[Senate Hearing 108-413]
[From the U.S. Government Publishing Office]



                                                      S. Hrg. 108 - 413


                        JUMPSTARTING THE ECONOMY

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

                                HEARINGS

                               before the

                    SUBCOMMITTEE ON ECONOMIC POLICY

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                                   ON

           INCREASING THE INVESTMENT IN THE EQUITY MARKET AND
                            IN RURAL AMERICA

                               __________

                        MAY 22 AND JUNE 25, 2003

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


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                            WASHINGTON : 2003
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire        THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina       DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island      JON S. CORZINE, New Jersey

             Kathleen L. Casey, Staff Director and Counsel

     Steven B. Harris, Democratic Staff Director and Chief Counsel

               Peggy R. Kuhn, Senior Financial Economist

             Martin J. Gruenberg, Democratic Senior Counsel

                   Aaron Klein, Democratic Economist

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                 ______

                    Subcommittee on Economic Policy

                    JIM BUNNING, Kentucky, Chairman

              CHARLES E. SCHUMER, New York, Ranking Member

ELIZABETH DOLE, North Carolina       ZELL MILLER, Georgia
RICHARD C. SHELBY, Alabama

                    Steven Patterson, Staff Director

                 James Socas, Democratic Staff Director

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                         THURSDAY, MAY 22, 2003

                                                                   Page

Opening statement of Senator Bunning.............................     1
    Prepared statement...........................................    29

Statement of Senator Schumer.....................................     7

                               WITNESSES

Peter R. Fisher, Under Secretary for Domestic Finance, Office of 
  Public Affairs, U.S. Department of the Treasury................     2
    Prepared statement...........................................    29

Wayne D. Angell, Former Federal Reserve Governor.................    10
    Prepared statement...........................................    30

James W. Stuckert, Chairman and Chief Executive Officer, J.J.B. 
  Hilliard and W.L. Lyons, Inc...................................    15

Mark Zandi, Chief Economist and Co-Founder, Economy.Com..........    18
    Prepared statement...........................................    37

                              ----------                              

                        WEDNESDAY, JUNE 25, 2003

Opening statement of Senator Bunning.............................    41

                               WITNESSES

Hilda Gay Legg, Administrator, Rural Utilities Service, Rural 
  Development Mission Area, U.S. Department of Agriculture.......    42
    Prepared statement...........................................    55

M. Scott Smith, Dean and Director, College of Agriculture, 
  University of Kentucky.........................................    44
    Prepared statement...........................................    57

Mark Haney, Vice President, Kentucky Farm Bureau Federation......    46
    Prepared statement...........................................    58

                                 (iii)

 
                       JUMPSTARTING THE ECONOMY:
                      INCREASING INVESTMENT IN THE
                             EQUITY MARKETS

                              ----------                              


                         THURSDAY, MAY 22, 2003

                               U.S. Senate,
  Committee on Banking, Housing, and Urban Affairs,
                           Subcommittee on Economic Policy,
                                                    Washington, DC.

    The Subcommittee met at 10 a.m. in room SD-538 of the 
Dirksen Senate Office Building, Senator Jim Bunning (Chairman 
of the Subcommittee) presiding.

            OPENING STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. I would like to call the first hearing of 
the Economic Policy Subcommittee of the 108th Congress to 
order.
    I want to thank all of our witnesses for being here to 
testify.
    Today, we have the first in a series of hearings titled, 
``Jumpstarting the Economy.'' I do not think that it could be 
more appropriately timed, since we are about to embark on a 
very interesting 2 days as far as the tax bill is concerned. I 
am very concerned with the state of our economy. I am very 
worried about the possibility of a double-dip recession. I know 
that that puts me at odds with more optimistic experts like 
Chairman Greenspan, but we have disagreed before. We are not 
growing like we can and we are not creating jobs--particularly 
not creating jobs. There are many reasons for this.
    I believe Chairman Greenspan acted way too slow to cut 
rates back in early 2001. He should have cut them in the fall 
of 2000. The corporate governance scandals have hurt trust in 
the markets. Sarbanes-Oxley and other actions have helped, but 
it will take a long time for corporate America to rebuild that 
trust. September 11 had a devastating effect on our economy. 
The two wars that we have had since then also have not helped.
    The reason why most of these events have been so harmful to 
this economy is because they have created uncertainty in our 
markets. If there is one thing that shakes the markets, it is 
uncertainty. I am hopeful that our witnesses today will help us 
find a way to bring some certainty back to the markets.
    Since the height of the bull market in March 2000, the 
stock market's values have been reduced by about $8.5 trillion. 
At the market's height back in early 2000, the market cap of 
the Wilshire 5000 totaled $17 trillion. By the time of the 
market's low in early October, the index's market cap had 
shrunk by about half of that amount, or about $8.5 trillion. We 
have a $10 trillion economy right now. We have had stock losses 
of $8.5 trillion in 3 years. It is not surprising that 
investors are skittish.
    If we are going to grow this economy, we have to get the 
people investing again. We need to create capital so businesses 
have the opportunity to invest and grow. Before we adjourn for 
Memorial Day, we will be voting on a growth package. I think it 
is critical that we send a package to the President for his 
signature.
    I wish the package was bigger, much, much bigger, I hope 
$350 billion is enough to move a $10 trillion economy, but we 
must make a start somewhere. We must create jobs and we must 
make sure that our economy grows. We must bring back some 
certainty to the markets if we are ever going to grow this 
economy and prevent a double-dip recession.
    Once again, I thank all of our witnesses for testifying 
today. And since my colleagues are at other meetings right now, 
I am going to start with Mr. Fisher from the Department of the 
Treasury as our first witness.
    The mic is yours, Mr. Fisher.

                  STATEMENT OF PETER R. FISHER

              UNDER SECRETARY FOR DOMESTIC FINANCE

                    OFFICE OF PUBLIC AFFAIRS

                U.S. DEPARTMENT OF THE TREASURY

    Mr. Fisher. Thank you, Mr. Chairman.
    I am very pleased that you have chosen to hold this hearing 
on the challenge of increasing the incentives for investment. 
If you will permit my written statement to be included in the 
record, I would like to briefly summarize my remarks.
    Senator Bunning. Without objection.
    Mr. Fisher. Thank you.
    To reinvigorate our Nation's economy in this decade, and to 
pay for our collective retirement in the coming decades, we 
need to 
enhance the incentives for investment that will create the jobs 

we need now and to sustain our standard of living in the 
future. 
To do this, both the public sector and the private sector must 
do 
their part.
    We in the Federal Government must examine and remove the 
legal and regulatory obstacles to greater savings and 
investment. In the private sector, to rebuild investor 
confidence, as you pointed out, Mr. Chairman, I believe that 
publicly traded companies need to do a better job of disclosing 
information to their shareholders.
    We are not satisfied with the current rate of job creation 
in our economy. In order to do something about this, we need to 
increase investment. There is only one place that new jobs come 
from--they come from the willingness of investors and 
entrepreneurs to put capital at risk in a business venture. The 
President has focused us precisely on this point, on sharpening 
the incentives for productive investment by reducing the biases 
against equity investment that now exist in our tax code.
    There is no better example of these distortions that 
discourage savings and investment than the current double 
taxation of corporate dividends. No one defends the double 
taxation of dividends from first principles, and no other major 
industrial nation taxes profits at such a punitive effective 
rate. We are encouraged by the progress now being made on the 
President's jobs and growth proposal, including progress toward 
lowering tax barriers to savings and investment.
    The Administration, as you alluded to, Mr. Chairman, is 
working closely with Congress today, yesterday, and over these 
next few days, to obtain the best package possible as quickly 
as possible. The President has made clear that the sooner we 
get this done, the sooner we will be creating the jobs that put 
people back to work.
    Increasing the incentives for savings and investment in 
America will require effort not only, or even principally, by 
the Government, but also by the private sector. In particular, 
it will require a sustained effort by corporate leaders to 
restore investor confidence.
    Congress passed the Sarbanes-Oxley Act, and the SEC and the 
Justice Department are successfully implementing its provisions 
to improve corporate governance. But publicly traded companies 
also have a responsibility to restore investor confidence by 
providing shareholders with better, more useful information 
about the companies in which they invest.
    Our Nation's securities markets are extremely efficient at 
pricing and allocating capital on the basis of all available 
information. Unfortunately, important information about the 
real economic leverage of the firm and about the firm's current 
condition and business prospects is too often not available.
    To restore investor confidence, shareholders need to be 
able to see the companies that they own through the eyes of 
management. Private-sector leaders should take the 
responsibility to transform the practice of corporate 
disclosure, to set new standards of best practices that will 
genuinely inform investors about their firm's risk /reward 
prospects. Until they do, I fear that investor confidence will 
not be restored to the point where we will see the increased 
equity investment that our economy needs.
    But if we in the Federal Government can strive to reduce 
the obstacles to savings and investment imposed by our tax 
code, and if corporate leaders strive to give shareholders more 
useful information about the companies in which they invest, 
then we are much more likely to see the expansion of equity 
investment that is necessary for our future prosperity.
    Thank you for this opportunity to be here and I look 
forward to your questions, Mr. Chairman.
    Senator Bunning. Thank you very much, Mr. Fisher.
    Let me start out by talking about the current bill that we 
have, or proposed bill that we have before us in the stimulus 
package, or the job-creation package, whatever you want to call 
it. It is the tax bill. What do you believe would happen if we 
did not--I say not--pass the stimulus package?
    Mr. Fisher. Well, when I look out at the economy, as you 
described it, I see a need for us to do two things to get the 
economy moving at a pace that will create jobs. We need to have 
balanced support for both consumption and investment. The 
package the President proposed, and still the variables now 
being debated these last few days do provide us balanced 
support--doing something for homeowners and families and hard-
working Americans, and doing something to give business 
incentives for greater investment.
    Particularly the latter. We see that over the last few 
years, we have a lack of business investment. As both you and I 
have pointed out, business investment is the key to new jobs.
    Therefore when I look at the risks to our economy now of 
under-performing its potential, then we will run a much higher 
risk of the double-dip inflation that you are concerned about. 
Or if not a double-dip, then lower growth than needed to create 
the necessary jobs. We simply do not need to take that risk. We 
should be doing something to provide balanced support.
    Senator Bunning. There are many ways to put 51 votes 
together to get a package passed. One of the unique ways that 
is in this bill, at least it was as of last night, and I 
suspect that it was this morning when the President appeared up 
here, is a $20 billion allotment for States.
    Now, we all know that State governments are having the same 
problem as the Federal Government. I know that a $8 billion 
shortfall is occurring presently in California. In Kentucky, it 
is not as large, but it is proportionately as large. And many 
other States are. I think there is only one State that does not 
have a budget deficit. It seems to me that, on the policy side 
of tax, that this is a horrible idea. I just would like your 
opinion on the Federal Government investing $20 billion in the 
shortfalls of State governments.
    Mr. Fisher. Well, I am aware of the proposals now 
circulating. I haven't had a chance to study the bill language 
that you may have been up late last night with.
    Let me be clear. Direct support for the States was not part 
of the President's proposals, going back to January. We felt 
the best thing to do for State governments was to try to get 
the economy going.
    I do not remember the exact figures now, but for every 1 
percent increase in GDP in the country, States experience a 
greater than 1 percent increase in sales tax revenues.
    It seemed to us that the more we focused on the combined 
problem of job creation and revenue shortfalls, that the best 
way to address both problems was to get investment moving and 
try to get the economy moving. So that was certainly our first 
choice going back to the President's proposals.
    Senator Bunning. Okay. You stressed in your testimony the 
need to reduce market distortions that discourage savings and 
investment and the need to increase transparency. Do you really 
think that the same measures will bring benefits in both the 
short- and long-term?
    Mr. Fisher. Yes, I do. I think that the real way to restore 
investor confidence and business leader confidence is to give 
them the kind of planning horizons that they need to make 
investments now. That is, confidence to make an investment 
today comes from being able to see far enough into the future, 
that you can make plans and have confidence.
    So to give our economy a boost today in the form of 
investment and, frankly, also to give American families 
confidence in their financial position for the future so that 
they can make consumption decisions today, you will get the 
effect in both places if you provide sound tax policies.
    And so, on the rate front, as I have said many times, just 
as homeowners experience an enduring improvement in their 
household cashflows when they refinance their mortgages at 
lower rates, and they get to see that they are going to have 
that income there month after month and quarter after quarter, 
they then feel more confident about their future and may feel 
better about buying large durable goods--a new refrigerator or 
a new car.
    Now for business men and women, it is the same issue. To 
make an investment now, they need to see that investment 
horizon, lowering the burden on investment, lowering the tax 
burden, in order to make that investment so that they can see 
the return.
    I think that when we do sound tax policies that have an 
enduring impact, we will get the benefit now of the investment 
that we have been lacking, and that very investment is what 
will sustain us into the future.
    Senator Bunning. Let's go back to the tax bill, then, 
because I am not a policy work, but I would like sound tax 
policy.
    We are creating a bill that adds more confusion and more 
pages to the current tax code. It certainly is not 
simplification. We are doing investment tax credit for 1 year 
at 50 percent. We are doing expensing 1 year at $100,000, it is 
my understanding. We are doing the child tax credit for 2 
years. We are doing the marriage penalty correction for 2 
years. That seems to me to be a horrible tax policy. You are 
talking about having the knowledge and the ability to look into 
the future and that business and investors like to be sure of 
what is going to be there. In 2 years, some of these things are 
not going to be there. In some cases, they are not going to be 
here after 1 year.
    So, as far as policy is concerned, we have created 
something that will pass with 51 votes. My opinion is that it 
will stimulate for a short period of time.
    The dividend is not the exact dividend policy that the 
President has brought forward, but it is the House version 
where we reduce capital gains on dividend income from the 
current rate, which would be 35 or whatever bracket that you 
are in, to apply a capital gain rate to it at 15 percent. If 
you are in the 10 percent bracket, it is reduced to 5 percent. 
And that stays in for quite a while.
    What we are doing is taking dividend taxation and not 
double-taxing it, but taxing it at a capital gains rate. You 
are looking at tax policy and that is your job. What kind of 
tax policy is that?
    Mr. Fisher. Well, as I said, the President's first 
preferences were in the proposal in January.
    Senator Bunning. I understand that.
    Mr. Fisher. And we prefer enduring, and enduring would be 
even better than what we may have on the table in front of us. 
However, I think we understand that sunset provisions are not 
uncommon in all forms of legislation so that Congress can take 
another look. I think it would be better to have enduring, but 
we are trying to get the best package that we can.
    Senator Bunning. The restrictions of $350 billion is pretty 
restrictive and pretty infinitesimal in a $10-plus trillion 
economy. Or if you look at the big picture of a 10-year 
picture, where you have a $100 trillion plus economy and you 
are looking at $350 billion, you must front-load--thank God for 
our Budget Act, where we allow about $190 billion to be in the 
first 2 years.
    But it is really difficult for me to swallow the way that 
we sunset because the planners, the policy planners, the people 
who do the planning for corporate America, that do the planning 
for individual accounts, have difficulty with the short-term 
effect of what this tax bill will bring.
    I just hope that it is stimulative enough to keep us on the 
upswing and we do get the capital necessary, particularly for 
the small business person because about 65 to 70 percent of all 
new jobs are created by small business, not the giant 
corporations.
    I will ask you one more question and let you be on your 
way.
    As you know, the 1-year anniversary of Sarbanes-Oxley is 
coming up. I know that Chairman Shelby of the full Banking 
Committee is planning an oversight hearing to mark the 
anniversary. Do you believe anything else is needed to be done 
in the area of corporate disclosure? Is there anything that you 
think we need to be watching as the SEC continues to implement 
that law?
    Mr. Fisher. Yes, let me make two observations.
    First, I think that I cannot now identify any additional 
actions that Congress should be taking. I am not aware of any. 
I think that we want to see the implementation of Sarbanes-
Oxley work its way through the corporate system going forward. 
However, I think there is an area we should be sensitive to and 
try to observe over the next year or so, which is the impact of 
the additional requirements to improve corporate governance, 
corporate disclosure, on small companies coming to our capital 
markets.
    That is a sensitive area that we should look at and 
observe. I do not think that we have enough data now to draw 
conclusions. But I think over the coming year or so, we should 
be sensitive to the question of whether small companies, 
emerging companies, can reach into our deep capital markets and 
become public companies and raise capital efficiently that way, 
or whether the requirements we have put in may be an obstacle.
    Clearly, given the weakness of the economy and the 
investment climate, I think the current data on new public 
offerings by small companies is something that we should not 
view as a consequence of Sarbanes-Oxley. But this is an area 
that I think we have to be concerned with going forward.
    I would also say that I think there is a great deal that 
corporate leaders can do and should do to improve the clarity 
of their disclosures to investors.
    I think the SEC is working diligently in implementing 
Sarbanes-Oxley. It has very good rules out on off-balance sheet 
disclosure. I know that FASB is working on these issues. But I 
still think that there is a good deal more that corporate 
leaders can do to improve the clarity of their disclosures with 
respect to off-balance sheet leverage and the clarity of 
disclosure with respect to their business prospects.
    I am very concerned looking back over the last decade that 
corporate leaders now have access to much better information 
internally, as a consequence of the data management revolution 
and what computers have been able to do for them in managing 
data.
    So, they have a much better sense of not so much the 
financial issues, but just their business prospects--new order 
flow, customer orders. That information is available to them in 
a way it was not available a decade ago. And that compounds the 
information, a symmetry on insiders versus outsiders. I think 
there are a number of businesses and a number of academics who 
are trying to lead the way to what is called the value 
reporting revolution, the business value--not so much the 
financial indicators, but business value disclosure to 
shareholders about the prospects of the business.
    I think there is a lot of room for corporate leaders to do 
a better job in the MDNA section of their disclosures to get 
that information out to shareholders. And that is another area 
that I think we should be watching over the coming years.
    But I think that is a terrific question you asked.
    Senator Bunning. Senator Schumer.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Yes, thank you. I want to apologize to 
you, Mr. Chairman, and to the witness and the other witnesses. 
Unfortunately, we have a simultaneous hearing in Judiciary 
where I am offering, along with Senator Grassley, the amendment 
on cameras in the courtroom. So, I am going to have to scuttle 
on down there. But I thank you, Mr. Chairman, for having this 
hearing.
    Thank you, Mr. Fisher, for your terrific service.
    First, I would like to just tell you that I think it was 
great that you were considering a position at the New York Fed. 
I guess you are not going to take that. I do not know. But if 
you are, we are going to miss you. Do you want to comment on 
where you are going, what you are doing, and all that?
    Mr. Fisher. No. No, thank you.
    Senator Schumer. No? I did not think so.
    [Laughter.]
    But you have done a great job.
    Mr. Fisher. Thank you very much.
    Senator Schumer. If you are staying, continue to do a great 
job. If you are leaving, you have done a great job.
    [Laughter.]
    Mr. Fisher. Thank you very much, Senator.
    Senator Schumer. The question I really wanted to focus on 
just a little bit is Secretary Snow's comments on the dollar, 
which have caused a whole lot of controversy and comment.
    The Wall Street Journal editorial--well, they were pretty 
negative. They said: ``But the huge danger in bashing the 
dollar comes from the currency markets themselves. Famous for 
overreacting, the dollar could fall too fast and too far. 
Foreign investors hold almost half of U.S. bonds, a third of 
U.S. corporate bonds, 10 percent of U.S. stocks. Their 
confidence in the U.S. dollar is not helped if they think the 
Treasury Secretary is trashing the value of what they own in 
order to squeeze out more export growth.'' And I am skipping a 
sentence or two. ``A dramatic sell-off in the dollar would 
force up interest rates, trounce the stock market, slowing 
economic growth even further. Someone in the White House should 
tell Mr. Snow that he is playing with fire.''
    Could you clarify the Treasury's position on the dollar? 
Are we abandoning a commitment to the strong dollar, being a 
strong currency, not one that people happen to like?
    Do you agree with the Journal that this is a dangerous 
position that could trounce the stock market? The worry here is 
not that Secretary Snow or the Administration or the Treasury 
would force the dollar to go down, but given the precariousness 
of it all, given that bond trading is now--Euros are an 
alternative currency, which we have had no alternative currency 
I guess since Bretton Woods. That even comments to that effect 
could cause the markets, as the Journal says, to push the 
dollar down.
    So that is my first question.
    Then, second, once it starts going down, many experts I 
have talked to say it could keep sliding down and there is 
nothing that we could do to stop it. Could you comment in 
general on this?
    Mr. Fisher. Senator, I think that I would rather talk about 
my future career.
    [Laughter.]
    Senator Schumer. Take your pick.
    [Laughter.]
    The pit and the pendulum.
    [Laughter.]
    Mr. Fisher. Senator, we have a policy of having the 
Secretary of the Treasury be the spokesman on the dollar.
    Let me be clear--I do not agree with the editorial you read 
me. I think it is really prudent and in our Nation's best 
interest to have one spokesman on the exchange rate.
    I have a great deal of experience in this area going back 
to my previous employment, and in the 1990's, on a bipartisan 
basis, I think we learned that having more than one spokesman 
on the exchange rate makes things worse, not better. I think 
that the best course here is to let us have one spokesman on 
the exchange rate.
    Senator Schumer. Let me ask you just a general question 
based on your knowledge and experience. Many people believe 
what Secretary Snow says. You have substantial input which I 
believe and I hope is correct. Is there a danger that if 
something, whether it be the Secretary's comments or anything 
else in the world, starts causing the dollar to slide, that 
that slide could become a cascade and could be unstoppable? Do 
we worry about that in Treasury before making remarks about the 
dollar?
    Mr. Fisher. We are always thinking about the market impact 
that our comments may have. And sometimes we correctly 
anticipate--I will speak for myself--what those remarks will 
be, vis-a-vis bond markets, for example, and sometimes we do 
not. But we are certainly always trying to anticipate the 
impact that our utterances can have.
    I also think, going back over the last several 
Administrations, we have learned that the less verbal 
intervention we have in markets of all types--bonds, stock, 
exchange--the better we are.
    Senator Schumer. Well, that would seem to--I do not mean to 
be persnickety here--that a little bit undercuts what the 
Secretary said the other day because his remarks clearly caused 
some change in the temperature.
    You know that. We all know that, and that was foreseeable. 
Now maybe it was positive, maybe it was negative. These issues 
are far more complicated. I leave them to much more complicated 
minds.
    So maybe that admonition holds. Let me just ask you one 
more question. How much should we worry that a decrease in the 
strength of the dollar could become more of a cascade and it 
gets to places where we wouldn't want the dollar to be for a 
whole lot of both domestic and international reasons. How much 
do you worry about that? That is the great worry everyone has, 
not where the dollar exactly is versus the Euro or any other 
currency. But if we do not stay with that strong dollar and 
bolster it, we do not have any control over this because it is 
so much in the hands of the great herd, as Thomas Freedman 
calls it, the traders. And that instead of it ratcheting down a 
few percentage points, or ten, it just starts going down. Do 
you worry about that? Is that a real worry? Apart from anything 
that the Treasury Secretary said.
    Mr. Fisher. The most important thing to recall is that we 
have had a floating exchange rate regime for almost 30 years 
now. The markets go up and down.
    I have felt that, and part of my job over the last decade 
both here and in my previous employment has been to lean 
against some of the conventional wisdom.
    Some people look out at markets and try to understand them 
by canvassing their available theories. They look back in their 
textbooks and if they find a theory, they say, well, there, I 
have my theory. Now it fits the market behavior, whether it is 
interest rates or exchange rates.
    I view one of the things that I have brought to this 
endeavor is to remind--excuse me--to go back. But if people 
look in their textbooks and they cannot find a theory, then 
they say, it is just a bunch of 30-year-olds shouting at TV 
screens.
    I have always reminded people, it is always 30-year-olds 
shouting at TV screens, whether you have a theory that explains 
it or not. And they are trying hard to be rational actors with 
the incentive structures they work with.
    Now sometimes they do things that we have a hard time 
understanding. And the best thing that I have always tried to 
do is to try to understand what is motivating their behavior as 
a way to understand it.
    I think that we get in a very odd, circular loop when the 
traders are trying to understand the official utterances and 
the thing goes around a little circle, and I think that is 
probably a counter-productive place to be, and that is why the 
less verbal intervention we have, the better.
    Senator Schumer. But that both says yes and no to my 
question. It says the 30-year-olds could take us on a tear in a 
place we wouldn't want to go. Right?
    Mr. Fisher. It is possible. I do not know what probability 
to attach to it.
    Senator Schumer. All right. Well, anyway, I want to thank 
you, Mr. Chairman. I want to thank you, Mr. Fisher, and our 
other witnesses. I apologize for the brevity. It is an 
interesting hearing. I am glad we are holding it. And I am 
sorry that conflicts occurred.
    Mr. Fisher. Thank you.
    Senator Bunning. Thank you, Mr. Fisher, very, very much for 
being here.
    Mr. Fisher. Thank you.
    Senator Bunning. If the second panel would come forward: 
Wayne Angell, the former Member of the Board of Governors of 
the Federal Reserve; James Stuckert, Chairman and CEO of J.J.B. 
Hilliard and W.L. Lyons, Louisville, Kentucky; and Mark--I am 
going to say Zandi----
    Mr. Zandi. Yes, that is correct.
    Senator Bunning. Chief Economist, Economy.com.
    Mr. Zandi. Yes, thank you.
    Senator Bunning. Mr. Angell, it is good to see you again. 
If you would like to start with your testimony, we are ready.

