--a 
decline in expected profit growth and an increase in the premium that 
investors required to hold risky assets. These factors continued to 
play important roles in the first three quarters of 2002 as the stock 
market continued its decline. Specifically, corporate accounting 
scandals called into question the reported profits of some firms, while 
risk premiums (as measured by the difference, or spread, between the 
yields of corporate bonds and those of U.S. Treasuries) rose to near-
record levels. Although some observers attributed most of the market's 
decline to the corporate scandals, it is worth noting that equity 
prices fell around the world, even in countries with different 
accounting systems and governance institutions. In any event, asset 
markets played important roles in the determination of the components 
of GDP in 2002, which we will now discuss in turn.
    Consumption. Consumption continued to be the locomotive for the 
recovery in 2002. Expenditure on consumer durables was especially 
strong, in large part because of motor vehicle sales that were sparked 
by aggressive financing offers. Additional strength in consumption 
stemmed from robust increases in incomes, as low inflation, tax relief, 
and steady nominal income growth kept real disposable incomes high. 
Another positive determinant of consumption growth in 2002 was the 
strength of the housing market, which was supported by low mortgage 
rates as well as continued growth in housing demand. Housing wealth is 
more widely distributed among American families than stock market 
wealth, and housing equity continued to rise in 2002. A common way for 
this equity to support consumption is through borrowing against home 
equity, the outstanding value of revolving home equity loans at 
commercial banks rose from $155.5 billion in December 2001 to $212.4 
billion in December 2002. Another way for homeowners to tap the equity 
in their homes is by refinancing their outstanding mortgages. Many 
refinancers chose to remove equity from their homes by taking out a new 
mortgage with a larger principal than the amount outstanding on the 
original mortgage. These ``cash-out'' refinancings boomed in 2002 as a 
result of the continued appreciation in housing prices and declining 
long-term interest rates. All in all, the positive effects on 
consumption stemming from higher incomes, higher housing wealth and 
lower interest rates helped to counter any negative influences on 
consumption than resulted from declining stock market wealth.
    Non-residential investment. The stock market was a depressing 
influence on business investment in 2002, as lower equity values make 
it more difficult to finance investment projects (Chart 1). Business 
investment was one of the weakest components of demand in 2002, 
declining by 1.9 percent over the four quarters of the year. The 
decline was heavily influenced by a precipitous decline in investment 
in structures, which fell 15.7 percent over the course of the year. The 
other, larger component of business fixed investment, equipment and 
software, was also weak, rising only 3.0 percent. In light of the rapid 
increase in investment in the late 1990s, many observers wondered 
whether the economy suffered from a capital overhang, built up by 
excessive investment in the years immediately before the 2001 
recession. As discussed in last year's Report, this possibility is hard 
to verify, because it requires anestimate of the ``correct'' amount of 
capital relative to the economy's output, a figure that is hard to know 
with certainty. Yet, as the 2002 Report also noted, some empirical 
evidence had emerged in 2001 indicating that a modest overhang had 
developed the previous year for some capital goods, notably servers, 
routers, switches, optical cabling, and large trucks. Evidence that a 
widespread overhang continues to hinder overall investment outside of a 
few particular industries, however, is harder to find.
    Residential investment. In contrast to the softness in non-
residential investment, residential investment grew briskly in 2002, 
sparked by the lowest mortgage interest rates in more than a 
generation. After hitting a recent peak of 8.64 percent in May 2000, 
interest rates for conventional, fixed-rate 30-year loans fell to 5.93 
percent by the end of December 2002, their lowest level since 1965. Low 
mortgage rates contributed to the 6.8 percent increase in single-family 
housing starts over their already high level of 2001, while boosting 
sales of new homes to record levels at the end of the year. The 
strength of housing construction during the past 3 years stands in 
contrast to past business cycles, when housing starts were not nearly 
as robust
    Net exports. Although the output of the U.S. economy remained below 
potential in 2002, its growth rate still outpaced those of many other 
industrialized countries. Slow growth among many of the United States' 
major trading partners, in turn, contributed to slow growth in U.S. 
exports compared with that of imports. Exports rose 5.0 percent during 
the four quarters of 2002, while imports grew 9.2 percent. This 
discrepancy between the rates of growth in exports and imports led to, 
an increase in the U.S. trade deficit, so that net exports exerted a 
drag on GDP growth in three of the four quarters of the year. (Net 
exports were essentially unchanged in the third quarter.)
    Government purchases. The war on terrorism continued to exert 
upward pressure on federal government purchases in 2002. In late March 
the President requested that the Congress provide an additional 
appropriation of $27.1 billion, primarily to fund this effort. More 
than half of this amount was allocated to activities of the Department 
of Defense and various intelligence agencies. Most of the rest was 
needed for homeland security (mainly for the new Transportation 
Security Administration) and for the emergency response and recovery 
efforts in New York City. Although most of this spending was required 
for one-time outlays only, it nevertheless contributed to the 7.3 
percent increase in real federal government purchases in 2002. State 
and local government purchases rose at a more moderate 1.7 percent 
during the same period.
                         the near-term outlook
    The Administration expects that aggregate economic activity will 
gather strength during 2003, with real GDP growing 3.4 percent during 
the four quarters of the year. The unemployment rate, which was 5.9 
percent in the fourth quarter of 2002, is projected to edge down about 
0.3 percentage point by the fourth quarter of 2003. Although growth in 
equipment and software investment was low, several factors suggest a 
rebound in 2003. To begin with, any capital overhang that might have 
arisen during the late-1990s investment boom has been reduced, because 
the level of investment fell in 2001; expectations of future GDP growth 
have stabilized after falling during 2001; and the replacement cycle is 
approaching for the short-lived capital goods put in place during the 
investment boom of 1999 and 2000. At the same time, the financial 
foundations for investment remain positive: real short-term interest 
rates are low, and prices of computers are falling more rapidly than 
they did in 2000. (Computer investment accounted for a third of all 
non-residential investment growth from 1995 to 2000.) Less bright is 
the outlook for non-residential structures, which still appears weak 
even after two years of decline. Even so, structures investment is 
projected to stabilize around the second half of 2003, as the maturing 
recovery generates higher occupancy rates for office buildings and 
greater demand for commercial properties. The recent passage of 
legislation for terrorism risk insurance may unblock some planned 
investments in structures that were held up because of lack of 
insurance. Real exports, which turned up in 2002, are projected to 
improve further during 2003. Although real imports and exports are 
expected to grow at similar rates during the four quarters of 2003, the 
United States imports more than it exports, and therefore the dollar 
value of imports is expected to increase more than the dollar value of 
exports. As a result, net exports are likely to deteriorate further 
during 2003. Consumption should remain robust in 2003. The negative 
influence of the stock market decline on household wealth, and thus on 
consumption, should wane as this decline recedes into history. 