                  STATEMENT OF WAYNE D. ANGELL

                FORMER FEDERAL RESERVE GOVERNOR

    Mr. Angell. Mr. Chairman and Members of the Subcommittee, 
thank you for the opportunity to testify today on the subject 
of the use of economic policy to speed up economic growth in 
our economy that has been mired too long in recession. This is 
a very welcome opportunity to address the particular 
difficulties faced by an economy in the throes of a capital 
goods cycle beset by risk of deflation. Half-way measures are 
handicapped at the outset by a tendency to underestimate the 
lingering power of previous episodes of policy restraint. Both 
monetary policy and fiscal policy are likely to be deemed 
stimulative or accommodative even while policy continues to 
retard economic growth. If policy had been accommodative then 
economic performance would not long be regarded as a problem.
    Now to make matters worse, the capital goods investments 
that we have seen and the capital goods technology have 
increased our capacity to growth this economy so much, that we 
could grow this economy at a 6 percent real rate for 6 years 
and not over-pressure our labor force. So the gap is large.
    We would not be hearing warnings about the risk of 
deflation if monetary policy had not been less accommodative 
than reported. We would not be beset by such a rapid and 
prolonged decline in equilibrium interest rates if fiscal 
policy had switched from restraint to stimulation. This problem 
is so severe, that at the outset, we need to define fiscal 
stimulus as a fiscal policy that would produce a Federal budget 
deficit even when labor and capital resources are fully 
employed. The current Federal budget deficit is not stimulative 
as the deficit only exists due to the reduction of tax receipts 
forthcoming from an economy seriously underutilizing its 
resources.
    Before we get to the question as to whether or not economic 
policy response might be the right course of action, I think it 
is important for us to look at the incoming data to see the 
nature of this downturn.
    First, as you can see by Chart 1, which actually is the 
last chart in the packet, nonfarm payroll employment has 
declined in 24 of the last 25 months to bring April employment 
as a percent of peak employment to the lowest level of the 
recession.
    Now many talk about the recession in the past tense. I do 
not use that tactic because, to me, a recession is a period in 
which employment is declining. And as you look at this chart, 
you can see that the employment is farther below the peak, 1.6 
percent, than it has been at any time since the recession 
began.
    Labor markets continue to be weak. The weekly unemployment 
claims numbers we had this morning once again showed that there 
is no sign this employment recession has ended.
    Although the decline in employment has only been 60 percent 
as deep, and the decline in output only 70 percent as deep as 
in the 1981-1982 recession, as you can see in Chart 2, it is a 
record since the 1930's in regard to the length of the 
employment decline.
    This is a capital goods downturn rather than a typical 
inventory cycle. As depicted in Chart 3, the total index of 
industrial production has declined only 6.7 percent from its 
April 2003 peak, whereas the index of business equipment 
production stands 18.5 percent below the peak month--indeed, 
this is a capital goods cycle.
    Six months after the March 2001 employment peak economic 
activity was hammered by the September 11 terrorist attacks and 
many, I think, believed that the bounce-back from that post-
attack doldrums amounted to a recovery. I do not agree.
    Another misleading indicator of economic recovery emerged 
in 2002 as solid gains in labor productivity enabled output to 
expand while employment and hours worked declined.
    Second, I think it is important for us to have a clear 
understanding as to why and how the 1991-2000 expansion came to 
an end. Was it simply that we had an unprecedented coincidence 
of bad events, such as Y2K and an over-exuberant stock market 
or was there an economic policy failure that was decisive?
    Sometimes the makers of economic policy become convinced 
that the best way to avoid an unwelcome event is to engage 
decisively in a new economic plan. That is exactly what 
happened in the 1990's when voices of alarm predicted a low 
savings rate in the United States would result in an 
unsustainable increase in imports in excess of exports until 
our indebtedness to the rest of the world would produce a 
global economic collapse. The chosen remedy was to pursue a 
large enough Federal budget surplus to offset deficient 
private-sector saving.
    It worked.
    In the four quarters to the second quarter of 2000, 
individual income tax payments to the IRS rose exactly twice as 
fast as the growth rate of personal income: 11.4 versus 5.7 
percent.
    The engine that had been driving our prosperity was an 
unprecedented capital goods boom that matched up with an 
unprecedented surge in capital goods technology. Disposable 
personal income took such a hit from the 11.4 percent increase 
in individual income tax payments that there was simply not a 
sufficient increase in disposable income to enable households 
to buy what had been produced.
    When I saw those second quarter at 2000 income tax receipts 
figures, I knew we would soon be in a recession.
    In the turning point year 2000, a second-, third-, and 
fourth-quarter slowdown in the growth of personal consumption 
expenditure coincided with a high rate of increase in capital 
good capacity that the return on capital goods plummeted. While 
interest rates on real capital were plunging in the second half 
of 2000, the FOMC action in lowering the target Fed funds rate 
was not begun until January 3, 2001. Even though the January 3 
cut in the Fed funds target was followed by an unprecedented 
stream of rate cuts through the year 2001, it was not 
sufficient to have avoided an 
employment recession. But without the FOMC's unprecedented 
actions, results would have been far worse.
    Although a tax rate cut was proposed by President Bush in 
early 2001, its enactment came in a compromise form that 
distributed nonincentive tax rebates in the third and fourth 
quarters of 2001 and implemented a phased-in tax rate reduction 
in fiscal years 2002, 2004, and 2006.
    Even though the monetary policy and tax rate policy 
response was far from ideal, it seems appropriate to credit the 
FOMC and the Congress for alleviating the rate of decline in 
employment and output. The half-scale tax remedy did not 
prevent a recession, but it cushioned the recession's rate of 
decline. And you can see that in comparison to the 1981 events.
    Now, I am going to skip most of the next section, but I am 
going to point something out as clearly as I can, Mr. Chairman. 
And that is, we all seem to understand that the growth of 
credit almost is identical to the growth of dollar GDP.
    What everyone seems to misunderstand in our double-entry 
bookkeeping, the growth of credit is exactly the growth of 
debt. So when people oppose the growth of debt, they are 
opposing the growth of credit. To get our economy in a zero-
inflation environment to grow at a 5 percent level, we must 
have a growth of credit at the 5 percent level. If credit is 
going to grow at 5 percent, then debt has to grow at 5 percent.
    If the Federal Government does not want to be a player in 
the growth of debt as a percentage of Federal borrowing keeping 
pace with the necessity of the growth of debt in the economy as 
a percent of borrowing, then we force the growth of household 
borrowing as a percentage of household debt to rise to 
unsustainable levels. And the same happens in the business 
sector debt.
    So if we have the Federal Government playing we are on 
strike in regard to our increase in borrowing, then it is 
important to understand that that requires then household 
borrowing to increase at a faster pace.
    Now the only thing that saved us in this swing of the 
Federal borrowing is the fact that the Federal Reserve 
maintained enough liquidity to keep housing prices moving 
somewhat higher and the low interest rates prompted a huge 
amount of refinancing, which enabled us to take a lot of 
household debt and slide it under the house. And that is why 
household debt was able to be increased as rapidly as it has in 
the past. But no one needs to look to an increase in household 
debt to get this economy moving toward full employment. It just 
is not going to happen.
    Business debt that was growing at an 8 percent rate in 
2002, the growth of business debt was down to 2.8 percent.
    So that ends the lesson in regard to the flow of funds data 
and the relabelling of debt as something that is positive 
because debt is the opposite of credit, and everyone knows we 
have to have more credit.
    Is the stimulus of Federal borrowing offset by a crowding-
out effect on private borrowing? Or, to put it another way, 
does an increase in Federal borrowing put upward pressure on 
interest rates?
    The answer to the first question is a clear no. Crowding 
out only occurs when Government expenditures require resources 
to be taken away from private goods production. A reduction in 
tax rates increases incentives to invest and to produce more 
and does not produce any crowding-out effect.
    Now the answer to the second question is yes. An increase 
in Federal borrowing will mean that interest rates will be 
somewhat higher than if we did not have an increase in the 
borrowing. But it is a far different matter to push the natural 
rate of interest up to 1 percent than to push it up to 10 
percent.
    So it is important to understand that we could have a 
problem with interest rates being too low, as well as a problem 
with interest rates being too high. If interest rates are too 
low, the reward for saving are too low to provide an adequate 
safe fixed income for people facing retirement or currently 
retired.
    I think we need to identify that as a problem. If you think 
low-interest rates are nice, you should want to move to Japan. 
But my friends in Japan have experienced 12 very sad and 
painful years.
    There is not likely to be any crowding-out effect from tax 
rate reductions. In the 1981-1982 recession, a tax rate cut 
worked to create jobs without any crowding-out effect. Now get 
this--the average monthly employment gain was 367,000 per month 
in the 22nd, 23rd, and 24th months past the peak of employment 
in July 1981. In contrast, the average monthly employment 
change in this recession in the same 22nd, 23rd, and 24th 
months was minus 87,000 per month after the March 2001 peak in 
employment. If economic policy should be geared toward an 
increase in employment then the 1981-1982 model warrants 
emulation.
    Is monetary policy likely to work in a deflationary 
environment? Monetary policy always works as long as the target 
variable chosen is countercyclical. The FOMC has the choice of 
selecting one of three target variables.
    I think maybe, Mr. Chairman, I will skip through that 
section. But I do want to mention that persistent economic 
growth rates below the growth rate of the labor force and the 
growth rate of capital goods capacity is a clear indication 
that the chosen target Fed funds rate has been too high to 
accommodate the money-hoarding preference of households and 
businesses. Selecting a lower target Fed funds rate will 
require an increased injection of monetary liquidity into the 
banking system.
    The sixth question I want to consider is could monetary 
policy restore the desired price level and thus the desired 
economic growth rate without changing tax rates?
    The pragmatic answer is not likely in a capital goods 
contraction as compared to a recession driven by an inventory 
correction. A persistent failure of the price level and the 
growth of output and employment to respond to significant cuts 
in the target Fed funds rate is evidence of fiscal restraint. 
Whereas, inventory recessions tend to be followed by a motive 
to increase production more than the increase in sales, in 
order to reverse previous inventory rundowns, capital goods 
recessions are not prone to such a predictable end. After a 
labor market has passed the ``soft market'' stage to a stage 
where labor market uncertainty has a cumulative depressing 
effect on ``lifetime income perceptions,'' then monetary easing 
alone is likely to be transmitted only through disruption of 
global exchange rates.
    My advice is to choose a tax rate that is likely to 
increase the expected economic growth rate of the United States 
to keep the 
dollar strong and stable. Monetary policy alone runs a danger 
of providing ``beggar thy neighbor'' remedy to domestic 
deflation. In other words, the more than moderate 2003 decline 
in the exchange value of the U.S. dollar against the Euro is 
likely simply to have transferred deflationary pressures from 
the United States to Europe. This is less than acceptable 
economic policy leadership.
    What tax proposals do I favor? The elimination of the 
double taxation of corporate income paid out in dividends is 
far better than any other proposal as it reduces our highest 
effective tax rates. The 15 percent capital gains tax rate and 
a 15 percent dividend tax rate still leaves a 44.75 percent 
combined tax rate.
    Chairman Bunning, that to me seems way too high to have the 
kind of capital goods market that we need and we cherish.
    There is simply more bang for the buck in eliminating 
double taxation as no other proposal will make common stock 
ownership so much more attractive. Not only does it eliminate 
the pernicious double taxation, but it also is likely to have 
the greatest effect in modifying corporate executive branch 
behavior to perfectly align the CEO's interest with shareholder 
interest. Why would top management wish to distribute the 
fruits of their labor in any other way than in paying 
dividends?
    And the exclusion of qualified dividends from taxation will 
first increase the dividend payout ratio, then it will alter 
the choice of employed workers to reduce the amount of income 
deferred from taxation into company retirement plans in favor 
of direct stock ownership. And for retired workers it will 
encourage withdrawing funds from the retirement programs, 
paying the income tax, and then securing tax-free income. I am 
convinced that Federal tax receipts would increase between 2004 
and 2010, as a result of the elimination of double taxation.
    Although it seems the Congress may choose a combination tax 
rate of 15 percent for both capital gains and dividends, I 
continue to prefer the original model presented by the 
President.
    Reducing maximum noncorporate business tax rates to the 35 
percent corporate rate is essential to provide an optimum 
increase in jobs for American workers.
    Thank you.
    Senator Bunning. Thank you, Mr. Angell.
    Mr. Stuckert.

                 STATEMENT OF JAMES W. STUCKERT

              CHAIRMAN AND CHIEF EXECUTIVE OFFICER

              J.J.B. HILLIARD AND W.L. LYONS, INC.

    Mr. Stuckert. Mr. Chairman and Members of the Committee, my 
name is James W. Stuckert and I am Chairman and CEO of Hilliard 
Lyons, based in the beautiful Bluegrass State of Kentucky. 
Hilliard Lyons is a full-service investment firm with one goal: 
To help individuals reach their investment objectives. Since 
investment counseling is our only business, increasing 
investment in the equity markets is vital to us. I am also 
Chairman of the Security Industry Association's, SIA, Regional 
Firms Committee, which represents the interests of regional-
firm members. I thank the Chairman and the Committee for the 
opportunity to present my views on how to jumpstart the economy 
and increase investment in the equity markets.
    Established in 1854, Hilliard Lyons is a member firm of the 
New York, American, and Chicago stock exchanges, National 
Association of Securities Dealers, and Securities Investors 
Protection Corporation. The firm offers one-on-one advice about 
stocks, bonds, options, retirement plans, money market funds, 
mutual funds, trust and estate planning, and investment 
management. We also research the investment potential of 
various companies and industries and we underwrite bonds for 
public improvements such as schools and highways, obviously, 
better known as municipals. Hilliard Lyons, a PNC Advisors 
company, has 550 financial consultants in 85 branches in 
Arkansas, Georgia, Illinois, Indiana, Kentucky, Michigan, 
Mississippi, North Carolina, Ohio, South Carolina, Tennessee, 
Virginia, and West Virginia.
    Over the past 25 years, the securities industry has faced 
and has overcome many challenges. And these include processing 
ever- 
increasing volumes of trades, converting to a shorter 
settlement 
period, the development of many new investment vehicles, the 
globalization of markets, and a terrorist attack that affected 
our financial systems like no other seen in our time. While the 
transition to an era of fear and uncertainty is not a future we 
would have chosen for our country, that is the reality that 
faces us today. With a pragmatism that is uniquely American, we 
have tackled these new realities head-on and have done 
everything feasible to mitigate loss and confusion. Regaining 
the public's trust and confidence in the greatest capital 
markets in the world is critical to jumpstarting our economy.
    One of the most important things we can do to restore 
confidence is to get the economy and markets rolling again. 
Indeed, as the markets go, so goes public trust and confidence. 
The monthly UBS/Gallup Index of Investor Optimism hit an all-
time low of just 5 points in March 2003, but it surged 61 
points in April, just as the markets began creeping upward. 
That increase presented the largest one-month jump in the 
Index's history, which started in 1996. Some of the increase in 
confidence may be due to the tough new regulations, 
protections, and sanctions mandated by the Sarbanes-Oxley Act. 
We are, however, unlikely to see a sustained restoration of 
investor confidence, investment, or economic growth, however, 
unless we as an industry continue to put the customer first.
    Congress can also help boost the economy and the markets by 
passing President Bush's jobs and growth package. The 
elimination of the double tax on dividend income--the 
centerpiece of the plan--would enhance the long-term growth 
potential of the U.S. economy, promote job creation and higher 
wage growth, strengthen corporate governance, and put the 
United States on a much more equal footing with our major 
trading partners.
    Current tax policy encourages corporations to rely too 
heavily on debt rather than equity financing because interest 
is deductible, while dividends are not. The bias favoring debt 
over equity financing, for example, led many companies to take 
on high levels of debt that left them vulnerable to the 
economic downturn. The President's proposal would improve the 
performance of our economy by relieving numerous distortions 
caused by the current corporate tax regime, including the 
income tax code's general bias against savings and investment.
    The President's economic package has undergone many 
revisions as it has worked its way through the legislative 
process, and even today, a new version of the package is being 
discussed. Even so, the best route to renewed economic vitality 
is the complete elimination of the double taxation on 
dividends.
    Ending the double taxation of dividends would help move our 
tax system to one that taxes income only once. This, in turn, 
promotes savings and investment, increased capital formation, 
job creation, and economic expansion. The increased economic 
activity would generate additional tax revenues that could 
offset a significant portion of the tax revenues foregone by 
the proposal.
    The immediate impact of eliminating the tax on dividends 
would be an annual tax savings of approximately $30 billion, or 
0.3 percent of our current GDP. This savings would be 
distributed broadly and shared by the more than 50 percent of 
U.S. households that own stock. Moreover, in the case of the 
tax cut on dividends, there are additional factors that would 
help boost the economy in the long run. Because the after-tax 
value of dividends would increase, investments in stocks would 
become more attractive. It has been estimated that the value of 
the equity market would increase by as much as 5 to 10 percent. 
And this increase in equity values would provide further 
economic stimulus through the wealth effect, for 
example, people spend more as their net worth increases. It is 
no accident that a rising stock market is a leading indicator 
of 
economic growth.
    The initial approximately $30 billion in tax savings is 
actually a very conservative estimate because it assumes no 
change in the current dividend policies of U.S. companies. But 
it is likely that even more companies would issue dividends. 
Now that a tax cut on dividends has been proposed, companies 
that have previously retained large amounts of cash have said 
they may distribute some of that cash to shareholders.
    As useful as a tax cut on dividends would be in reviving 
the current sluggish economy, the main benefits would be long-
term. The double taxation of corporate earnings reduces 
companies' return on capital and therefore increases the cost 
of capital. Lowering the cost of capital by eliminating taxes 
on dividends would encourage companies to invest more in 
plants, equipment, and other capital stock, enhancing long-term 
growth and leading to more jobs and higher wages.
    Importantly, eliminating the double tax on equity-financed 
investments would bring U.S. tax policy more in line with our 
major trading partners. With the exception of only the United 
States, all G7 countries provide protection against the double 
tax on dividends. In addition, the United States has the second 
highest dividend tax rate among the 30 OECD nations. Twenty-
seven of the 30 OECD countries have adopted one or more ways of 
alleviating the double tax. Whether competing at home or 
abroad, the double tax makes it more difficult for a U.S. 
company to compete successfully against a foreign competitor.
    According to the most recent IRS data, 34.1 million tax 
returns--or 26.4 percent of total tax returns, representing 71 
million people--reported some dividend income in the year 2000. 
Of all taxpayers that claimed some dividend income in 2000, 
nearly half--45.8 percent--earned less than $50,000 in adjusted 
gross income, including dividends. This proposal would also 
benefit more than 13.1 million small-business owners or self-
employed taxpayers. Importantly, almost half of all savings 
from the dividend exclusion would go to taxpayers 65 and older, 
thereby giving retirees an additional reliable, long-term 
source of income to supplement their Social Security earnings 
and other retirement savings. Also, it is estimated that the 
average annual tax savings for the 9.8 million seniors 
receiving dividends would be $936.
    Perhaps the greatest long-term benefit from the elimination 
of the double taxation of dividends would be the incentives for 
companies to return to the principles of sound financial 
management. With half of American families invested in the 
stock market, nothing is more important to the securities 
industry than restoring the public's trust in the strongest 
capital markets in the world. While we cannot blame the bubble 
of the late 1990's and its painful aftermath on the tax system, 
the current system did little to reign in the excesses and in 
some cases contributed to them. From the standpoint of both 
shareholders and the health of our economy, companies should be 
encouraged to concentrate on real earnings.
    In that vein, encouraging companies to pay dividends would 
limit excesses because dividends offer proof of real profits. 
The payment of dividends by a company may give investors a 
strong signal of the company's underlying financial health and 
profitability. Indeed, a firm cannot pay dividends for any 
length of time unless the company has the earnings to support 
such payments. In an environment where reported earnings are 
viewed with some skepticism, cash dividends will bolster the 
credibility of earnings reports. Moreover, the payment of 
dividends would better align the interests of shareholders and 
managers by allowing shareholders to participate in decisions 
regarding corporate investment. Finally, because dividends 
serve as a stronger foundation for long-term value, companies 
that pay them will have fewer motives to artificially inflate 
profits just to cause temporary increases in stock prices.
    SIA correctly forecast the sub-par performance of the U.S. 
economy in the first quarter of 2003, as well as the further 
weakening in the current quarter. The depth and length of the 
downturn is uncertain, and will be determined by several 
interrelated variables. Among them are the expense of the 
reconstruction in Iraq, the direction of oil prices, how 
quickly consumer and investor sentiment rebounds, and whether 
the recent resumption of growth in business fixed investment 
will continue.
    The SIA's view is that it is critical that we focus on 
stimulating business fixed investment, which contradicted 
traditional recessionary patterns by leading the economy into a 
downturn while consumption remained relatively strong. In this 
vein, not all fiscal stimuli are created equal, and the tax 
measures that are focused on investment are much more important 
than those that provide a short-term, transient boost to 
consumption. President Bush has focused on the dividend 
proposal as key to job creation. Capital formation, spending on 
machinery and equipment, and plant and facilities will 
stimulate job creation more than spurring incremental 
consumption.
    Mr. Chairman, I commend you for holding a hearing to review 
the economic situation on how to jumpstart the equity markets. 
Our number one goal is regaining the public's trust and 
confidence in our industry and our capital markets, and we are 
doing everything we can to ensure that our customers' interests 
always come first. Sound economic policy, as embodied in the 
President's jobs and growth package, is also critical to 
reinvigorating our economy. I urge Congress to pass it quickly.
    Thank you.
    Senator Bunning. Thank you, Mr. Stuckert.
    Mr. Zandi.