Consumption growth will also be supported by fiscal stimulus and the 
lagged effects of recent interest rate cuts. Finally, low interest 
rates will continue to support the purchase of consumer durables, just 
as they did for much of 2002.
                           long-term outlook
    The Administration forecasts real annual GDP growth to average 3.4 
percent during the first four years of the projection. As this is 
somewhat above the expected rate of increase in productive capacity, 
the unemployment rate is projected to decline as a consequence. In 2007 
and 2008, real GDP growth is projected to continue at its long run 
potential rate of 3.1 percent. The growth rate of the economy over the 
long run is determined by the growth rates of its supply-side 
components, which include population, labor force participation, the 
workweek, and productivity.
    The Administration expects non-farm labor productivity to grow at a 
2.1 percent annual average pace over the forecast period, virtually the 
same as that recorded from the business cycle peak in 1990 through the 
fourth quarter of 2002. This projection is notably more conservative 
than the nearly 2\3/4\ percent average rate actually recorded since 
1995. In addition to productivity, growth of the labor force is 
projected to contribute 1.0 percentage point a year to growth of 
potential output on average through 2008. Taken together, potential 
real GDP is projected to grow at about a 3.1 percent annual pace, 
slightly above the average pace since 1973.
               the 2003 economic report of the president
    The central goal of the Administration's economic policies is the 
promotion of economic growth. The remaining chapters of the Report 
illustrate ways in which pro-growth economic policies can improve 
economic performance at home and abroad by striking the right balance 
between the encouragement and regulation of firms, by promoting 
flexibility and dynamism in labor markets, and by reducing tax based 
disincentives to economic activity.
                     improving corporate governance
    Corporate governance is the system of checks and balances that 
serves to align the decisions of corporate managers with the desire of 
shareholders to maximize the value of their investments. It is a 
largely private-sector activity built on the bedrock of the nation's 
legal infrastructure. Good corporate governance can substantially 
reduce the costs to investors of delegating decisions to managers; as 
must inevitably occur when corporations obtain external financing. Good 
governance also contributes to the ability of U.S. corporations to 
maintain dispersed ownership and to the existence of well-developed 
financial markets. It enables corporations to compete more effectively 
in financial and product markets that have become increasingly global. 
The economy then benefits through more effective use of the available 
factors of production, including managerial talent, external capital, 
and natural and human resources. Importantly, strong corporate 
governance improves the attractiveness of corporate investments to 
households and other investors by more closely aligning managers' 
actions with investors' interests, and by making information about the 
corporation and the quality and diligence of its management more 
transparent to outsiders. Chapter 2 of the Report examines the 
evolution of institutions for corporate governance in the United 
States. Last year was marked by important reforms in U.S. corporate 
governance, including new laws, government regulations, and private-
sector initiatives. The reforms were in part a response to the failure 
of some managers and accountants to provide accurate information about 
corporate financial and operating performance--events that drew 
attention to possible weaknesses in the current system of governance.
    In calling for reform in March of last year, the President 
articulated a plan based on three core principles of good corporate 
governance--accuracy and accessibility of information, accountability 
of management, and independence of external auditors. The plan 
recognizes both the complexity of modern corporate governance systems 
and their inherent flexibility. Its call for a careful reexamination of 
private governance customs and legal rules was followed by a series of 
private and public sector initiatives. These include stepped-up 
enforcement efforts by state and federal authorities, facilitated by 
the President's creation of a Corporate Fraud Task Force in July to 
focus on conduct by managers and accountants that has been a source of 
concern. The President also signed the Sarbanes-Oxley Act in July, 
which the Securities and Exchange Commission is now implementing 
through a series of new regulations.
    Under the Sarbanes-Oxley Act, a new regulatory body is being 
created to strengthen the incentives of auditors to meet their legal 
obligation to serve the interests of shareholders and other investors. 
The Securities and Exchange Commission must issue new disclosure 
regulations, including rules designed to make it easier for investors 
to gauge the incentives and performance of corporate managers. State 
governments are also instituting changes; state law is fundamental to 
the governance structures of corporations. Private-sector organizations 
were among the first to respond to the President's call for reform. 
Self-regulatory organizations such as those that operate the nation's 
stock exchanges contribute in important ways to the quality of U.S. 
corporate governance. Along with individual investor organizations, 
corporate officials, and others, these organizations have taken steps 
to strengthen U.S. corporate governance.
    Even in the midst of these reforms, it is important to remember 
that change is not new to U.S. corporate governance. The U.S. system of 
corporate governance is designed to be flexible. This flexibility 
indeed accounts for its capacity to support economic growth over the 
decades, and for its strong global reputation. The chapter highlights 
the three main components of the U.S. corporate governance system: 
external governance mechanisms, internal corporate governance, and laws 
and regulations. External and internal corporate governance mechanisms 
serve to align managers' interests with those of shareholders and can 
adapt to changing market conditions. The surety provided by the U.S. 
legal system in upholding the contracts that investors enter into when 
they supply capital to corporations contributes to the flexibility of 
the corporate governance system. This framework, which relies on both 
the flexibility of private institutions and the integrity of public 
institutions, remains in place throughout the present reforms and 
provides a model for other economies to follow.
              developing regulation for a dynamic economy
    Competitive, efficient, and equitable markets are the cornerstone 
of a flexible and dynamic economy. Regulation of economic activity is 
an essential element of a market economy, but regulation can hinder 
economic growth and well-being just as it can advance them. Well 
formulated regulation can lead to improved market outcomes, but 
regulation that is ill-conceived or that is not cost-effective can have 
unintended consequences that actually make matters worse. Chapter 4 of 
the Report illustrates how both the government and the private sector 
play critical roles in ensuring a flexible economic environment that 
promotes growth and prosperity by allowing economic resources to be 
redeployed as opportunities evolve. The chapter provides a framework 
for the evaluation of regulatory policies, focusing on federal 
regulation and how it can foster or hinder economic dynamism.
    Regulation stems from a number of needs. Some demands for 
regulation reflect a desire to improve the efficiency of markets 
rendered imperfect by spillover effects, informational problems, or 
lack of competition. By compensating for or correcting these market 
imperfections, such regulation may enhance growth. Other demands for 
regulation, in contrast, reflect a desire to change market outcomes, 
for reasons that may be compassionate or selfish, far-sighted or 
opportunistic. Regulatory policy must identify and deny those demands 
for regulation that seek only economic rents for a privileged few, and 
instead be based on sound science and economics, along with a careful 
evaluation of the social needs behind the desire for regulation. The 
chapter suggests some guidelines for evaluating both new regulations 
and proposed regulatory reforms that will help reduce the costs of 
regulation and achieve the best possible outcomes. When regulation is 
necessary, it should be flexible and market based, and the burden of 
each regulation should be justified by the benefits it confers. An 
important Administration initiative is the revision of the Office of 
Management and Budget's Guidelines for the Conduct of Regulatory 
Analysis and the Format of Accounting Statements. Conducted jointly by 
the Council of Economic Advisers and the Office of Management and 
Budget, this initiative stresses the principles of sound regulatory 
policy based on economic analysis. The revised guidelines have recently 
been published and sent to agencies and external experts for peer 
review.
    Part of a complete understanding of the consequences of regulation 
is recognizing that the impact and efficacy of specific regulations can 
change over time with changes in technology, economic conditions, and 
scientific knowledge. An excellent example is the President's Clear 
Skies Initiative. Aimed at reducing power plant emissions of 
atmospheric pollutants, this program was designed in light of 
scientific evidence linking impairments of human health to exposure to 
certain polluting chemicals. Importantly, however, Clear Skies has also 
been crafted in such a way that economic incentives provide the 
mechanism for reduction of these pollutants at least cost to the 
economy.
    Regulatory review and reform offer an important means for 
policymakers to control the buildup of regulatory costs and limit the 
economic harm of outdated regulations. Although many regulatory changes 
have been clear successes, others have created problems. Examples 
include the experience with the savings and loan industry in the 1980s 
and the more recent experience with electricity markets in California. 
To avoid in the future the kinds of unsatisfactory outcomes that 
resulted from these episodes, regulatory reform should be guided by the 
same basic principles as the development of new regulations.
                          analyzing tax policy
    An efficient tax system adequately finances government activities, 
while imposing as few distortions as possible on household and business 
decisions. A tax system with high marginal tax rates or a complicated 
structure impedes work effort and saving and hinders the risk taking 
and entrepreneurship that are the foundations of growth. Tax rates that 
are unequal across activities encourage tax avoidance and lead to 
potentially wasteful efforts at regulation, reporting, and monitoring 
to control it. Tax deductions, exclusions, and credits are often 
undertaken with the aim of targeting resources to worthwhile social 
goals, but they can create considerable complexity for taxpayers. They 
can also impose high effective tax rates in the range of income over 
which the tax benefits are gradually withdrawn, in some cases 
discouraging additional work effort among the very people the 
preferences were intended to help. The combined result of all of these 
imperfections can be a tax system that imposes significant compliance 
costs and wastes resources by misallocating them to non-productive 
activities.
    Chapter 5 of the Report considers how tax policy changes could 
improve economic growth and real incomes for all Americans. Such 
changes involve difficult questions of how best to balance the 
sometimes competing objectives of simplicity, fairness, and faster 
long-term growth. The chapter considers some approaches that economists 
have identified to achieve the gains of higher incomes and efficiency 
within the framework of the existing tax system. Even relatively modest 
changes can lead to important improvements in economic incentives and 
efficiency. In particular, the opportunity exists to reduce significant 
differentials in tax rates across different activities and to lower the 
tax on the return to capital in ways that improve incentives. Small 
improvements in this regard can have large long-run effects, because 
saving and investment decisions made now will affect capital 
accumulation, technological change, and innovation for years to come.
    An excellent example is the President's proposal to abolish the 
double tax on corporate income. The current taxation of corporate 
income is an important example of how the current Tax Code falls short 
of the goal of taxing income only once. Taxing corporate income twice, 
once at the corporate and again at the individual level, reduces the 
after-tax reward to investing. It distorts corporate financing 
decisions, diminishes capital formation, and results in too little 
capital being allocated to the corporate sector. As a result, the 
capital stock grows more slowly than it could otherwise, lowering the 
productivity of workers and thus the growth of their real wages. The 
President's plan to eliminate this double taxation will boost long-term 
efficiency and support increased investment that will promote higher 
near-term growth and job creation.
    The chapter also discusses ways in which the dynamism of the U.S. 
economy affects the evaluation of tax policies. For example, the effect 
of the tax system on an individual taxpayer is not well represented by 
a one-year, static snapshot of his or her income. Rather, its impact 
changes significantly over time as the taxpayer proceeds through the 
stages of life and his or her earnings rise and fall. Earnings 
typically rise through the working years, as the individual gains 
experience and human capital, then fall as the individual retires and 
exits the work force. (Chart 2 shows the progression of marginal tax 
rates for a hypothetical couple.) One's tax bill is also affected by, 
among other things, changes in employment, marriage and divorce, having 
and raising children, giving to charity, starting up a business, and 
buying and selling assets. The ebbs and flows of the business cycle 
also have an impact. In evaluating the distribution of the tax burden 
and how changes in the Tax Code affect that distribution, it is 
therefore important to consider the full range of individuals' lifetime 
experiences. For example, a college student is likely to have little 
income today but will benefit from tax relief upon entering the labor 
force. Conversely, a working couple nearing retirement who currently 
pay the top marginal income tax rate would benefit today from a 
reduction in that rate, but they might benefit less in the future once 
they have retired and their income is lower. In short, because 
everyone's tax situation changes over time for a variety of reasons, 
proper analysis of the distribution of taxation must consider not just 
who will benefit from tax relief today but who will benefit in the 
future as well.
                designing dynamic labor market policies
    As noted above, employment growth during 2002 did not keep pace 
with the recovery in output. From December 2001 through December 2002, 
non-farm payroll employment fell by 229,000, while the unemployment 
rate stayed between 5.6 and 6.0 percent. These statistics may give the 
impression of a static labor market. Yet dynamism remains the 
predominant characteristic of the labor market in the United States: in 
2002 millions of workers found new jobs, started new businesses, and 
raised their earnings. Chapter 3 of the Report documents some important 
dimensions of these labor market dynamics and discusses their 
implications for employment and productivity growth and for the design 
of policy.