                    STATEMENT OF MARK ZANDI

                 CHIEF ECONOMIST AND CO-FOUNDER

                          ECONOMY.COM

    Mr. Zandi. Thank you, Mr. Chairman.
    I have prepared remarks that mostly center on the dividend 
tax proposal. They seem a little less relevant today compared 
to yesterday, since it looks like we are going to get an 
agreement. So what I thought I would do, if you think this is a 
good idea, I will just introduce myself. I have that written 
down here. And then I will just make five points that I think 
are important in regard to this.
    Senator Bunning. That's fine.
    Mr. Zandi. Good. My name is Mark Zandi. I am Chief 
Economist and Co-Founder of Economy.com.
    Economy.com is an independent provider of economic, 
financial, country, and industry research designed to meet the 
diverse planning and information needs of businesses, 
governments, and professional investors worldwide.
    My marketing guy actually wrote this.
    [Laughter.]
    Senator Bunning. That's all right.
    Mr. Zandi. It doesn't go off my tongue as quickly as it 
probably should.
    We have over 500 clients in 50 countries, including the 
largest commercial and investment banks, insurance companies, 
financial services firms, mutual funds, manufacturers, 
utilities, industrial and technology clients, and governments 
at all levels. In fact, the State of Kentucky is a very good 
client. We provide them the economic inputs that drive their 
revenue projections, although we are not responsible for their 
budget problems.
    Senator Bunning. Shortfall?
    Mr. Zandi. Yes.
    [Laughter.]
    We have it right. Economy.com was founded in 1990, and we 
are an employee-owned corporation. We are headquartered in West 
Chester, Pennsylvania, a suburb of Philadelphia. We also have 
an office in London and one in Sydney, Australia.
    Let me make five points.
    First, the economy is struggling. I think it is on the 
precipice of recession, if it is not already in recession.
    Mr. Angell made a good case that it has never left 
recession. Not only is the economy's problems long-lived, but 
also they are very broad-based.
    If you look across industries, these are industries that 
are laying off workers. All of manufacturing, from aerospace to 
vehicle manufacturing, commercial construction, wholesaling, 
distribution, retailing, investment banking, and now State 
governments are laying off as well. They have only done that 
three times since the Great Depression, and this is one of 
those times.
    The problems are evident across the country, from coast-to-
coast. I am just going to name some big economies from east-to-
west that I think are still in recession by any metric. I do 
not think there is much debate. Boston and New York City in the 
Northeast; Atlanta and Dallas in the South; Detroit and St. 
Louis in the Midwest; Denver, the Bay Area of California, and 
Seattle in the West. All are in very severe, deep recessions. 
No sign of any let-up.
    Interestingly enough, just for your own personal interest, 
Kentucky is struggling, but it is held up quite well relative 
to most other economies. It has performed much, much better 
than I would say most of the State economies across the 
country.
    Senator Bunning. Small business.
    Mr. Zandi. Small business, they certainly have been hurt 
very badly, yes.
    Senator Bunning. No, but that is the reason it is held up.
    Mr. Zandi. Yes, that is a very good point. Actually, most 
of the difficulties in our economy, interestingly enough, have 
been at large companies, large, big, publicly traded companies, 
I think for various reasons. Small businesses have struggled, 
but they have actually held up, you are right, a lot better 
than most.
    Senator Bunning. Lay-offs have not been as big.
    Mr. Zandi. Yes. The second point is that I do think that 
the economy is poised to grow. I do think that the excesses 
borne of the stock market bubble around Y2K have largely been 
worked off.
    There was significant investment, excess investment in 
information technology. I think businesses have done a very 
good job of getting that back in line. In part, it is just due 
to the rapid pace of technology.
    The average economic life of a piece of IT equipment is a 
little less than 4 years. For computer hardware and software, 
it is a little less than 2 years. If you just think back, most 
of that investment was done more than 2 years ago and now the 
economic life of the stuff is evaporating. And if businesses 
want to maintain their productivity gains that they have worked 
so hard to garner, they are going to have to start investing 
pretty soon.
    We have started to see some pick-up in investment. Computer 
hardware and software investment has actually risen over the 
past year, modestly, but it has risen.
    So, I do think that we are poised for growth. I think that 
our main problem now is a lack of confidence; and even on that 
front, I feel a little bit better, post-Iraq.
    Confidence has improved. Consumer confidence has rebounded. 
The financial markets have seen a rather dramatic improvement. 
Equity prices are up 15 percent from their March nadir.
    Even more importantly, the corporate bond market has 
enjoyed a very powerful rally. Spreads between corporate yields 
and Treasury bills have narrowed dramatically. That is a very 
good measure of the angst of investors. The narrowing in 
spreads have been most substantive in the lowest quality 
corporate bonds, junk bonds. And that is indicative of a rather 
sharp improvement in confidence.
    Business confidence as well has improved. We have a survey 
that we conduct off of one of our websites of businesses across 
the country in many industries, in many different parts of the 
country, and that has improved dramatically since its low a 
couple of months ago. So, I think we are poised for growth.
    Now having said that, my third point is that I think that 
fiscal stimulus is definitely needed. And I agree with you. I 
think the bigger, the better.
    I think we are at a very fragile point and if things do not 
go 
exactly as scripted, we are going to have a big problem. 
Monetary policy, regardless of what the monetary theories are 
saying, is now treading in waters that they have never tread 
before, and it is going to create a great deal of--so far, 
everything is working. And the comments that the Chairman made 
a couple of weeks ago worked their magic. But I am not sure how 
many times he will be able to do that if the economy does not 
soon turn the corner. Again, I think the economy is at a very 
fragile point. Nothing can go wrong here.
    Fiscal stimulus is very important. I would have much rather 
seen a much larger tax package myself. But I think a $350 
billion tax package is a reasonable attempt. I think the 
potpourri of tax cuts that were included were a reasonably good 
effort at trying to get the economy going. All I can say is I 
hope it gets passed quickly and that stimulus is provided very 
quickly to the economy.
    Now let me say something about the elements of the package. 
And this goes to my fourth point.
    I personally think eliminating, as in the case of this 
package, scaling back the dividend taxation is neither here nor 
there for the economy in the near-term. It is not going to 
provide stimulus to this economy this year, or even next. And 
unfortunately, because of the sunset provisions, I think that 
reduces the efficacy in the long-run as well.
    We are talking about investor confidence. How can investors 
have any confidence about values if they do not know what the 
tax policy is going to be?
    Now everyone says, well, there is a very high probability 
that these sunset provisions will get the dividend tax extended 
long into the future. But investors just cannot attach 100 
percent probability to it, particularly because they know we 
are running very large budget deficits. At some point, that is 
going to be a problem. And it may just very well be the case 
that that problem will become most evident when one of those 
sunset provisions are expiring.
    I think the sunset provisions significantly reduces the 
efficacy of any benefit. I think the benefit, even if it were 
completely eliminated with no sunset provisions, is minor.
    The value of eliminating dividend taxation completely is 
equal to the present value of the future stream of tax savings. 
Simple calculation--apply a reasonable discount rate. At most, 
you get 10 percent pop to the market. No, I think 10 percent is 
great, but it is down 40 percent, as you pointed out, from its 
peak. Now, I am not sure that investors really believe that 
even a 10 percent pop would change behavior very quickly. So, I 
am very skeptical that dividend tax reduction would do anything 
for the economy near-term. And as structured, because of the 
sunset provisions and other aspects of it, I am very skeptical 
that it is going to do anything for the economy longer-run, 
either. I think that is one part of the legislation that is--
there is no downside to it, but it is neither here, nor there 
for the economy, long-run or short-run.
    Then, finally, let me end with this.
    Here are a couple of things that I think you should do very 
quickly. First, you should extend unemployment insurance 
benefits. The Federal program is expiring at the end of the 
month. That would be a huge mistake not to extend that one more 
time.
    The pain in the labor market is very significant. The 
length and duration of unemployment is now 20 weeks. It is now 
longer than it was in the 1991 recession. You have a lot of 
very, very distressed households. Personal bankruptcy filings 
are at a record high and rising very rapidly. Delinquency rates 
on credit cards are at record highs. Mortgage foreclosure rates 
are at record highs. Auto delinquency and repossession rates 
are at record highs.
    If that is not extended, that would severely exacerbate 
credit quality problems and may induce a contraction in 
consumer spending, and that is exactly what we do not need at 
this point.
    Another thing I would do, and this is where I disagree with 
you. I think aid to State governments is vitally necessary. I 
think the contraction that will occur because of State 
government cuts that we are seeing now in jobs and programs and 
now tax increases, is going to significantly offset the 
economic benefit that you are now providing to the economy 
through these tax cuts, through the Federal fiscal stimulus.
    I really do not see the downside to it, and I do not bind 
to the arguments that State governments overdid it in the boom 
times. If you look at State government spending as a share of 
GDP, it is no higher today than it was 30 years ago. If you 
look at State government employment as a share of total 
employment, it is lower today than it was 30 years ago. 
Government is no bigger, State government is no bigger than it 
was.
    Then, moreover, the arguments that there is a moral hazard 
problem I think are specious. The idea being that if you help 
States out today, that they will get into a bigger trouble down 
the road, I think that that is a rather minor issue.
    And frankly, in times of crises, we have always looked 
aside regarding moral hazard problems. We did that with Korea. 
We did that with Mexico. What is wrong with doing that with 
California, Kentucky, and Massachusetts?
    So, I really do not see that argument at all. I think 
providing a check to a State government today would be a 
tremendous boost to the economy precisely because those 
programs are in place. The monies would go to the people who 
need it most very, very rapidly.
    Finally, let me end with this. Another thing that we should 
think about, we are all focused on lowering the cost of 
capital. But in the same breath, we are all talking about jobs. 
We want to promote jobs, right? We want to get the economy to 
create jobs. Well, how do you do that? You lower the cost of 
labor. And what are the most important costs to businesses with 
respect to labor? Health care costs and pension costs.
    My health care premiums for my employees is rising at a 
double-digit pace and it has been doing that for 3 years. 
Frankly, it is getting to be a very significant problem. And 
the real problem is there is no end in sight. If I do a 
calculation of the health care costs that I am going to face as 
a small business owner, it is prohibitive because I do not see 
any end to 10 percent, 15 percent health care premium increases 
for the next 10 to 15 years. As a result, you add that up. That 
is a very significant cost to businesses, particularly small 
businesses who are struggling to shoulder these health care 
benefit costs.
    So, I think it is critical, vital that Congress quickly 
begins to address this more carefully because this is going to 
be a very significant problem. And frankly, I think that is one 
of the key reasons why businesses are more likely to invest in 
a piece of computer equipment, software or telecom equipment 
before they invest in a person. So even when the economy does 
improve, it will take a long time before we see any significant 
improvement in job creation.
    Thank you.
    Senator Bunning. Thank you, Mr. Zandi.
    First of all, thank you all very much for being here.
    On accelerated tax depreciation, there is a 50 percent 
bonus depreciation for property acquired between May 1, 2003 
and January 1, 2005. That is about 20 months. That is from May 
to December 2003 and all of 2004.
    Small business expensing, we now have a $25,000 investment 
expensing. That is increased to $100,000 for 2003, 2004, and 
2005.
    Capital gains and dividend--unfortunately, we did not do 
what the Senate did. We did what the House did. So, we have a 
15/5 capital gains tax rate, and that applies only after sales 
of May 6, 2003, and it sunsets the end of 2009. The dividend 
treatment is the same as the House bill, where it is 5 and 15. 
It applies to dividends from domestic corporations and certain 
foreign corporations. And that also sunsets in the year 2009.
    Now let me get to some questions. That is just a rundown 
that my staff gave me out of the meeting that the President 
just had with those who are going to pass the bill tomorrow.
    Governor Angell, you and I have agreed on a lot of things. 
But what do you believe will happen if we would not pass the 
stimulus package?
    Mr. Angell. Mr. Chairman, I believe that not passing this 
stimulus package runs the risk of some very bad things 
happening.
    Number one, we are going to go for a long, long time before 
we increase output at a rate in excess of the growth of labor 
productivity and, consequently, the jobless recovery can go on 
and on and on, wasting precious resources. To me, that is the 
biggest waste we can ever have, is to not have the opportunity 
for people that would like to have jobs, have jobs.
    Our entire educational system is adversely impacted when 
students do not see graduates able to use their studies and to 
develop the kind of income that they would like to have.
    The second very bad risk is a risk to U.S. global economic 
leadership. We have done a great thing in terms of formulating 
trade policies that leave us with almost a perfect capital 
competitive market. That is, real capital goods globally are 
very, very integrated. But fluctuating exchange rates can play 
havoc on what occurs. I just do not like to see the United 
States, who is in a better position to ward off deflation than 
any other countries, using this beggar-thy-neighbor policy of a 
lower exchange value for the dollar.
    So, I strongly dislike the risk we are currently taking and 
I am not in agreement with the U.S. Treasury's position today.
    Senator Bunning. Talking down the dollar.
    Mr. Angell. No. I just think that turns back--when I was a 
Member of the Board of Governors of the Federal Reserve System, 
we had a little bout of that when someone in the Administration 
thought that we could sell more cars if somehow or other we 
could get the dollar's value to go down. And for a country that 
relies upon the entire world's willingness to invest in our 
country, that is a very risky affair.
    I advise central banks in Asia, monetary authorities in 
Singapore and Hong Kong. And when I am there, the one question 
they want to ask is should we maintain a high concentration in 
U.S. dollars?
    Now when I was going over there as a member of the Bear, 
Stearns team, I was able to tell them, yes, you should. But 
today, I wouldn't be able to provide that kind of message.
    So, to me, it is a very risky affair for world economic 
power with world economic leadership to be relying so heavily 
on interest rate reductions. Mr. Zandi can talk all he wants to 
about the higher interest rates. The fact of the matter is that 
interest rates are going to go lower, not higher. But these low 
interest rates, without the promise of a tax bill that will 
promote U.S. economic growth, and thereby, the rate of return 
on capital will rise, the dollar could be in significant 
trouble. And that is a huge, huge risk, not for just us, but 
for the entire global economy.
    Senator Bunning. We are going to pass the bill. I just 
wanted you to give me your opinion.
    Mr. Angell. Well, I am pleased you are going to pass it.
    Senator Bunning. We have bought enough votes to do that.
    Mr. Angell. Okay.
    [Laughter.]
    Senator Bunning. We have at least 51. We may have 52.
    Mr. Stuckert, just because you left Louisville, did not 
mean that you thought that you were going to get out of the 
rain. You brought it with you from Kentucky.
    [Laughter.]
    Mr. Stuckert. You are right.
    [Laughter.]
    Senator Bunning. In your testimony, you talked extensively 
about the President's dividend proposal. Now that you know some 
of the other factors that are in the proposal, would you like 
to comment on them?
    Mr. Stuckert. Well, I certainly share your comments 
earlier, Senator Bunning, relative to the fact that there is 
some tax on the dividends that you prefer not be there.
    I am pleased that it will last until the end of the year 
2009, and 15 percent being the maximum, should generate some 
people buying the dividend-paying stocks, of course. And 
hopefully, those particular companies, their cost of capital 
will be reduced.
    I personally think, as we try to consult with individuals, 
that the total tax policy of the United States of America has 
been against investment and against savings.
    It always appalls me that when we try to guide individuals 
in their financial well-being for retirement plans and all, 
there is no--with the exception of a little bit of an expanded 
IRA, which is not really going to be enough to attract major 
monies for retirement--people feel that they have been put upon 
by the fact that they have to pay a lot of taxes, number one, 
on their income; and in turn, when they invest into anything, 
they have to pay taxes again, not only to the Federal 
Government, but also the State.
    That is obviously why the 401(k) plans have grown 
dramatically, because those are tax-free until they are taken 
out.
    Actually, the dividend and the capital gains, I think that 
anything that aids investments and savings in particular for 
individuals, the Federal Government cannot take care of 
everybody.
    At some point, taxation policy has to be such that it is 
very easy for the baby boomers--maybe it is too late for them--
but the Gen Xers and all the rest of them, somebody has to sit 
down and say, this is a good deal for me. I will start saving 
money and not be 
penalized for doing so, and have the dividends and the interest 
that I am receiving from my savings be just taxed away from me.
    So if this is the beginning, I just think it is a wonderful 
start. I think that, overall, our American economy is at a 
disadvantage vis-a-vis the G7, the OECD countries. These people 
have, relatively speaking, no double taxation on dividends.
    I think that the elimination of the tax on dividends down 
to 15 percent will probably help corporations pay monies out to 
the stockholders and then they in turn will spend it in the 
best interests of their particular likes and dislikes. I just 
think that that will help. That is something to me that will 
revive confidence and revive the American economy in the 
process.
    Senator Bunning. Do you realize that the last time we 
lowered capital gains rates from 28 to 20, that the first year 
we did that, we had a spike of $75 billion in revenue. We 
finally have gotten the CBO and the OMB to score a reduction in 
the capital gains rate as a positive rather than a negative.
    We used to have a terrible time with the OMB and the CBO 
trying to get that scored positive. Over 10 years, it kind of 
is a wash now, because people usually make that capital gains 
sale in the first or second year of a situation where they do 
have--not too many people have capital gains, and that is a big 
problem. But at least some do. And this will stimulate, in my 
opinion, some portion of the economy by creating new dollars to 
spend on other things.
    Mr. Zandi, you were quoted in The Wall Street Journal by 
Alan Murray on January 28, 2003, saying: ``A necessary 
condition for any improvement in the economy is getting Iraq 
behind us. It would be nice to get both, an end-of-the-war 
related uncertainty and a stimulus package. But the first is 
the most important.''
    Well, do you consider the war with Iraq behind us?
    Mr. Zandi. Oh, yes. And it was very successful.
    Senator Bunning. Okay. The next in line is a stimulus 
package.
    You have heard the broad outlines of the stimulus package. 
Do you think that this is going to be a stimulus, or do you 
think that it is not? By the way, I want you all to know that 
in the Senate budget resolution, we put in the ability to 
front-load any kind of a reconciliation package by $190 billion 
in the first 2 years. And that is the reason that we have been 
able to construct this package for job growth the way it is 
constructed.
    If we hadn't had that in there, it would have been pushed 
back over a 10-year period. If you do $190 billion in the first 
2 years, that is a lot better, and have the $160 billion over 
the next 8 years----
    Mr. Zandi. I think the stimulus package is very positive, 
and it was a very good effort. It is a hodgepodge of different 
things. But I think when you add it all up, in totality, it 
will help. I am very happy that it passed as quickly as it did.
    I would have been hopeful that it would have been passed a 
little bit quicker, but I think the war got in the way of that. 
Everyone was busy with lots of other things.
    But I think policymakers have done a great job here. I 
think it will be very helpful.
    Now let me say this. I wouldn't stop here.
    Senator Bunning. No, we are currently working on an 
international bill, also.
    Mr. Zandi. Yes. I do think that the economy is still very 
fragile, and nothing can go wrong. Everything has to go well. 
We need a little bit of luck in addition to the end of the war 
and the stimulus package to get through this without finding 
ourselves in some difficult straits.
    Senator Bunning. By the way, on the unemployment benefits 
that you suggested, we are working very hard to get either a 
13-week or a 26-week addition before they expire.
    Mr. Zandi. That is great. And let me say one more thing 
about the stimulus package.
    It is not so much the dollars and cents that matter. They 
do matter. I do not mean to downplay that. But what matters 
perhaps even more is the sense among business people and 
consumers that you are working hard at trying to do something, 
that you recognize that the economy is a problem.
    Even if people have jobs, they are hanging on. Many are 
just hanging on--part-time jobs, self-employed because they 
have no other options. They are stepping out of the labor force 
altogether because there is just nothing suitable.
    Just the mere fact that you are working hard and discussing 
and debating these things I think is very valuable.
    I wouldn't let the debate and discussion end here. I think 
I would start talking about what is next, because all of us 
economists are all sitting here telling you, we are poised for 
growth. But, frankly, it is faith-based forecasting at its 
best.
    All the data--I cannot point to a statistic that will say, 
proof positive that that is going to happen. We could all be 
dead wrong, and of course, we have been dead wrong in the past. 
So, I think I would be----
    Senator Bunning. The big thing I want you all to know, and 
Mr. Angell knows this probably better than most, is that the 
employment numbers always lag by about 6 to 9 months. But we 
have to see some upswing shortly, or we have to level off on 
the loss of jobs before we can start gaining jobs. The numbers 
usually in any kind of recessionary period or downturn, the 
last thing we see positive is job growth. We have to get some 
of that ready to go before we can see the unemployment numbers, 
instead of growing at 6\1/4\ or 6.1, we have to see and do 
things that are necessary to be done.
    One other thing you brought up and I want to talk to you a 
little bit about sending $20 billion to the States.
    There is a law in Kentucky, whether you know it or not----
    Mr. Zandi. I did not know it.
    Senator Bunning. --that limits employment by State 
government. It is a law, at 33,000 employees. They have 38,500 
employees in State government. If they just did it by 
attrition, we wouldn't be in the pickle we are in in Kentucky. 
And we are not in a big one like some others are. We wouldn't 
be spending more than we take in.
    Now all the States are having that problem. But for the 
Federal Government to hand out checks and think that we are 
going to continue to hand out checks to offset their shortfalls 
is not, in my opinion, a good policy to get into, because we 
cannot do it next year or the following year.
    And so, they are going to have to look at their internal 
problems, particularly their Medicaid problems. Kentucky has 42 
different participations in Medicaid. They are only required to 
do 15. Those are the mandated programs. Our Medicaid shortfall 
in Kentucky is horrendous, comparatively speaking. And I think 
other States are very similarly disposed.
    Mr. Angell, I want to ask you a loaded question. If you 
were the Fed Chairman, what would you have done differently 
with the monetary policy of this great country?
    Mr. Angell. Well, Mr. Chairman, first of all, before I 
answer the question, I want you to know that, in my opinion, 
Chairman Greenspan has been an inordinate help to this country 
because I know central bankers all over the world. And I know 
that even though Alan did not act as fast as I would have 
preferred he acted in the last half of 2000, what he did and 
what he stayed with was far better than any other central 
banker that I know about.
    Senator Bunning. I won't dispute that. I agree with that.
    Mr. Angell. So my view, which has been predominated by an 
index of core commodity prices, has never failed me in terms of 
indicating whether monetary policy is tight or easy.
    This view for me suggests that monetary policy has been a 
lot tighter over this last 18 months that the Fed has been 
pleading its case that it is accommodative.
    I always become very uncomfortable when a central bank 
evaluates itself and says, we want you to know that we have a 
policy that is accommodative. In my experience, central banks 
that say they are accommodative generally are not. I listened 
to the central bank of Japan say that for 8 of the last 12 
years, they finally gave up even trying to say that, and the 
central bank in Japan is still too tight.
    The Japanese central bank must tell the Japanese people 
what they want the exchange value of the yen dollar to be at 
the end of 2006. And they have not been willing to do that.
    So, I am a hawk on inflation. I proved that during my 
voting years at the Board of Governors. But I am also a hawk 
against deflation. And recognizing this deflation risk is 
something that I think was sorely needed.
    I give Alan Greenspan great praise for his decision to 
indicate that there is a great risk of deflation, disinflation 
being too steep, than the risk of inflation. And because of 
that, we have had a movement upward in 10-year Treasury bond 
prices and 5-year Treasuries and 2-year Treasuries and that is 
doing us a lot of good.
    Senator Bunning. The market is reflecting that in the 
return 
on those.
    Mr. Angell. Yes. Now, Mr. Chairman, you did not ask me for 
a forecast, but I will give you one, anyway.
    [Laughter.]
    Senator Bunning. Okay.
    Mr. Angell. If this equity market does not indicate that it 
really is a bona fide, recognizable bull market by the time of 
the June 25 and 26 FOMC meeting, I think the FOMC will 
undoubtedly take the correct step of lowering the target Fed 
funds rate.
    Senator Bunning. I do, too. By 50 basis points.
    Mr. Angell. I hope by 50 basis points. What many do not 
understand is that the demand for money is such that lowering 
the target Fed funds rate by 50 basis points will require a 
tremendous quantitative injection of reserves. I like that on 
all accords, except I would like it a lot better if the 
Treasury Secretary was being more committed to a strong dollar.
    Senator Bunning. Sometimes we can overcome what Secretaries 
of Treasury say. We did it, if you remember correctly, when 
Secretary Baker tried to talk down the dollar during his tenure 
as the Treasury Secretary, and we were able to overcome that. 
And I think we can overcome whatever anybody says by action. 
This stimulus package will, in my opinion, overcome our 
Secretary of the Treasury's misstatements about the dollar and 
the value of the dollar in regards to other currencies.
    Mr. Angell. Mr. Chairman, I commend you for your optimism. 
I share that kind of optimism. I appreciate particularly the 
work that many of you have done in regard to achieving the 
results of this tax cut package that you have now achieved.
    Senator Bunning. Last, but not least, Mr. Zandi. You 
mentioned your problem with medical and furnishing insurance. 
It is a big problem not only you have, but also it is across 
the board in every company and every corporation.
    What do you think about the proposals that are before the 
Congress on medical liability and the correction that we would 
like to see in that regard?
    Mr. Zandi. You are referring to the liability caps?
    Senator Bunning. I am referring to the ability to control 
in some manner the cost of medical liability.
    Mr. Zandi. I think that needs to be addressed. I think that 
is a big part----
    Senator Bunning. There is one that has already passed the 
House. The Senate has not acted. And I am just wondering how 
you feel.
    Mr. Zandi. I do think that the accelerating cost of medical 
liability is a large contributing factor to the rapid rise in 
health care costs, and obviously, health care premiums that 
businesses and all of us are paying. Therefore, I think that 
that is a place where Government can step in and should work to 
try to limit those costs.
    Senator Bunning. Gentlemen, I thank you all for your 
testimony. This hearing is adjourned.
    Mr. Zandi. Thank you.
    Mr. Angell. Thank you.
    Mr. Stuckert. Thank you.
    [Whereupon, at 11:50 a.m., the hearing was adjourned.]
    [Prepared statements submitted for the record follow:]
               PREPARED STATEMENT OF SENATOR JIM BUNNING
    I would like to welcome Senator Schumer and all of my colleagues to 
the first hearing of the Economic Policy Subcommittee of the 108th 
Congress. I would also like to thank all of our witnesses for 
testifying today.
    Today, we have the first of a series of hearings titled; 
``Jumpstarting the Economy.'' I am very concerned with the state of our 
economy. I am very worried about the possibility of a double-dip 
recession. I know that puts me at odds with more 
optimistic economic experts, like Chairman Greenspan, but we have 
disagreed before. We are not growing like we can, and we are not 
creating jobs. There are many reasons for this.
    I believe Chairman Greenspan acted way to slow to cut rates back in 
early 2001. He should have cut them in the fall of 2000. The corporate 
governance scandals have hurt trust in the markets. Sarbanes-Oxley and 
other actions have helped, but it will take a long time for corporate 
America to rebuild that trust. September 11 had a devastating effect on 
our economy. The two wars we have had since then have also not helped.
    The reason why most of these events have been so harmful to this 
economy is because they have created uncertainty in our markets. If 
there is one thing that shakes the markets, it is uncertainty. I am 
hopeful that our witnesses today will help us find a way to bring some 
certainty back to our markets.
    Since the height of the bull market in March 2000, the stock 
markets' market value has been reduced by about $8.5 trillion. At the 
market's high back in early 2000, the market cap of the Wilshire 5000 
totaled $17 trillion. By the time of the market's low in early October, 
the Index's market cap had shrunk by about half that amount, or about 
$8.5 trillion. We have a $10 trillion economy. We have had stock losses 
of $8.5 trillion in 3 years. It is not surprising that investors are 
skittish.
    Therefore, if we are going to grow this economy, we have to get 
people investing again. We need to create capital so businesses have 
the ability to invest and grow. Before we adjourn for Memorial Day, we 
will be voting on a growth package. I think it is crucial that we send 
a package to the President for his signature. I wish the package was 
bigger, I hope $350 billion is enough to move a $10 trillion economy. 
But we must make this start. We must create jobs and we must make sure 
our economy grows.
    We must bring some certainty back to the markets if we are ever 
going to grow this economy and prevent a double-dip.
    Once again, I thank all of our witnesses for testifying today.