    The mobility of workers--across jobs, up the opportunity ladder, 
and even in and out of employment--is one important dimension of a 
dynamic labor market and one of the great strengths of the U.S. labor 
market. American workers change jobs frequently, particularly during 
the first decade of their working lives, in part because doing so 
allows them to gain new experience and skills and, importantly, to 
increase their earnings--most earnings growth for younger workers comes 
about through job changes. For these new entrants, however, employment 
itself is the key aspect of this dynamic, because tenure on a job 
provides returns in terms of skill development and on-the-job training. 
This improvement in skills, in turn, makes possible increased earnings. 
Although staying on the ladder of upward mobility means maintaining an 
attachment to the labor market, it does not necessarily mean staying 
put in any one job. In a well-functioning labor market, there are large 
flows between employment and unemployment, and a substantial number of 
jobs are created and destroyed each year.
    These large flows are further evidence of the flexibility of the 
U.S. economy, as expanding firms and industries take on more workers 
while those in decline contract their labor forces. Research shows that 
frequent job changes for the young are, in an important sense, the 
means through which individuals are matched to the jobs that will 
provide them with the best opportunities.
    Government policies are more effective when they recognize and 
foster labor market mobility. Policies can support this mobility--and 
earnings growth--by encouraging skill development and education. 
Another important policy goal is to meet the desire of individuals for 
social insurance against the adverse consequences of short-term 
macroeconomic fluctuations and personal misfortune. Policymakers face 
difficult tradeoffs in designing social insurance, however, because the 
provision of insurance can itself distort behavior, making individuals 
less likely to enter employment or to exert full effort toward finding 
a job. As an example, for decades the Aid to Families with Dependent 
Children program provided insurance against destitution, but it also 
created a financial incentive for recipients to stay out of the work 
force. Welfare reform and the Earned Income Tax Credit are examples of 
policies that have supported individuals in time of need while also 
giving them incentives to enter the labor market and find jobs.
    The Administration has proposed a new program to help unemployed 
workers find jobs quickly. Qualifying workers would receive a Personal 
Reemployment Account of up to $3,000 each, with funds to be used for 
expenses such as training, child care, or relocation. These accounts, 
which are in addition to unemployment compensation, would be targeted 
to those unemployed workers who are deemed most likely to exhaust their 
unemployment benefits before finding a new job. Those who find a new 
job within 13 weeks would be able to receive a cash payment of the 
remaining funds in the account as a ``re-employment bonus.'' Personal 
Reemployment Accounts thus would provide not only support for training 
and skill development, but also potential additional transition 
assistance. One advantage of these accounts compared to traditional 
unemployment insurance is that traditional insurance encourages workers 
to wait until their insurance runs out before finding a new job (Chart 
3).
                        promoting global growth
    Chapter 6 of the Report examines how countries throughout the world 
can promote economic growth and thereby enhance the well-being of their 
people. In recent years many countries, especially in the developing 
world, have experienced robust growth, which has led to reduced 
poverty, lower infant mortality, improved health outcomes, and longer 
life expectancy. Many others, however, have been far less successful at 
promoting growth and have not seen similar improvements in social 
indicators. The central theme of the chapter is that all countries can 
experience faster growth by creating an economic environment in which 
market signals lead to better economic performance. Three principles 
guide these growth-oriented policy reforms. The first is economic 
freedom, in which encouraging competition and entrepreneurship leads to 
stronger growth. Economic freedom involves, among other things, a 
stable domestic macroeconomic environment with low inflation, 
appropriate government regulation, encouragement of entrepreneurial 
initiative, and openness to the global economy. The second pro-growth 
principle is governing justly--safeguarding the rule of law, 
controlling corruption, and securing political freedom Indeed, the 
relationship between the strength of the rule of law in a country and 
its per-capita income is striking (Chart 4). The third principle is 
investing in people. These investments include those that promote the 
health and education of the population, making workers more productive. 
No one of these principles is enough to guarantee strong growth; 
rather, all three are mutually reinforcing aspects of a pro-growth 
agenda. The specific policy measures that will implement these pro-
growth principles similarly involve a number of elements: responsible 
fiscal and monetary policies, an appropriate size and role of 
government, domestic flexibility and internal competition, openness to 
the global economy, a healthy and educated population, and sound 
institutions. Countries that pursue a broad range of policies 
consistent with these principles perform better than those that do not. 
During the 1980s and 1990s, for example, those countries that were more 
open to the international economy grew much faster on average than 
those that were more closed.
    The President has inaugurated three important policy initiatives 
designed to stimulate economic performance in countries around the 
world: trade liberalization initiatives negotiated pursuant to Trade 
Promotion Authority, which will promote countries' openness to 
international trade and investment; the Millennium Challenge Account, 
which will provide direct financial assistance to developing countries 
adopting pro-growth policies; and reform of the multilateral 
development banks, which will encourage private sector involvement in 
results-oriented development programs undertaken by the World Bank and 
the regional development banks. Through these and other policies, the 
United States will help countries address the challenge of improving 
their economic growth. Ultimately, however, creating a pro-growth 
environment is up to each country's own people and government. The 
initiatives of the United States will help in important ways, 
especially by reinforcing pro-growth decisions by governments and 
individuals. They are not, however, substitutes for the adoption of 
good policies in developing countries themselves, which are ultimately 
the key to success. The pro-growth agenda embodied in these three 
policy initiatives will enhance growth and prosperity both at home and 
abroad. This is the most direct way to improve standards of living and 
thus the lives of people around the world.
                               conclusion
    The United States is recovering from both an economic downturn and 
the aftershocks of the terrorist attacks of September 2001. Government 
policies have aided this recovery in important ways, with support from 
both fiscal and monetary initiatives. Perhaps most important in 
ensuring recovery, however, has been the underlying flexibility and 
dynamism of the U.S. economy. In the midst of the downturn, workers 
continued to find new opportunities, savers continued to reallocate 
their funds in search of greater returns, and firms continued to 
regroup and to invest in future growth. The economic policies of the 
Administration will likewise continue to support this quest for growth, 
both here at home and around the world.
    Thank you, Mr. Chairman. We look forward to your questions.