                               ----------

                 PREPARED STATEMENT OF PETER R. FISHER
                  Under Secretary for Domestic Finance
                        Office of Public Affairs
                    U.S. Department of the Treasury
                              May 22, 2003

    Chairman Bunning, Ranking Member Schumer, and Members of this 
Subcommittee, I am pleased you have chosen to hold this hearing on a 
top economic priority for our Nation, both now and for decades to come: 
Increasing investment.
    For the immediate future, our challenge is to rebuild business 
appetite for taking risks on the future and thus for creating jobs. 
Looking farther into the 21st Century, a major challenge for our 
society is to pay for the collective retirements of my generation and 
those that follow, while keeping commitments to current retirees and 
those near retirement. Over both horizons, the central task for 
Government and for the private sector is boosting savings and 
investment. First, Government must 
examine and remove legal and regulatory obstructions to savings and 
investment. The President has focused our attention on the need to 
reduce the biases against equity investment. Second, to bolster 
investor confidence, shareholders should demand and firms should do a 
better job of disclosing their key indicators of business and financial 
performance and prospects--the ones they actually use in managing their 
businesses.
    Our key macroeconomic challenge today is to face the aftermath of 
the extraordinary events of the 1990's. Federal Reserve monetary 
policy, global economic integration, and telecommunications advances 
combined to fuel real prosperity and higher productivity, but 
investors' overestimation of their impact contributed to a stock market 
bubble. We continue to live with the consequences of these events and 
the destruction of trillions in household wealth as the bubble burst.
    Business investment began slowing in 2000, causing demand for labor 
to soften. Let's be clear where jobs come from. New jobs come from 
investment--the willingness of investors and entrepreneurs to put 
capital at risk in a business venture. The President has focused us 
precisely on that point: Sharpening the incentives for investors and 
entrepreneurs to invest in the most productive ventures. And higher 
productivity means higher wages and a stronger economy for everyone.
    The task before us is much the same throughout this new century: To 
enhance incentives for private sector savings and investment. We are 
going to pay for the retirement and health care of the baby boom 
generation one way or another. We can increase private savings and 
investment, or we will reach lower standards of living in the future 
than we would otherwise.
    How can Government and business achieve these goals now and in the 
future? The President has clarified the main task for us in Government: 
To remove the legal, tax, and regulatory distortions that discourage 
savings and investment.
    There is no better example than the current double taxation of 
corporate dividends. No one defends this bias from first principles; 
and no other major industrial nation taxes profits at such a punitive 
effective rate. By taxing dividends twice, our tax code encourages 
companies to retain earnings instead of paying them to shareholders; to 
raise excessive levels of debt; and to dedicate some of America's 
leading minds to tax minimization instead of job creation. And by 
imposing a high marginal rate on profit, our tax code thins the vital 
blood of economic growth: Risk capital.
    We are encouraged by the good progress being made on the 
President's Jobs and Growth proposal, including progress toward 
lowering tax barriers to savings and investment. We are working with 
the Congress to obtain the best package possible, as quickly as 
possible. The President has made clear that the sooner we get this 
done, the sooner we can create jobs and put people back to work.
    Boosting savings and investment in America will also require 
restoring investor confidence. Congress passed Sarbanes-Oxley, and the 
SEC and Justice Department are successfully implementing its provisions 
to improve corporate governance. But companies too have 
responsibilities to lead--to provide investors with meaningful, high-
quality information. This is not principally a task for Government to 
achieve.
    Our securities markets are extremely efficient at pricing and 
allocating capital on the basis of all available information. 
Unfortunately, important information is too often not available to 
shareholders. We will not restore our investor confidence until 
shareholders truly can see the companies in which they invest through 
the eyes of their agents in management, until they can see the real, 
economic leverage and the key indicators of business value that 
insiders can.
    When investors have a picture of the real, economic leverage 
employed, regardless of the distractions of off- vs. on-balance sheet 
distinctions, attention will naturally turn to cash flow: To how 
management expects to pay down the leverage and still have some income 
left over for the shareholders. Exposing true leverage--contractually 
obligated net present value--is the only way that shareholders and 
creditors can judge true performance and can distinguish profit from 
business operations and from financial engineering.
    Private sector leaders must transform the practice of corporate 
disclosure, to set a new class of best practices that will genuinely 
inform investors about the risk/
reward prospects of the firms in which they invest. I wish that 
Government could set best practices by fiat; I do not think it can. 
Only the private sector-- corporate executives, lawyers, accountants, 
bankers, analysts, and money managers--can make it happen.
    The President has urged us to focus on this top national economic 
priority: Encouraging investment. Sharpening the tax incentives and 
improving corporate disclosure are crucial steps toward that goal--both 
to create jobs now and to generate the wealth later to pay for our 
collective retirement.

                               ----------

                 PREPARED STATEMENT OF WAYNE D. ANGELL
                    Former Federal Reserve Governor
                              May 22, 2003

    Mr. Chairman and Members of the Subcommittee, thank you for the 
opportunity to testify today on the subject of the use of economic 
policy to speed up economic growth in an economy that has been mired 
too long in recession. This is a very welcome opportunity to address 
the particular difficulties faced by an economy in the throes of a 
capital goods cycle beset by risks of deflation. Half-way measures are 
handicapped at the outset by a tendency to underestimate the lingering 
power of previous episodes of restraint. Both monetary policy and 
fiscal policy are likely to be deemed to be stimulative or 
accommodative even while policy continues to retard economic growth. If 
policy had been accommodative then economic performance would not long 
be regarded as a problem.
    We would not be hearing warnings about the risk of deflation if 
monetary policy had not been less accommodative than reported. We would 
not be beset by such a rapid and prolonged decline in equilibrium 
interest rates if fiscal policy had switched from restraint to 
stimulation. This problem is so severe that at the outset we need to 
define fiscal stimulus as a fiscal policy that would produce a Federal 
budget deficit even when labor and capital goods resources are fully 
employed. The current Federal budget deficit is not stimulative as the 
deficit only exists due to the reduction of tax receipts forthcoming 
from an economy seriously underutilizing its precious resources.
    First, a question arises as to whether or not an economic policy 
response would be an efficient remedy to the current recession. But 
before we get to that question let's take a look at what incoming data 
are telling us about this downturn.

 This is the longest employment recession since the 1930's. 
    Non-farm payroll employment has declined in 24 of the last 25 
    months to bring April employment as a percent of peak employment to 
    the lowest level of the recession. Chart 1 
    compares the slow and the persistent decline in employment in this 
    cycle as a percent of the peak employment to the steeper yet 
    shorter decline in the 1981-1982 recession.
 Labor markets continue to be weak as business managers are 
    able to reduce labor costs by capital investments and 
    restructuring--labor productivity has continued to post sizable 
    gains. Weekly unemployment claims show no sign that this employment 
    recession has ended.
 Although long in duration the decline in employment has been 
    only 60 percent as deep and the decline in output only 70 percent 
    as deep as in the 1981-1982 recession. See Chart 2.
 This is a capital goods downturn rather than a typical 
    inventory cycle. As depicted in Chart 3 the total index of 
    industrial production has declined, so far, only 6.7 percent from 
    its April 2003 peak, whereas, the index of business equipment 
    production stands 18.5 percent below the peak month--and indeed, 
    this is a capital goods cycle.
 Six months after the March 2001 employment peak economic 
    activity was hammered by the September 11 terrorist attacks on the 
    World Trade Center and the Pentagon. Recovery from the terrorist 
    event gave a false impression of economic recovery.
 Another misleading indicator of economic recovery emerged in 
    2002 as solid gains in labor productivity enabled output to expand 
    while employment and hours worked declined.

    Second, it is important to have a clear understanding as to how the 
1991-2000 expansion came to an end. Was it simply that we had an 
unprecedented coincidence of bad events such as Y2K and an over-
exuberant stock market or was there an economic policy failure that was 
decisive?

 Sometimes the makers of economic policy become convinced that 
    the best way to avoid an unwelcome event is to engage decisively in 
    a new economic plan. That is exactly what happened in the late 
    1990's when voices of alarm predicted that a low saving rate in the 
    United States would result in an unsustainable increase in imports 
    in excess of exports until our indebtedness to the rest of the 
    world would produce a global economic collapse. The chosen remedy 
    was to pursue a large enough Federal budget surplus to offset 
    deficient private sector saving.
 In the four quarters to the second quarter of 2000 individual 
    income tax payments to the IRS rose exactly twice as fast as the 
    growth rate of personal income: 11.4 versus 5.7 percent.
 The engine that had been driving our prosperity was an 
    unprecedented capital goods boom that matched up with an 
    unprecedented surge in capital goods technology. Disposable 
    personal income took such a hit from the 11.4 percent increase in 
    individual income tax payments that there was simply not a 
    sufficient increase in disposable income to enable households to 
    buy what had been produced.
 In the turning point year 2000 a second, third, and fourth 
    quarter slowdown in the growth of personal consumption expenditure 
    coincided with such a high rate of increase in capital goods 
    capacity that the return on capital goods plummeted. While interest 
    rates on real capital were plunging in the second half of 2000, 
    FOMC action in lowering the target Fed funds rate was not begun 
    until January 3, 2001. Even though the January 3rd cut in the 
    target Fed funds rate was followed by an unprecedented volley of 
    rate cuts through the year 2001, it was not sufficient to have 
    avoided an employment recession. But without the FOMC action 
    results would have been worse.
 Although a tax rate cut was proposed by President Bush in 
    early 2001, its enactment came in a compromise form that 
    distributed nonincentive tax rebates in the third and fourth 
    quarters of 2001 and implemented a phased in tax rate reduction in 
    fiscal years 2002, 2004, and 2006.
 Even though the monetary policy and tax rate policy response 
    was far from ideal, it seems appropriate to credit the FOMC and the 
    Congress for alleviating the rate of decline in employment and 
    output. The half scale tax remedy did not prevent a recession, but 
    it cushioned the recession's rate of decline.

    Third, let's consider some facts to be learned about deficits and 
debt from a review of the data from the Federal Reserves Flow of Funds 
statistical base:

 Economic growth in current dollars ($GDP) averaged 5.0 percent 
    from 1991 to 2002 matching the growth of total sector borrowing as 
    a percent of total sector debt which averaged 5.2 percent by an 
    arithmetic mean and by 5.1 percent by a median. Total sector 
    borrowing rates during these 12 years is considerably lower than 
    the 7.8 percent average for 37 years from 1965 to 2002--a lower 
    inflation rate reduces the rate of growth of debt necessary to 
    sustain an expansion. Think how much worse this decline would have 
    been if we had entered the recession with a 12 percent rate of 
    inflation.
 When Federal borrowing as a percent of Federal debt actually 
    declined at a 3 percent annual rate as it did from 1998 to 2001 
    then borrowing from non-Federal sectors must necessarily have 
    increased enough to make up for negative Federal borrowing 
    contribution. Household borrowing as a percent of household debt 
    increased to a 7.7 percent rate up from the 12-year average of 6.8 
    percent. And business borrowing surged from its 12-year average as 
    a percent of business debt from 5.1 to 8.8 percent.
 But the problem with requiring a surge in household borrowing 
    and business borrowing to offset a decline in Federal borrowing is 
    that households and businesses are not able to sustain such a high 
    increase in borrowing as a percent of debt. The result was not only 
    a 2002 slowdown in business borrowing as a percent of business debt 
    to 2.8 percent, but also a slowdown in total borrowing to a level 
    insufficient to maintain an expansion of output. Give credit to the 
    FOMC for providing sufficient liquidity to enable the price of 
    houses and condominiums to continue to move somewhat higher and 
    thereby provide a sufficient level of equity extraction to enable 
    households to continue a spending pace sufficient to keep output 
    growth positive.

    Fourth, is the stimulus of Federal borrowing offset by a crowding-
out effect on 
private borrowing? Or, put another way, does an increase in Federal 
borrowing put upward pressure on interest rates?

 The answer to the first question is ``No.'' Crowding out 
    occurs only when Government expenditures require resources in 
    competition with the production of private sector goods. A 
    reduction in tax rates increases incentives to invest and to 
    produce by leaving buying power in the private sector. There is no 
    crowding-out.
 The answer to the second question is ``Yes.'' But it is a far 
    different matter to push the natural rate of interest up to 1 
    percent than to push it up to 10 percent. The problem today is that 
    interest rates are too low to provide a meaningful reward for 
    saving and too low to provide an adequate safe fixed income for 
    people facing retirement or currently retired.
 There is not likely to be any crowding-out effect from tax 
    rate reductions. For example in the 1981-1982 recession, a tax rate 
    cut worked to create jobs without any crowding-out effect as the 
    average monthly employment gain was 367,000 per month in the 22nd, 
    23rd, and 24th months after the July 1981 peak in employment. In 
    contrast, the average monthly employment change was minus 87,000 
    per month in the 22nd, 23rd, and 24th months after the March 2001 
    peak in employment. If economic policy should be geared toward an 
    increase in employment then the 1981-1982 model warrants emulation.
 Given that the FOMC has now recognized that the risk of 
    deflation exceeds the risk of inflation, interest rates are more 
    likely to remain too low for several years. It is a time to 
    understand that economies besieged by a disinflation to deflation 
    risk are likely to be in a low-interest rate environment for many 
    years to come. The only likely escape is through the incentives of 
    tax rate reduction.

    Fifth, is monetary policy likely to work in a deflationary 
environment?

 Monetary policy always works as long as the target variable 
    chosen is countercyclical. The FOMC has the choice of selecting one 
    of three target variables: A target Fed funds rate, a target growth 
    of reserve bank credit or a target price level. Any one of these 
    target variables could work to counter deflation.
 The FOMC has chosen to target the Fed funds rate as a way to 
    measure out the amount of monetary liquidity additions and 
    subtractions. Consequently, I will confine my focus to selecting a 
    target Fed funds rate that is likely to increase the growth rate of 
    real economic output to a level sufficient to stimulate employment 
    growth. The problem with monetary policy in long-cycle periods is 
    not that monetary policy runs out of ammunition, but that the 
    monetary authority quite often misjudges the degree of economic 
    restraint contained within a chosen target Fed funds rate.
 Persistent economic growth rates below the growth rate of the 
    labor force and the growth rate of capital goods capacity is a 
    clear indication that the chosen target Fed funds rate has been too 
    high to accommodate the money hoarding preference of households and 
    business. Selecting a lower target Fed funds rate will require an 
    increased injection of monetary liquidity into the banking system.
 A reduction of the target Fed funds rate from 1.25 to 0.75 
    percent would require a significant injection of liquidity to bring 
    a supply of liquidity consistent with a 0.75 percent rate. It is 
    monetary nonsense to argue that ``quantitative easing'' can provide 
    more liquidity at the existing Fed funds rate. Any increase in the 
    supply of reserves would result in a lower Fed funds rate. As long 
    as the Fed funds rate is positive the FOMC is likely to want to 
    measure its quantitative easing by the extent of the change in the 
    Fed funds rate.

    Sixth, could monetary policy restore the desired price level and 
thus the desired economic growth rate without changing tax rates?

 The pragmatic answer is ``not likely'' in a capital goods 
    contraction as compared to a recession driven by an inventory 
    correction. A persistent failure of the price level and the growth 
    of output and employment to respond to significant cuts in the 
    target Fed funds rate is evidence of fiscal restraint. Whereas, 
    inventory recessions tend to be followed by a motive to increase 
    production more than the increase in sales, in order to reverse 
    previous inventory rundowns, capital goods recessions are not prone 
    to such a predictable end. After a labor market has passed the 
    ``soft market'' stage to a stage where labor market uncertainty has 
    a cumulative depressing effect on ``lifetime income perceptions'' 
    then monetary easing alone is likely to be transmitted only through 
    disruption of global exchange rates.
 My advice is to choose a tax rate reduction that is likely to 
    increase the expected economic growth rate of the United States 
    sufficient to keep the dollar strong and stable. Monetary policy 
    alone runs a danger of providing ``beggar thy neighbor'' remedy to 
    domestic deflation. In other words, the more than moderate 2003 
    decline in the exchange value of the U.S. dollar against the Euro 
    is likely to have simply transferred deflationary pressures from 
    the United States to Europe and Japan. That is less than acceptable 
    economic policy leadership.

    Seventh, what tax rate proposal do I favor?

 The elimination of the double taxation of corporate income 
    paid out in dividends is far better than any other proposal as it 
    reduces our highest effective tax rates.
 There is more bang for the buck in eliminating double taxation 
    as no other proposal will make common stock ownership so much more 
    attractive. Not only does it eliminate the pernicious double 
    taxation but also it is likely to have the greatest effect in 
    modifying corporate executive branch behavior to perfectly align 
    the CEO's interest with shareholder interest. Why would top 
    management wish to distribute the fruits of their labor in any 
    other way than in paying dividends.
 The exclusion of qualified income from taxation will first 
    increase the dividend payout ratio then it will alter the choice of 
    employed workers to reduce the amount of income deferred from 
    taxation into company retirement plans in favor of direct stock 
    ownership. And for retired workers it will encourage withdrawing 
    funds from retirement programs, paying the income tax, and then 
    securing tax free income. I am convinced that Federal tax receipts 
    would increase between 2004 and 2010 as a result of the elimination 
    of double taxation.
 Although it seems the Congress may choose a combination tax 
    rate of 15 percent for both dividends and capital gains, I continue 
    to prefer the original model presented by the President as it is 
    much more likely to provide the surge in common stock values. We 
    have never moved from recession to recovery without first seeing a 
    new bull market in common stocks.
 Reducing maximum noncorporate business tax rates to the 35 
    percent corporate rate is essential to provide an optimum increase 
    in jobs for American workers.

    
    
    
    
    
    
                    PREPARED STATEMENT OF MARK ZANDI
              Chief Economist and Co-Founder, Economy.com
                              May 22, 2003

    Mr. Chairman and Members of the Subcommittee, my name is Mark 
Zandi, I am the Chief Economist and Co-Founder of Economy.com.
    Economy.com is an independent provider of economic, financial, 
country, and industry research designed to meet the diverse planning 
and information needs of businesses, governments, and professional 
investors worldwide. We have over 500 clients in 50 countries, 
including the largest commercial and investment banks; insurance 
companies; financial services firms; mutual funds; manufacturers; 
utilities; industrial and technology clients; and governments at all 
levels.
    Economy.com was founded in 1990. We are an employee-owned 
corporation, that is headquartered in West Chester, Pennsylvania, a 
suburb of Philadelphia. We also maintain an office in London.
    I will make three points in my remarks. First, the economy is 
struggling significantly, and a well-designed fiscal stimulus plan that 
is passed quickly would be useful in jumpstarting the economy and by 
extension the equity market. Second, while the elimination of the 
double taxation of corporate income is a laudable economic objective, 
doing so will provide only a small boost to the equity market, and do 
little to support the economy's near-term prospects. This is 
particularly true of the current proposals to simply scale-back 
dividend income taxes for a limited period. Third, the long-term 
economic benefits of the proposals to scale-back dividend income taxes 
are also small, as any gains to economic efficiency are all but offset 
by the economic drag resulting from larger budget deficits and higher 
interest rates.

Fiscal Stimulus
    The need for more fiscal policy stimulus is motivated by the 
struggling economy that is operating well below its potential. The 
economy is posting gains in real GDP, but those gains are barely half 
those necessary to support any meaningful job growth and a stable 
unemployment rate.
    Adding to the pernicious character of the economy's current 
problems is that they are extraordinarily broad-based. Industries as 
wide-ranging as manufacturing, commercial construction, travel, 
retailing, investment banking, and now State governments are reducing 
payrolls. The economy's difficulties are also widespread from coast-to-
coast. Large economies ranging from Boston and New York in the 
Northeast, to Atlanta and Dallas in the South, to Chicago and Detroit 
in the Midwest, to the Bay Area of California and Denver in the West, 
are engulfed in full-blown recessions.

Near-Term Impacts
    Fiscal stimulus is needed to jumpstart the economy and by extension 
the stock market, but such stimulus must be well-designed and it must 
be provided quickly. Scaling back dividend taxation, particularly as 
envisaged under the plans currently being debated, will provide at best 
only marginal support to the economy this year and early next, when it 
needs it most.
    The link between scaling-back dividend taxation and the economy's 
near-term performance is largely through stock prices. Stock values 
will rise by an amount equal to the present value of the stream of 
future tax savings. With approximately only one-half of individual 
dividend income excluded from taxation, under the current plans, stock 
values will receive an estimated boost of no more than 5 percent. The 
increase in stock prices will occur quickly as investors discount the 
tax benefit. Indeed, at least part of this benefit may already be 
discounted in current stock prices, as investors have likely attached 
some probability to some reduction in dividend 
income taxes.
    A key conduit through with higher stock prices affect the economy 
is through the positive wealth effects on consumers. The wealth effect 
postulates that households consider all their financial resources when 
deciding how much to spend and save. When household net worth rises, 
households are more willing and able to increase their spending out of 
income and thus save less. Conversely, when household net worth is 
falling, households are more anxious about their financial well-being 
and are less willing and able to spend out of income and thus save 
more.
    The wealth effect from a change in stock values is estimated to be 
almost 2.5 cents. That is, for every permanent dollar increase in stock 
values, consumer spending ultimately increases by 2.5 cents. This 
wealth effect is distributed over nearly 3 years and is very small in 
the first year given that households must expect that any increase in 
wealth is permanent before changing their spending and saving behavior 
in response.
    Higher stock prices also support the economy through a lower cost 
of equity capital for businesses. Businesses are able to issue new 
equity at lower cost to finance their growth, supporting stronger 
business investment.
    The economic benefit of a positive wealth effect and lower cost of 
equity capital occurs with long lags. The lags are likely to be even 
longer in the current economic environment, which is characterized by a 
high degree of consumer and business angst and uncertainty. Given the 
approximately 40 percent plunge in stock values during the past 3 
years, households will be skeptical that any increase in the value of 
their stock portfolios represents a permanent increase in the value of 
their portfolios. Without that expectation, households will be slow to 
increase their spending in response. Businesses will also be unlikely 
to quickly raise more equity capital to finance increased investment in 
response to any rise in stock prices. The equity market remains 
particularly unreceptive at this time to companies looking for capital 
to expand, and businesses remain exceedingly cautious in taking risks 
given heightened geopolitical concerns.
    Mitigating the economic boost of scaling-back dividend income 
taxation is the higher long-term interest rates that will result. Like 
equity investors, fixed income investors will quickly discount the 
implications of such a change, most importantly being the larger long-
term Federal budget deficits that will result from the lost tax 
revenues.
    As is evident historically, larger long-term deficits result in 
higher long-term interest rates. During the first half of the 1980's, 
when the Federal debt was expanding at over a double-digit pace, real 
10-year Treasury yields were over 8 percent. As debt growth slowed 
during the 1990's and fell during the later half of the decade, real 
Treasury yields were halved.
    Interest rates on tax-free bonds such as municipal bonds will be 
under added pressure, as they compete for investable funds against the 
stocks of dividend paying companies.
    Higher interest rates raise the cost of debt capital to businesses, 
at least partially offsetting the boost to investment provided by the 
lower cost of equity capital. The higher rates also constrains consumer 
spending on consumer durables and housing demand. This in turn weighs 
on near-term growth in house prices and housing wealth, at least 
partially offsetting the boost to consumer spending provided by the 
increase in stock wealth. The wealth effect out of housing wealth is an 
estimated 4.5 cents over a 3-year period. This is larger than the 
wealth effect out of stock wealth given the substantially broader 
ownership of housing. Well over two-thirds of households own their 
home, while not quite one-half of households own stocks.
    Of all the tax cuts currently being considered by policymakers, 
scaling-back dividend taxation provides the smallest near-term economic 
stimulus. The near-term economic bang for the buck, or 1-year change in 
real GDP provided for a given dollar of lost tax revenue, is only 9 
cents. This compares to a near-term economic bang for the buck of 59 
cents for rolling forward the marginal personal tax rate cuts now 
legislated to occur next year and in 2006, for example, and 124 cents 
for providing direct aid to hard-pressed State governments, and 173 
cents for extending emergency Federal unemployment insurance benefits.

Long-Term Impacts
    The elimination or scaling back of dividend taxation does result in 
several important long-term economic benefits. Most importantly, it 
reduces the disadvantage the corporate sector now faces in the 
competition for capital. Under current law, some corporate income is 
taxed twice, but most small businesses are taxed only once at the 
personal level, and the imputed income on housing is not taxed at all. 
These differences in tax treatment lead to less investment in the 
corporate sector than is economically optimal.
    Eliminating or scaling-back dividend taxation also reduces the 
current tax incentive businesses have to use debt over equity to 
finance their operations. The resulting over-leveraging of businesses 
does make them more vulnerable to financial problems during recessions, 
forcing them to undertake more draconian cost-cutting and thus 
exacerbating the downturn.
    There are also long-term economic benefits as businesses will 
devote a higher share of their corporate income to paying dividends. 
Businesses will thus find it more difficult to temporarily lift their 
stock prices through stock repurchases and other financial engineering 
techniques. These strategies, which were very popular during the equity 
market boom of the late 1990's, likely result in inefficient corporate 
decisionmaking.
    These economic benefits, however, are ultimately significantly 
offset by the higher actual and anticipated future budget deficits that 
result. As previously discussed, larger persistent deficits result in 
higher long-term interest rates. This weighs on business investment and 
ultimately productivity growth and the economy's long-term potential 
growth. Indeed, the economic drag of higher interest rates ultimately 
outweighs the economic benefits of eliminating or scaling-back dividend 
taxation.
    The long-term economic bang for the buck, or 10-year increase 
change in real GDP provided for a given dollar of lost tax revenue, is 
estimated to be 20 cents. The most significant economic bang for the 
buck occurs 3 to 5 years after taxes are reduced, but due to the 
pernicious economic effects of higher interest rates, real GDP is lower 
by year 8.