    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

    
        Prepared Statement of Eric M. Engen, Resident Scholar, 
             American Enterprise Institute, Washington, DC
    Mr. Chairman and members of the committee, it is a great privilege 
to have the opportunity to appear before you today. My name is Eric 
Engen. I am a resident scholar at the American Enterprise Institute in 
Washington, D.C. where my research focuses on the effects of tax and 
budget policy on the economy. Prior to joining AEI, I was a senior 
economist and section chief at the Federal Reserve Board of Governors.
    My testimony provides perspectives on some of the tax policy 
reforms discussed in the Economic Report of the President and proposed 
in the President's recent budget.\1\ In particular, I focus on the 
investment and saving incentives provided by the tax relief for 
corporate earnings and the tax-free saving accounts.
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    \1\ I am testifying on my own behalf and not as a representative of 
AEI.
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    My principal conclusions are as follows:
     The taxation of capital income, sometimes at very high 
marginal rates, in the U.S. tax system stands in marked contrast to the 
implications of optimal tax theory in the economics literature, which 
has generally concluded that the optimal tax on capital income is zero. 
Capital taxes reduce saving and investment, and a smaller capital stock 
reduces the productivity and wages of workers.
     The proposal to remove the ``double taxation'' of 
corporate earnings would lower the cost of investment for firms and 
increase the after-tax returns to savers that hold corporate equity, 
thus stimulating capital formation, boosting the productivity of 
workers, and raising wages and income.
     Exempting corporate profits from personal income taxation 
reduces the tax incentives for corporations to retain earnings instead 
of paying dividends. Higher dividend payouts would help improve the 
allocation of corporate capital and assist stockholders in monitoring 
corporate managers.
     Exempting corporate profits from personal income taxation 
reduces the tax incentives for corporations to finance investments with 
debt instead of equity. Less corporate debt reduces the probabilities 
of default and bankruptcy in an economic slowdown and thus would lower 
the risk premium included in the cost of financing corporate capital.
     The United States has the second highest corporate tax 
rate among its economic competitors and is one of only three countries 
in the OECD that does not provide dividend tax relief. Although the 
corporate tax rate would still remain relatively high, eliminating the 
double taxation of dividends would improve the competitiveness of U.S. 
firms in the global economy.
     The President's proposals for expanding tax-free savings 
accounts would continue the trend seen for more than twenty years of 
moving the personal income tax towards a consumption tax base.
     The Retirement Savings Accounts (RSAs) would be the most 
likely to increase personal saving as it would significantly increase 
the contribution limits associated with Roth IRAs, which RSAs would 
replace. The higher the contribution limits for these accounts then the 
greater the economic incentives for households to increase saving.
     The Employer Retirement Savings Accounts (ERSAs) typically 
do not increase the contribution limits that employees will receive 
from similar types of current plans--401(k) and 403(b) accounts, for 
example--and thus would not be expected to increase marginal saving 
incentives more than current plans. However, the simplification and 
lower compliance costs of ERSAs should increase the availability of 
employer-based retirement accounts, particularly for small-business 
employees.
     The effects of Lifetime Savings Accounts (LSAs) on 
aggregate personal saving are harder to estimate and more likely to be 
mixed, although they would probably be the most popular owing to their 
lack of withdrawal restrictions. Particularly in early years after the 
introduction of LSAs, households would have the incentive to merely 
shift assets from currently taxed bank accounts and mutual funds into 
an LSA. For lower- and middle-income households, eventually existing 
assets would be exhausted and marginal incentives to increase saving 
would start to become effective. For higher-income households, this 
process would take longer.
                               background
    Capital income, which reflects the returns to saving and 
investment, can face substantial rates of taxation, particularly if 
generated by corporate businesses. The federal corporate income tax 
rate for most corporations is currently 35 percent, and state corporate 
taxes add, on average, another 4 to 5 percent to the effective 
corporate tax rate. When corporate income is delivered to shareholders, 
it then often faces combined federal and state personal income tax 
rates on dividends that can exceed 40 percent. Thus, the overall 
marginal tax rate on distributed corporate income can easily be over 60 
percent.\2\ Even if corporate earnings are retained but ultimately 
dispersed to shareholders through the redemption of stocks that give 
rise to capital gains, which are typically taxed at a 20 percent rate 
in the personal income tax, the tax bite on the return from investment 
in corporate capital is still quite sizable. The high rates of taxation 
on capital income in the United States stand in marked contrast to the 
implications of optimal tax theory in the economics literature. 
Numerous economic studies have concluded that an optimal tax system in 
most scenarios will not include a tax on capital.\3\ This conclusion 
reflects the highly distortionary effects of capital income taxes over 
long time periods--a distortion that ``explodes'' or ``compounds'' even 
with a small capital income tax.
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    \2\ This second layer of taxes on dividends can be avoided if the 
shareholder is tax-exempt, such as a non-profit organization, and are 
typically delayed until withdrawal if the dividends go to shares held 
in a tax-preferred retirement or insurance arrangement, such as a 
401(k) or other pension plan, an IRA, or variable annuity. See William 
Gale, ``About Half of Dividend Payments Do Not Face Double Taxation,'' 
Tax Notes (Nov. 11, 2002).
    \3\ Ken Judd, ``Optimal Taxation and Spending in General 
Competitive Growth Models,'' Journal of Public Economics (1999) and 
``The Impact of Tax Reform in Modern Dynamic Economies,'' in K. Hassett 
and G. Hubbard (eds.) Transition Costs of Fundamental Tax Reform 
(2001), and Alan Auerbach and James Hines, ``Taxation and Economic 
Efficiency,'' in A. Auerbach and M. Feldstein (eds.) Handbook of Public 
Economics, Volume 3 (2002) provide recent discussion and summaries of 
this literature.
---------------------------------------------------------------------------
    Economic growth and a higher standard of living in the United 
States are ultimately achieved by increasing the productivity of U.S. 
workers. Increased productivity requires investment, which is funded by 
saving. Thus, the economic burden of capital income taxes is not just 
born by high-income capital owners. The lower level of capital 
accumulation that results from high capital income taxes also has 
adverse effects for workers. Less capital makes workers less 
productive. If worker productivity is lower, then wages are lower.\4\ 
Therefore, even if workers owned no capital--a description that is 
increasingly less appropriate for households in the United States, more 
than half of whom own corporate stocks--then workers would still be 
better off with no tax on capital because their wages would be 
higher.\5\
---------------------------------------------------------------------------
    \4\ A recent National Bureau of Economic Research working paper by 
Casey Mulligan, ``Capital Tax Incidence: First Impressions from the 
Time Series'' (#9374, December 2002) finds evidence that the economic 
burden of capital taxes are shifted significantly on to workers over 
the long run.
    \5\ Greg Mankiw, ``Commentary: Balanced-Budget Restraint in Taxing 
Income from Wealth in the Ramsey Model,'' in K. Hassett and G. Hubbard 
(eds.) Transition Costs of Fundamental Tax Reform (2001) presents an 
economic model that provides this result.
---------------------------------------------------------------------------
    When compared to our primary economic competitors, such as 
countries in the OECD, the United States has a relatively high 
corporate income tax rate and, unlike most of these competitors, does 
not provide relief for the ``double taxation'' of corporate income.\6\ 
The combined U.S. federal and local corporate income tax rate is almost 
40 percent, second only to Japan, while the average corporate income 
tax rate for other OECD countries is closer to 30 percent. Moreover, 
the United States is one of only three OECD countries that do not have 
provisions in its Tax Code for some relief from the double layer of 
taxation of corporate dividends. Switzerland and Ireland do not provide 
dividend tax relief but their corporate income tax rates are among the 
lowest in the OECD--21 percent and 12.5 percent, respectively.
---------------------------------------------------------------------------
    \6\ Eric Engen and Kevin Hassett, ``Does the U.S. Corporate Tax 
Have a Future?'' Tax Notes 30th Anniversay Issue (2002) discusses more 
fully these issues concerning high corporate taxation in the United 
States relative to our economic competitors. Indeed, since that article 
was written, some European countries--such as Belgium, Italy, France, 
and Luxembourg, for example--have lowered their corporate tax rates 
even further than shown in the paper.
---------------------------------------------------------------------------
    The global economy is expanding rapidly. It is vital to the growth 
of the U.S. economy for U.S. businesses to be internationally 
competitive. Higher taxes in the United States on the returns to 
corporate capital inhibit the competitiveness of U.S.-based companies 
in foreign markets. As financial markets become more global, U.S. 
investors may tend to be more willing to invest in foreign-based rather 
than U.S.-based companies. Mergers may be more likely to be set up as a 
foreign acquisition of a U.S. corporation. Transactions where a foreign 
subsidiary acquires a U.S.-based parent company may become more 
frequent. The high rates of taxation on the return from corporate 
investment can tend to make the United States a relatively unbecoming 
location for the headquarters of a multinational corporation, which 
can, in turn, cause U.S. multinationals share in the global market to 
shrink.
                  president's proposals for tax reform
1. Reduction of the Tax on Corporate Earnings
    There are several different methods in which relief could be 
provided for the double taxation of corporate dividends in the United 
States. One would provide a shareholder credit for corporate taxes 
paid. When a corporate shareholder receives a taxable dividend, the 
shareholder would be entitled to a credit against their taxes for the 
corporate taxes effectively paid on the dividend income. Many countries 
that have tax relief for double taxation of dividends use a form of the 
shareholder credit. However, the Treasury Department advised against 
this approach in a 1992 Report because of the complexity of actually 
implementing the shareholder credit.\7\ In its Report, Treasury 
recommended instead that dividend tax relief could be better 
implemented if a shareholder was allowed to exclude from gross income 
the dividends received from a corporation. The President's proposal is 
consistent with Treasury's earlier assessment that this dividend 
exclusion framework is simpler than a shareholder credit, and could be 
implemented with less structural change to the Tax Code.\8\ It also 
accounts for the fact that about half of dividend payments are 
currently not taxed, and thus removes the economic distortion of 
disproportionate taxes on dividends with a smaller reduction in federal 
revenues.
---------------------------------------------------------------------------
    \7\ Department of the Treasury, ``Integration of the Individual and 
Corporate Tax Systems: Taxing Business Income Once'' (January 1992).
    \8\ Indeed, for about a decade prior to its repeal in the Tax 
Reform Act of 1986, taxpayers were permitted a limited exclusion of 
dividends from gross income in the personal income tax.
---------------------------------------------------------------------------
    The President's proposal not only removes the double taxation of 
corporate earnings distributed to shareholders, it also removes the 
double taxation on corporate earnings that are retained. The retained 
earnings of a corporation should be reflected in an increase in the 
value of corporate shares, which when sold generate taxable capital 
gains. Although the advantages of deferral and preferential tax rates 
mean that the second layer of taxation on these capital gains is 
smaller than the tax on dividends, the tax is still positive. If the 
President's proposal only exempted dividends from personal taxation 
then dividends would be tax-advantaged compared to retained earnings. 
However, under this proposal, the tax treatment of all corporate 
earnings is equal.
    There are a number of economic benefits that could be attained by 
having corporate earnings taxed only once. Taxing corporate earnings 
only once would lower the cost of investment for firms and increase the 
after-tax returns to savers that hold corporate equity, thus 
stimulating capital formation, boosting the productivity of workers, 
and raising wages and income. Although economists are not in complete 
agreement about the effect of dividend taxes on investment, typically 
the empirical results suggest that a reduction in the tax on dividends 
would markedly increase investment.\9\
---------------------------------------------------------------------------
    \9\ A seminal study by Jim Poterba and Larry Summers, ``The 
Economic Effects of Dividend Taxes,'' in Altman and Subrahmanyam 
(eds.), Recent Advances in Corporate Finance (1985) found that dividend 
taxes had substantial negative effects on corporate investment. A 
recent study by Alan Auerbach and Kevin Hassett, ``On the Marginal 
Source of Funds,'' Journal of Public Economics (2003), found a smaller 
but still economically significant effect of dividend taxes on 
investment.
---------------------------------------------------------------------------
    The effect of reducing the tax on corporate earnings can also 
potentially raise stock prices. A fundamental determinant of the value 
of a share of corporate equity is the present discounted value of all 
future after-tax dividend payments. Thus, a reduction in taxes on 
dividends could lead to higher corporate stock values. However, if the 
reduction in dividend taxes stimulates new investment, then some of 
this new investment may be done by new firms that enter into markets 
and compete away the profits of existing firms, thus inhibiting 
increases in stock prices. The more (less) new investment then the less 
(more) likely that stock prices rise.