Conclusions
    The economy is struggling and while it is expected to avoid another 
recession given the very successful military action in Iraq, more 
Federal fiscal stimulus is needed. The fiscal stimulus plan 
policymakers are currently coalescing around is a good effort to 
provide that stimulus, although it must soon become law to be of 
significant help.
    Scaling back dividend income taxation, however, will do little to 
jumpstart the economy. There are longer-term economic benefits to 
scaling-back dividend taxation, but they are significantly diluted 
under the plans being considered by the resulting higher budget 
deficits and long-term interest rates. The benefits of dividend tax 
cuts would thus be significantly enhanced if they were coupled with 
broader corporate tax reform that would result in a fiscally neutral 
change.
    While such tax reform is laudable, it is a complex and thus time-
consumer endeavor, and thus should not be included as part of the 
current fiscal stimulus plan.


                       JUMPSTARTING THE ECONOMY:
                             RURAL AMERICA

                              ----------                              


                        WEDNESDAY, JUNE 25, 2003

                               U.S. Senate,
  Committee on Banking, Housing, and Urban Affairs,
                           Subcommittee on Economic Policy,
                                                    Washington, DC.

    The Subcommittee met at 2 p.m. in room SD-538 of the 
Dirksen Senate Office Building, Senator Jim Bunning (Chairman 
of the Subcommittee) presiding.

            OPENING STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. The Subcommittee will come to order. It is 
2 o'clock, and I like to start things on time. A lot of people 
do not realize that.
    I would like to welcome all of our witnesses to the second 
hearing of the Economic Policy Subcommittee of the 108th 
Congress. I am very happy that we have three of my fellow 
Kentuckians on the panel today.
    Since our first hearing in May on increasing investment in 
equity markets, the Dow has gone up over 590 points, and the 
Nasdaq has risen over 115 points. I understand a tax bill might 
have passed that day, but I give full credit to our hearing. 
Hopefully, Chairman Greenspan will not mess things up today and 
will cut rates another 50 basis points. We will know in about 
15 minutes. We want to bring the same results we brought to the 
equity markets to rural America.
    For our second hearing, I would like to focus on the 
economics of rural America. During the tech boom of the 1990's, 
our economy experienced rapid growth. Productivity has 
increased at historic rates. The equity markets grew to record 
levels, so much so that there were many examples of janitors at 
tech companies becoming millionaires because of their stock 
options. I hope now they sold those stocks before the bubble 
burst.
    Rural America, for the most part, did not experience that 
rapid growth. The tech boom did help, especially to increase 
productivity. Many farmers use global positioning systems, 
called GPS's, to assist in running their farms. The Internet 
has also been a huge help to make farmers more productive. But 
rural America did not experience the same highs many other 
parts of America did during the 1990's. Fortunately, they also 
have not experienced the same lows of this last recession, but 
they still lag behind.
    I would like to talk about where we are today in rural 
America. What the state of the economy is currently, and what 
we see for its future. I would also like to talk about what we 
can do to help grow the rural economy. In many parts of 
Kentucky and the rest of the country, our young people are 
leaving the rural areas because they do not believe that they 
will be able to get jobs. Now, we must change that.
    I am very happy to have the Administrator of the Rural 
Utilities Service, Hilda Legg, here today; also the Dean of the 
Kentucky School of Agriculture, Scott Smith; we also have the 
Vice President of the Kentucky Farm Bureau, Mark Haney. I used 
my Chairman's prerogative to stack the deck with Kentuckians. I 
am very thankful you agreed to take time out of your busy 
schedules to testify here today, and I look forward to hearing 
your testimony.
    Ms. Legg, if you would like to start us off ? And we will 
make all of your full statements part of the record, so you do 
not have to worry about that.

                  STATEMENT OF HILDA GAY LEGG

             ADMINISTRATOR, RURAL UTILITIES SERVICE

                 RURAL DEVELOPMENT MISSION AREA

                 U.S. DEPARTMENT OF AGRICULTURE

    Ms. Legg. Thank you, Chairman Bunning, for this opportunity 
to participate in a hearing that, of course, I feel 
passionately and personally very committed to. It is a public 
forum for us to understand the problems and the challenges that 
rural America faces and to seek answers to those challenges. 
So, I am grateful for this opportunity.
    As the Administrator of the Rural Utilities Service and as 
a part of USDA's Rural Development team, I work with our 
programs that provide financing for the infrastructure 
construction for electric power, telecommunications, and water 
and waste disposal services. I come from a background that 
includes building economic development in Kentucky, as well as 
with the Appalachian Regional Commission.
    Our focus in the Rural Development mission area is to help 
rural areas achieve economic and social gains that are solid 
and long lasting.
    The Federal Reserve Bank of Kansas City's Center for the 
Study of Rural America reports in their May Overview, that the 
rural economy continues to hold steady, with rural jobs very 
slightly gaining 0.7 percent in February compared to a year 
ago. Job growth is increasing at a very slightly higher 
percentage in rural areas compared to growth in metropolitan 
areas, according to the Bureau of Labor Statistics. And while 
no one is claiming this is a boom cycle, it appears that in the 
rural economy, at least we are heading in some of the correct 
directions.
    Rural America is an eclectic mix of races, ethnic groups, 
terrain, climate, amenities, businesses, and institutions. 
While agriculture is certainly prominent, no one industry 
dominates the rural landscape as it did a couple of centuries 
ago, nor does a single pattern of population decline or growth 
exist for all rural areas. Diversity then presents 
opportunities for some creative answers and unique 
partnerships.
    At the beginning of the 21st Century, according to the U.S. 
Census and the USDA's Economic Research Service, rural America 
comprises 2,305 counties, contains 80 percent of the Nation's 
landmass, and is home to 56 million people.
    In Secretary Ann Veneman's book ``Food and Agriculture 
Policy,'' she stated that despite the fact that seven out of 
eight rural counties are now dominated by nonfarming 
activities, that in no way 
diminishes the importance of ranching and farming in rural 
areas. However, in many communities, this diversity provides a 
strength that can help us to sustain through those times of not 
enough rain or too much rain, as recently.
    Our challenge that we face from the infrastructure program 
is that while we have seen a serious downturn in the 
infrastructure development, especially in the telecom field 
recently in the more national picture, in our rural areas we do 
not have the problem of lots of dark fiber. That does not exist 
in rural America.
    The fact is we have had to relearn an old lesson, that it 
really takes a good business plan, no matter what the 
technology that you are trying to deploy. High-speed 
telecommunications are absolutely mandatory for new job 
creation, not just for the future of rural America but also for 
today. Just like a good road, high-speed telecommunications 
requires a use for it to be beneficial, it must add to the 
economic structure of a rural area. There is no doubt that 
without that infrastructure being built, they will not come. 
Just to install broadband telecommunications capability without 
a plan of how to use it is a high stakes rolling of the dice.
    Rural America finds itself in the midst of a revolution of 
change in the areas of telecommunications and electric 
infrastructure programs. The Telecommunication Act of 1996 has 
created an interesting and complicated landscape. While many of 
the larger providers have chosen to place their resources in 
the more densely populated areas of the country, but we see a 
vast number of entrepreneurs, from small traditional telecom 
companies to new start-up businesses, are stepping bravely into 
this new and hopefully competitive market in rural America. The 
general investment community is very hesitant today to finance 
telecommunications development needs, especially in rural 
communities. Therefore, the challenge of USDA is to provide 
funding for high-speed telecommunications development while 
continuing our history of high-quality loans that are a good 
use of taxpayers' dollars entrusted to us, Senator, by the 
Congress.
    Clean, safe drinking water and ecologically sound waste 
disposal are equally vital aspects of both rural health needs 
and quality of life for rural citizens. There is no more basic 
human need than that of clean, safe drinking water.
    In the electric infrastructure program, the development of 
renewable energy is not only improving the availability of 
energy to rural residents, but we are also seeing the 
development of what we call ``power farming'' as a potential 
new crop for farms and rural residents. Ethanol, solar, and 
wind are the most economically competitive energy sources, 
while bioenergy projects continue to improve the economic 
future for farms and rural businesses.
    As a Nation, we are only as strong as our weakest link. It 
is always easy to look at the national numbers and percentages 
while forgetting the individual needs of rural citizens and 
communities. Low percentages of unemployment sound a little 
hollow to that person who is unemployed. To him, it is 100 
percent unemployment.
    USDA, like any other Federal agency, does not have easy 
answers. We do find that by working with our rural partners and 
the community leaders, we can make gains in rural communities. 
And by one degree at a time maybe we can turn that ship around 
and in a different positive direction. The USDA Rural 
Development field staff, in State and local offices, still 
serves as our frontline in working directly with rural leaders 
for stronger communities.
    Building quality infrastructure, housing, and businesses 
based on long-term plans and good business models, that is what 
will make our economy grow. Local leadership and citizens 
commitment is a key ingredient to making these programs work.
    To create a new competitive edge for rural industries will 
require access to strong education to keep up with the changing 
world. It will require available capital for business 
development. And maybe most importantly, it will require strong 
rural leadership to make these things happen at that local 
level.
    Thank you, Senator Bunning, for the opportunity, and I will 
be glad to answer questions whenever appropriate.
    Senator Bunning. Thank you, Ms. Legg.
    Mr. Smith.

                  STATEMENT OF M. SCOTT SMITH

           DEAN AND DIRECTOR, COLLEGE OF AGRICULTURE

                     UNIVERSITY OF KENTUCKY

    Mr. Smith. Thank you, Chairman Bunning, for the opportunity 
to share these remarks on rural economic development. In 
serving as Dean of the University of Kentucky College of 
Agriculture and also the Director of the Kentucky Cooperative 
Extension Service, I can assure you that rural economic issues 
play a very large part in shaping the mission of our 
organizations.
    Rural counties and small cities in Kentucky, and throughout 
the Nation, face some significant economic challenges. The 
recent economic slowdown compounded with significant changes in 
the agriculture economy threaten job and income security in 
many rural areas. In some important ways, the current economic 
climate has had a relatively greater negative impact on some 
rural areas compared to metropolitan areas. Most notably, very 
recent downturns in rural manufacturing combined with some 
troubles in the farm economy are laying a combined one-two 
punch on many rural areas. For example, national manufacturing 
employment from 2002 declined by over 10 percent in rural areas 
of America compared with approximately 7 percent in 
metropolitan areas. Almost 140 rural factories closed last 
year.
    Meanwhile, the rural service sector and rural construction 
activity would probably best be described as flat. Rural 
recreation and tourism apparently has not fully recovered from 
9/11. And layered on top of this, in tobacco States like 
Kentucky, the shrinking quota and the changing tobacco program 
will continue to have dramatic effects, truly dramatic effects, 
not just on farmers but on entire rural communities.
    Although the farm economy was widely described as 
recovering in 2001 and 2002, much of this advance was due to 
transfer payments. We all appreciate the uncertainty and the 
undesirability of relying on farm programs to sustain the rural 
economy. But even in the best of times for agriculture, farm-
level profitability, while remaining crucial, cannot by itself 
support the full weight of rural development. Consider, for 
example, that an increasing fraction of farm families in 
Kentucky and elsewhere are economically dependent upon the 
opportunities for off-farm rural employment. And you understand 
that farm and rural nonfarm economies continue to be ever more 
interconnected.
    Unfortunately, the potential declines, of which there are 
some signs, in the rural manufacturing sector could make 
business recruitment a realistic option for fewer and fewer 
rural communities. In such circumstances, retaining local 
businesses, creating new local enterprises, and adding value to 
local products, be they farm products or otherwise, these 
become indispensable measures for sustaining the local economy. 
To do this in both rural businesses and farms, we will need to 
have innovative leadership, as Ms. Legg said, and greater 
technical assistance to identify new income opportunities and 
enhance their products and services.
    Rather than speak today about specific policy strategies or 
issues in economic development, I would like to take this 
opportunity to comment on the general characteristics of at 
least one promising, very promising, rural economic development 
initiative in Kentucky.
    One Kentucky program taking an integrative and 
comprehensive approach is the Kentucky Agricultural Development 
Fund. Unique among the States, Kentucky has invested 50 percent 
of its share of the National Tobacco Settlement, well over $100 
million to date, in programs supporting both agricultural and, 
therefore, rural development. This massive and innovative 
program has benefited from the full participation of State 
government, farm and community organizations like Farm Bureau, 
the University's Land Grant system, and hundreds, maybe 
thousands of local leaders. Beyond investing in on-farm 
profitability and diversification, the Fund has supported 
projects in value-added and alternative products, agri-tourism, 
rural infrastructure, entrepreneurship and leadership 
development, marketing, and resource conservation. This is 
surely one of the Nation's most comprehensive and ambitious 
rural development initiatives.
    Complex, multidimensional economic problems demand 
integrative, comprehensive strategies. And programs like this 
acknowledge that multiple ingredients must be assembled for 
economic success: Infrastructure, leadership and 
entrepreneurship, access to capital, a skilled and productive 
workforce, access to and ability to use new technologies.
    I would be happy to comment more and answer any questions 
about the ag development programs in Kentucky as time permits, 
but I want to conclude by touching on the role of organizations 
like mine, the land grant colleges, in rural economic 
development.
    As many public universities around the Nation, including 
the University of Kentucky, are mandated to become an even 
greater force for economic development, a few States are 
pursuing a new and broader mission for the traditional land 
grant system of Cooperative Extension and the Experiment 
Station. This new land grant approach fosters R&D and 
technology transfer in a wide array of enterprises, including 
farming, of course, but certainly not limited to agricultural 
production. So in Kentucky, we are building rural research and 
extension partnerships in everything from engineering to fine 
arts. In one major initiative, we teamed up the university 
medical center, State health agencies, and county extension 
agents to greatly expand health education and information 
access in rural areas.
    In another multistate consortium, we are working to grow a 
manufacturing engineering extension service to better support 
rural factories. And in the planning stages, and perhaps of 
interest to this Committee, is a project with Kentucky housing. 
They intend to require high-speed Internet connectivity in all 
units that they finance. A nongovernment IT firm is committed 
to creating a specialized web resource system. And the 
extension service will provide content on family and consumer 
issues: Health, nutrition, personal finance, and other topics 
specifically configured for this particular audience.
    Our diverse partners in such programs understand the power 
of a Statewide, county-level extension network for rural 
development and the ability to connect this network to the 
University, State, and Federal level information and expertise. 
So just as the land grant institutions supported the dramatic 
advancement of the Nation's farming economy in the last 
century, they can well serve the broader mission of rural 
economic development in years to come.
    I thank you for the opportunity to comment and for the 
Banking Committee's thoughtful deliberations on this crucial 
and very challenging topic.
    Senator Bunning. Thank you very much, Mr. Smith.
    Mark Haney, would you like to proceed?