    Exempting corporate profits from personal income taxation reduces 
the tax incentives for corporations to retain earnings instead of 
paying dividends.\10\ Higher dividend payouts would help improve the 
allocation of corporate capital because this proposal would remove the 
``lock-in'' effect caused by the current tax incentives that make it 
easier for a firm to keep and reinvest corporate earnings. Instead, 
there would be no tax disincentive for corporate earnings being 
reinvested in capital with the highest expected return, whether it is 
in the same firm or in another business venture. Moreover, a higher 
payout of dividends would assist stockholders in monitoring corporate 
managers. Dividends can only be paid with ``real'' earnings and thus 
corporate managers could not hide behind a Tax Code that discourages 
dividends while they generate only ``paper'' profits.
---------------------------------------------------------------------------
    \10\ Jim Poterba, ``Tax Policy and Corporate Saving,'' Brookings 
Papers on Economic Activity (1987) found that dividend payout rates are 
quite sensitive to changes in marginal income tax rates.
---------------------------------------------------------------------------
    Exempting corporate profits from personal income taxation reduces 
the tax incentives for corporations to finance investments with debt 
instead of equity.\11\ Less corporate debt reduces the probabilities of 
default and bankruptcy in an economic slowdown and thus would lower the 
risk premium included in the cost of financing corporate capital.
---------------------------------------------------------------------------
    \11\ John Graham, ``Do Personal Taxes Affect Corporate Financing 
Decisions?'' Journal of Public Economics (2002) and ``Taxes and 
Corporate Finance: A Review'' mimeo, Duke University (2003).
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2. Tax-Free Savings Accounts
    Retirement Savings Accounts. Of the three saving account proposals, 
RSAs would be the most likely to increase personal saving as it would 
significantly increase the contribution limits associated with Roth 
IRAs, which RSAs would replace. The profusion of asset shifting seen 
when IRAs were initially introduced on a universal basis over two 
decades ago has probably been exhausted. The higher contribution limits 
allowed by these accounts would result in a greater number of savers 
facing increased marginal incentives for saving.\12\ These marginal 
incentives for saving would tend to be more prevalent for lower- and 
middle-income households.\13\
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    \12\ Eric Engen and William Gale, ``IRAs and Saving in a Stochastic 
Life Cycle Model'' (1993) and ``Do Saving Incentives Work?'' Brookings 
Papers on Economic Activity (1994).
    \13\ Eric Engen and William Gale, ``The Effects of 401(k) Plans on 
Household Wealth: Differences Across Earnings Groups'' NBER working 
paper #8032 (2000).
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    Employer Retirement Savings Accounts. ERSAs typically do not 
increase the contribution limits that employees will receive from 
similar types of current plans--401(k) and 403(b) accounts, for 
example--and thus would not be expected to increase marginal saving 
incentives beyond those available in current employer-based plans. 
However, the simplification and lower compliance costs of ERSAs should 
increase the availability of employer-based retirement accounts, 
particularly for small-business employees. The costs and complexity of 
setting up retirement plans are frequently cited by small business 
owners as reasons for not offering a pension plan to their employees.
    Lifetime Savings Accounts. The effect of LSAs on aggregate personal 
saving are harder to estimate and more likely to be mixed. Particularly 
in early years after the introduction of LSAs, households would have 
the incentive to merely shift assets from currently taxed bank accounts 
and mutual funds into an LSA. For lower- and middle-income households, 
eventually existing assets would be exhausted and marginal incentives 
to increase saving would start to become effective. For higher-income 
households, this process would take longer. Moreover, because LSAs have 
no withdrawal restrictions then these accounts would be more likely to 
attract saving done for more short-term purposes than retirement 
saving, such as precautionary saving. Models of household saving 
typically imply that precautionary saving is less sensitive to changes 
in the after-tax return than longer-term retirement saving.\14\ For 
this reason, even if an LSA provides a marginal tax incentive for a 
household to save more, it may not induce as much increased saving as 
an RSA or ERSA which focuses on retirement saving.
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    \14\ Eric Engen, ``Consumption and Saving in a Life Cycle Model 
with Stochastic Earnings and Uncertain Lifespan'' (1993)
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    In general, the RSA and ERSA proposals are merely extensions of 
recent trends to increase the contribution limits to tax-favored 
retirement accounts and to simplify the provision of employer provided 
retirement accounts. Essentially, increasing the contribution limits 
for retirement accounts moves the personal income tax increasingly 
towards a consumption tax base as it exempts an increasing share of 
capital income from taxation. LSAs would be a much newer saving vehicle 
and would be a significant step further towards a consumption tax. LSAs 
would probably be quite popular since they do not have withdrawal 
restrictions. However, partly because the contribution limits prohibit 
households that save greater amounts from having a marginal incentive 
to save more, estimating the impact of LSAs on saving would be more 
speculative.
    Another important issue in evaluating the potential net saving 
effects of these accounts is the possible interaction with household 
borrowing--in particular, tax-deductible mortgage borrowing.\15\ To the 
degree that households that own a house essentially use increases in 
taxdeductible mortgage debt to essentially finance tax-favored saving, 
without having to reduce spending, then net personal saving does not 
increase. A complete shift to consumption tax treatment at the personal 
income tax level entails exempting all capital income received from 
taxation and also not allowing interest paid for borrowing to be tax-
deductible. Both of these features are important for getting the full 
benefits of increased saving by switching to a consumption tax. To the 
degree that these saving accounts limit contributions, and since the 
tax deductibility of mortgage interest remains available, then the 
positive effects on personal saving from these accounts are less than 
what would be expected from a complete switch to a consumption tax 
base.
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    \15\ Eric Engen and William Gale, ``Debt, Taxes, and the Effects of 
401(k) Plans on Household Wealth Accumulation'' (1997).
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                               __________
             Prepared Statement of Hon. Edward M. Kennedy, 
                    U.S. Senator from Massachusetts
    I commend our Chairman, Senator Bennett, for his leadership in 
holding this hearing on the President's Economic Report, and I join in 
welcoming today's witnesses to the Committee.
    Many of us in Congress have continuing concerns about the 
Administration's economic policy and its responses to the challenges 
facing our economy. When President Bush took office, his budget 
officials estimated that the cumulative surplus for the years 2002-2011 
would be $5.6 trillion. Now, the Congressional Budget Office says the 
huge surplus for that period ``has been all but eliminated.'' And 
that's before the President's proposed new tax cuts are factored into 
the budget.
    The principal proposal that President Bush has put forward to 
strengthen growth is to reduce taxes for the wealthy. The 
Administration's plan ignores the basic needs of most Americans and 
their widespread concerns about the faltering economy. Massive tax 
breaks for the wealthy are wrong. We cannot afford to shortchange 
essential priorities such as protecting homeland security, protecting 
social security and Medicare and investing in health care, education 
and job training.
    It was bad enough to pass a huge tax cut for the wealthy last year, 
when we had a surplus. Today, with the surplus gone, it is even more 
irresponsible for the Administration to propose huge new tax cuts now 
that drain the resources needed to meet obvious long-term commitments 
like national defense, Social Security and Medicare.
    Only two years ago, the national unemployment rate was 4 percent--
not 6 percent as it is now. The ranks of the uninsured and the poor 
were falling--not rising, as they are now. Workers were building 
retirement savings and planning for the future--not worrying about 
whether their jobs and their savings, as they are now. States had 
budget surpluses, not deficits that require cuts in basic services or 
new tax increases.
    States are cutting Medicaid, denying needed care for as many as one 
million low-income Americans. Cities are closing fire stations and 
laying off police officers and firefighters, who are our first 
responders in case of terrorist attacks.
    Yet the Administration is proposing more of the same old flawed 
policies. The President wants an even larger tax cut that is heavily 
tilted toward the very rich. That plan is not even an effective 
economic stimulus, since the most benefits go to the least likely to 
spend them.
    The President's economic plan offers little tax relief now, when 
the economy most needs a jump-start. Less than five percent of his 
economic package will be felt in most people's pockets and wallets 
during this fiscal year. It's no wonder that more than 450 economists--
including 10 Nobel Prize winners--signed a statement criticizing the 
President's proposal as an ineffective short-term stimulus that worsens 
our long-term budget outlook.
    The President's proposal is not a serious economic stimulus 
package. A true stimulus plan should meet three key criteria: It should 
be an immediate stimulus. It should be temporary, to avoid long-term 
damage to the economy. And it should provide needed assistance to state 
and local governments to ease their budget crises. Unlike the federal 
government, they have to balance their budgets.
    Obviously, Congress is sharply divided on these issues. I continue 
to hope that we can reach a fair compromise, but so far there seems to 
be little chance that we will do so. I urge the Administration to work 
with Congress on a plan that will genuinely help the economy and 
benefit all our citizens too.
                               __________
Greenspan Quotes from Monetary Policy Hearing Before the Senate Banking 
                     Committee on February 12, 2003
                       deficits hurt the economy
    ``There's no question that as deficits go up, contrary to what some 
have said, it does affect long-term interest rates. It does have a 
negative impact on the economy, unless attended.''
    Senator Corzine: ``I just wanted to make sure that I heard you say 
deficits impact long-term interest rates, in your view, and have an 
impact then on the investment function over a period of time.''
    Chairman Greenspan: ``you heard me correctly, sir.''
    ``The presumption that deficits some how would increase the GDP--
the more deficit, the greater the GDP--is a short-term view which I 
don't believe continues in the longer run. So I think we have to focus 
on, one maintaining maximum economic growth, but simultaneously 
recognize that a necessary condition to do that is that deficits have 
to be contained.''
    Greenspan confirmed his previously stated view that: ``The 
desirability of eliminating the federal debt, which is still, frankly, 
my first priority because I think it's had an extraordinarily important 
impact on the economy, on the financial markets, on long-term interest 
rates, and on economic growth.''
                          no need for stimulus
    ``I'm one of the few people who still are not as yet convinced that 
stimulus is a desirable policy at this particular point.''
                  tax changes must be revenue-neutral
    ``I support the program to reduce double taxation on dividends and 
the necessary other actions in the federal budget to make it revenue-
neutral.''
    On the new Bush tax cut--``I do believe it should be revenue-
neutral.''
    ``But it [eliminating the double taxation of dividends] should be 
done in the context of pay-go rules, which means that the deficit must 
be maintained at minimal levels.''
                the tax cut does not ``pay for itself''
    ``We are not going to make up for that huge revenue loss that the 
dividend tax cut would produce on spending.''
    ``Faster economic growth alone is not likely to be the full 
solution to currently projected long-term deficits.''
                         importance of savings
    ``We must be sure that the Federal Government does not impinge on 
the private sector's capability of creating goods and services and 
expanding the standard of living of the American people. And that 
requires that it not drain the savings resources of the private sector, 
which it does when it's running a deficit.''
    ``There are relationships between the government deficit, domestic 
investment and domestic savings which are all tied together. And they 
cannot go off in different directions without affecting each other.''
    ``The more savings that we have that are productively used in our 
economy, the greater the productivity, the greater the growth, the 
greater the prosperity that we have.''
    ``In my judgment to try to formulate a budget policy which is 
stable, meaning that it does not create pressures on private finance 
which eliminates the underlying growth pattern in the economy.''
          need to craft a budget without a structural deficit
    ``We have to be very careful because there is no self-equilibrating 
mechanism when that [structural deficits] is occurring because a rise 
in the debt increases the amount of interest payments, which in turn 
increases the debt still further and there is an acceleration pattern 
after you reach a certain point of no return.''
                    permanent tax cuts do not exist
    ``I don't think that we can have permanent tax cuts or permanent 
spending programs in the sense that they exist independently of the tax 
base or the revenue-raising base of the economy . . . The notion of 
permanence cannot rationally be consistent with the programs we're 
involved in.''
                           aid to the states
    ``I have no objection obviously to having federal funds go to the 
states . . . I do have some problems--how would one in fairness create 
a program which did not essentially benefit those who are the least 
conservative in the programs relative to those who were? If that can be 
done, then I think that there are obvious arguments in favor of it.''
    ``To the extent that taxes are raised in order to close those gaps, 
I would assume that it is restrictive of economic activity in the 
locality.''
                            municipal bonds
    ``The issue that municipal finance, the interest rates that are 
involved would be affected by essentially creating a whole new segment 
of demand for un-taxable issues.''
                         problems down the road
    ``Short of an outsized acceleration of productivity to well beyond 
the average pace of the past seven years or a major expansion of 
immigration, the aging of the population now in train will end this 
state of relative budget tranquility in about a decade's time.''
  

                                  
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