                    STATEMENT OF MARK HANEY

                         VICE PRESIDENT

                KENTUCKY FARM BUREAU FEDERATION

    Mr. Haney. Thank you, Mr. Chairman.
    I again thank you for the opportunity to represent my 
fellow Farm Bureau members to speak on the current status of 
the agriculture community and rural America. And thank you for 
allowing a member of the farm community to be able to come and 
testify.
    We have lots of advantages and disadvantages living in the 
rural community, but I think the advantages outweigh the 
disadvantages by a lot. However, I do want to kind of talk 
about the current status of the agriculture community in rural 
America and in rural Kentucky.
    We came off of kind of a tough year in 2002 for a variety 
of reasons, one being weather related. Net farm income was off 
from about $45 billion down to about $30 billion. Farm policy 
was in transition. Falling grain prices were part of the 
factor. And that $15 billion loss not only hit farm families in 
rural America but also hurt small businesses, lending 
institutions, and made for a somewhat sluggish economy.
    That was not necessarily all the things that contribute to 
maybe sluggish conditions in the rural economy in America, and 
you will, I guess, hear somewhat of a common theme among the 
panelists today. Some of the things that I mentioned they have 
also.
    It is very important that we in rural America have 
communications, telecommunications in particular. We find 
ourselves sometimes in need of better communication facilities. 
We struggle to deal with the new infrastructure in rural 
America for telecommunications, specifically broadband Internet 
service, cellular towers. We need cellular towers in rural 
America almost as bad as we need four-lane highways. We 
desperately have to have communication.
    We also find ourselves a bit behind in physical 
infrastructure. We read about many State legislatures coping 
with economic woes, and we find ourselves in rural America with 
bridges and highways in constant need of repair. We have to 
have the physical infrastructure to get our crops to market, do 
the things that we really have to do to be able to market the 
crops that we grow.
    To keep a highway system going, it is constantly--we have 
to do that on a continual basis, and we cannot take breaks in 
that because there is a need of economic input.
    We also find ourselves in rural communities dealing with 
other topics like solid waste. It can be a real problem. Trash 
pick-up is not really a luxury in rural America, but it is a 
problem. We have trash just like everyone else. I live in an 
area in southern Kentucky, or southeastern Kentucky somewhat, 
where we are really fortunate. We have Congressman Hal Rogers 
and his PRIDE program that is making tremendous gains in this 
field. He is restoring pristine waters to our community. We are 
able to clean up dumps, illegal dumps, health hazards, all the 
things that need to be going on, inspiring people with a 
feeling of pride in their daily lives. I think if we could do 
that on a national basis, similar type programs, I think it 
would be very, very good.
    Another problem we have in rural Kentucky is not 
necessarily just our problem, but it is a real problem in rural 
Kentucky, and that is affordable health care. Rural Kentucky is 
made up of small businesses, and being a farmer, I consider 
myself a small businessman. I have a brother that is a partner. 
We operate a 450-acre farm that has been in our family for more 
than 130 years. We have fifth generation living on our farm 
right now. Health care is a problem for everyone, especially 
small businesses. Small businesses make up most of rural 
America, and it is a problem for them to provide their family 
with affordable health care, much less their employees. So, we 
find that that is a real need in rural America.
    Also, we find that long-term care for our seniors is a big 
problem in rural Kentucky. In my county, I have people that I 
know personally that have a senior family member that maybe has 
to be in an institution in a different county, maybe two or 
three counties away, as much as maybe 100 miles, to be able to 
house that individual. I think that is a real problem, 
especially if we want to keep people living in rural America, 
living in rural Kentucky.
    We do have an advantage, I think, in rural Kentucky. Most 
of our assets are fixed assets. Our savings are invested in 
fixed assets--land, buildings, equipment--not necessarily so 
much in the market that you spoke about, the stock market or in 
equities. So even though we may be slow to gain wealth in rural 
America, we are slow to lose wealth though. Those farms, those 
buildings, are there for generations, and they provide 
stability in our people, in our citizens. I think that is one 
of the biggest pluses that we have in rural America.
    To keep people involved in agriculture, to keep people 
involved living in rural America, I think we need to make 
business advantageous to small businesses. That is what, in my 
opinion, is going to keep people living in rural America. Where 
we live, where I live in particular, there is a lot of off-farm 
income that allows people to operate small family farms and 
have a way of life in a rural setting. I think that is a very 
positive thing, and I think that is a thing that we need to 
strive.
    One other comment that I would like to make deals more in 
particular with Kentucky agriculture. Kentucky is made up of a 
high number of small farms. Kentucky is the fourth largest 
State in the number of farms. However, our farms are small 
farms. In Kentucky, the average size of a farm is 150 acres. 
The national average is about 430 acres. But what has been able 
to sustain those small farms has been tobacco. For pretty much 
of the 20th Century, the tobacco warehouses, tobacco auction 
markets were as prevalent throughout the small communities in 
Kentucky as post offices were. It has just been a tradition and 
a way of life.
    However, we find that it is beginning to change. Because 
tobacco is a management system, we have a quota. And we find 
the quota beginning to shrink. The quota from 1997 was over 700 
million pounds. The quota for 2003 is about 290 million pounds. 
So, we can see how many people are actually getting out of the 
business or, more specifically, trying to stay in until they 
find stability in what the tobacco market is going to be.
    In the last few years, we find quota lease prices going 
from 25, 30 cents a pound to--it is not unheard of to hear 60, 
70, 80 cents a pound for people to be able to purchase quota or 
lease quota just to be able to maintain in the tobacco industry 
until they see what is going to happen.
    So there is talk of a buyout that we in Kentucky are very 
much in support of. We think it will give stability to the 
people that want to continue in the business. Many, many farms 
are waiting to find out what they can do. They are in a 
transition period right now. They are ready to transition the 
farm, the family farm into the next generation, but they are 
waiting for the buyout. Not only will it help the farm economy, 
but it will also have a nationwide health benefit if it is tied 
to the FDA's regulation of tobacco products.
    If there are any questions about the buyout or anything 
about Kentucky agriculture, I would be happy to entertain 
those. Again, I want to thank you for the opportunity to come 
and testify today.
    Senator Bunning. Thank you, all three of you, for your 
testimony. We will have just a few questions for you. Not too 
many.
    Ms. Legg, in recent years, the number of employees that 
telecommunicate to work has been on the rise. Employees are 
able to work from their homes and avoid the long commutes and 
higher prices of living that occur in cities. This being said, 
there has still not been a lot of employees migrating to rural 
areas to take advantage of this telecommunications. What can be 
done to notify more businesses and telecommunicators to the 
benefits of rural America and add other value-added enterprises 
to farms?
    Ms. Legg. That is an excellent question. I think what it is 
going to take is a combination of efforts.
    First of all, the high-speed connection has to be there, 
not just Internet access, because if you are really going to do 
business from home, the dial-up modem, which is the most 
prevalent accessibility of Internet is not competitive. If you 
are doing business in a global marketplace, you have to have 
the high speed.
    We have at USDA in our rural development program a 
broadband program to try to build out that infrastructure, as 
Mr. Haney mentioned, to try to get high-speed access into those 
rural communities. But as in any program of economic 
development in rural America, it is economies of scale. How 
does the private sector build out in a more densely populated 
area and have enough take rate, if you will, to pay back a 
loan, even a low-interest, Government-backed loan? So, you have 
to look at the economies of scale.
    What I think we have to do, the number one thing, is to 
help drive the market, help to create the awareness of what 
that high-speed connection can do. As you pointed out, 
telecommuting, members of your business working from home, yes, 
that is somewhat of a culture shift from some of us that are 
much more traditional workplace-bound. But that is why it takes 
leadership. That is why it takes education. It is the awareness 
of what that connectivity can do for your business or for you 
as an individual if you are allowed to work at home.
    So it is a combination. We do have to have financial 
resources, but we almost have to have a willingness to change 
the way we have traditionally approached many aspects of our 
life in order to recruit that. And then I think we have to do 
maybe a stronger emphasis on the whole aspect of business 
development because if you are going to sustain job growth and 
retention in rural America, it is going to be your small- to 
medium-size businesses, by and large, for long-term stability. 
Mr. Haney mentioned five generations. It is doing that kind of 
thing.
    I think the emphasis has to be on some entrepreneurial 
aspects within our culture, how you can make a living in rural 
America, but you must have that infrastructure capability to 
connect you to the global marketplace. And we have examples of 
how we try to do that and are doing it with our rural 
development programs. But, again, it comes back to the business 
piece of it as well, being able to repay those investment 
loans.
    Senator Bunning. To follow up, how do we convince our small 
entrepreneurs and our small business people to buy into that 
type of set-up? Because if I want to live in Somerset or if I 
want to live somewhere in rural--and I do not consider Somerset 
rural--it is one of the major cities in Pulaski County, maybe 
the largest city there. But if I wanted to live in Inez in 
Martin County--and that is rural--how do we convince an 
entrepreneur to buy into the fact that people actually can 
perform valuable work through high-speed Internet connecting 
and they do not have to report to work every day to do it?
    Ms. Legg. And that they will be actually working.
    Senator Bunning. That they will be. I mean, you can check 
on the connection.
    Ms. Legg. It really is a culture shift, and what we have to 
do, again, I was appreciative of Dr. Smith here talking about 
the leadership. We have to lead by doing. You are doing that by 
presenting this public forum. We have to get out there and--
actually what I call the three A's of technology: First, just 
to be aware of what it is, which many of our rural residents 
still do not know what ``Surfing the Net'' is; and, second, we 
have to have access--that is the infrastructure; and the third 
thing it has to have is application. It has to be applicable. 
It has to make business sense. We, as a whole, I think, have to 
do a better job of how we educate our businesses and our 
entrepreneurs about how it makes their business more efficient 
if they have telecommuting employees or if they have high-speed 
bandwidth and do global marketing. It is a matter of 
demonstrating that.
    And through some of our rural business development programs 
at RUS and certainly through some of our marketing efforts with 
the rural utilities program, we are trying to get that--it is 
about the application and the business advantage. It is like 
the old REA I use all the time the analogy of. When we first 
began to put electricity, if you were used to baking on a wood 
stove--you may not have ever done that, Senator, but I do 
remember that in my household. You did it, chopped the 
kindling. It was a part of your daily activity. Your recipes 
were geared to baking on a wood stove. Why did you need to buy 
a new stove? Why did you need to do this? Why did you need a 
monthly electric bill? Your life was going on pretty much the 
way it was. But we went out at the old REA and actually did 
demonstrations. They took the circus on the road. They showed 
housewives in rural America how to use an electric stove or an 
iron or washing machine. It was a huge cultural shift.
    I do not think that analogy could be lost in today's 
technology. How do we help people learn how it helps them make 
their lives and their businesses better?
    Senator Bunning. Dr. Smith, you mentioned some things that 
the extension program was getting into. Can they also get into 
this type of educational program that I was just speaking 
about?
    Mr. Smith. Yes, absolutely. And, in fact, some initial 
efforts have been made, not just in Kentucky, but also in other 
States. Ms. Legg mentioned entrepreneurship, and we believe 
that entrepreneurship can be cultivated and taught. There are 
programs in Appalachian Ohio which focus on entrepreneurship 
development that are partnerships of the State government and 
the extension service. We have a small program that is about to 
start in the Morgan County, Menifee County area, around the IT 
Center in Morgan County, that focuses on development of an 
entrepreneurial nucleus in those counties and building the 
networks, providing them with the information resources. And as 
part of that, building the awareness and the access to that 
culture of leadership and entrepreneurship.
    I think that it is a very important opportunity and 
responsibility of the extension service, of the community and 
technical college system, and of State government and the 
Federal Government as well. The development districts and 
others, small business development centers can all be a part of 
this, and they all need to be. 
But extension, because of our trusted position in every county 
seat 
has a unique role to play, and we intend to begin exploring 
that 
opportunity.
    Senator Bunning. Mr. Haney, you mentioned the tobacco 
buyout, and I want to pursue that to a degree. The tobacco 
Senators here in the U.S. Senate have been meeting off and on 
since the beginning of this session, trying to come up with 
some kind of viable piece of legislation. And we keep running 
into the same problem. How are we going to pay for it? I think 
we can solve the problem of the buyout if we can find the 
dollars to do it.
    Does somebody from your community and/or your organization 
have an idea where we can find the dollars to--now, I do not 
want to get back to Phase 1 and Phase 2 because that is ancient 
history and it is water over the dam. We had an opportunity 5 
years ago, and some of our leading spokesmen for buyout at that 
time--Senator McConnell said do not leave this on the table. 
Unfortunately, everybody in the farming community thought that 
the quotas would not be now 40 percent of what they were at 
that time, and that is about where they are at.
    Can you advance some type of system where we can go to 
buyout at the levels that we have talked about, 12 and 8, and 
take care of everybody that is involved in growing burley and 
dark-leaf tobacco in Kentucky?
    Mr. Haney. Yes, sir, I think--you mentioned the 8 and 4, 
and I think that is kind of stuck in rural Kentucky. Anywhere 
you go in the State of Kentucky or most any tobacco State, they 
are talking about $8 and $4 being the value of the quota, 
depending on if you are a quota owner or if you are a grower.
    I personally do not see any way to have a quota buyout 
without it being tied to FDA legislation. I know that some 
people would like to think about other ways of doing that, and, 
of course, we are open to talk about it anyway. But we think 
FDA legislation is probably the most legitimate way to fund 
this, and it would be a user fee, an assessment on the product, 
all tobacco products, not just a few but all tobacco products 
sold in the United States.
    Senator Bunning. And part of that you think can be sold 
because those who fought us so vigorously in the past as far as 
growing 
tobacco would be amenable to the buyout because of the FDA's 
involvement in the controlling of that growing on the farm? Is 
that why you think that they may be willing?
    Mr. Haney. Yes, sir. I think there is a lot of people that 
have been opposed to tobacco production over the years that 
would like to see Federal regulation of that industry or 
especially those products. I guess with the entrepreneurial 
spirit of rural America and many farmers that I know, when you 
have somebody really wanting to have Federal regulation of 
tobacco, and there are people that really need a tobacco 
buyout, then I think it is time to sit down and talk and maybe 
negotiate.
    Senator Bunning. Let me ask you the question that 
constantly comes up in our meetings. Do farmers in Kentucky and 
in the other tobacco States expect to have a program that is 
still there to back up after a buyout occurs?
    Mr. Haney. I think there is a need for not the program per 
se that we have right now. I do not think anyone says that the 
program that is existent is the one that we need in the future. 
It is not exactly filling the need right now, and that is the 
need for some change.
    However, I think there is a need for a structure, some 
structure of the industry, especially through a transition 
period. I just cannot hardly describe what tobacco and tobacco 
production, the importance it plays in rural Kentucky, 
especially, Senator, in the northeastern counties of Kentucky.
    Senator Bunning. You do not have to. I used to represent 
all those counties.
    [Laughter.]
    Mr. Haney. I know that, sir. And even in eastern Kentucky 
and where I live, it is very important to a lot of people. Now, 
I know you think maybe I live in urban America, but I really do 
not. Somerset is a nice size town, but I live out in a little 
town called Nancy, agriculture-based. I have been in the fruit 
production all my life, and tobacco has been grown in my family 
for years and years and years.
    However, where we live in Kentucky, light industry is now 
there. The medical industry is a huge employer. People are able 
to have off-farm income, not necessarily dependent upon tobacco 
production. We live in a community that is so fortunate to be 
able to do that. But as you know, most communities, especially 
in eastern Kentucky, where small farms are there, no industry, 
those people are so dependent upon the tobacco production. So 
for at least a transition period--we all know that tobacco 
production is down and going to stay down. Domestic use is on 
the decline, and domestic purchasing is on the decline. We see 
the handwriting on the wall. But we do need help in a 
transitioning period.
    Senator Bunning. Dr. Smith, do you see the conversion of 
the rural economy from--I will give you an example. Robertson 
County is 85 percent dependent on tobacco; Mason County that I 
represented is right around 80 percent dependent on tobacco. Do 
you see the ability of our rural counties in Kentucky to 
convert, bring in small business people and have those 
entrepreneurs that you are talking about take at least a 
portion of that economy on rather than the--believe me, I 
understand the grip and the heritage that was brought from 
Virginia to Kentucky at the beginning, and that heritage is 
still there on growing burley tobacco in Kentucky and other 
kinds of tobacco products. But do we have the ability?
    Mr. Smith. Yes, I believe we do. I painted a fairly 
negative picture of nonfarm employment in rural America, but 
opportunities remain. And throughout most of the 1990's, 
nonfarm employment in rural areas was a success story through 
rural manufacturing and other enterprises.
    Counties like the ones you mentioned have to diversify. 
Regardless of the outcome of the tobacco programs and tobacco 
production in those areas, they will either become commuting 
locations where people go to Cincinnati or northern Kentucky 
for jobs, or they will find ways to diversify. And I think they 
have many opportunities: Small businesses, different 
agriculture and natural resource-related opportunities. 
Forestry and value-added timber production is a developing 
success story in parts of eastern Kentucky.
    There are opportunities like that in many parts of the 
State. There will be no single answer that works for each 
location in each geographical area. It will depend very much on 
the entrepreneurship, the leadership, and the initiative coming 
from those homegrown enterprises. I think that we cannot 
emphasize enough the importance of not relying totally on 
recruitment of outside businesses, that we have to grow our own 
in Kentucky and encourage and support those counties as they 
attempt to do.
    Senator Bunning. I have just been informed that the Federal 
Reserve lowered the Fed fund rate by one-quarter of a point. 
Unfortunately for us, it should have gone 50 basis points 
instead of 25. But Alan Greenspan is not right all the time.
    [Laughter.]
    Let me ask, and you brought this up, Mr. Haney, about 
prescription drugs and health care for our seniors in rural 
Kentucky and rural America. We are working on a bill, as you 
well know, that will for the first time in over 30 years do 
something to Medicare that will allow a prescription drug 
benefit to be added to not only Medicare Part B, but also we 
will have other options. They will all be private sector 
options, and it will give what I consider a generous benefit to 
the neediest of the needy in not only Kentucky but all over 
this country. From 160 percent of poverty down, the most we 
will charge, starting in 2006, is a 10 percent premium. That is 
all you will have to pay, down to 2.5 percent if you are in the 
100 percent of poverty to 74 percent.
    If you are below 74 percent, Medicaid will have a wrap-
around that will pick up those prescriptions for $1 and $3. 
That is all the cost that the poorest of the poor seniors will 
have.
    One thing I want you to know, we have looked at long-term 
care, and that is the real bogeyman, or whatever you want to 
call it, because of the cost to whoever is footing the bill, 
whether it be the State government, local government, Federal 
Government. The cost of long-term care, as you well know, is 
footed by Medicaid in some instances right now to a degree, but 
generally by the individuals that are supporting the person 
that is in long-term care, the family.
    We do not have a solution for that right now. We are 
looking for solutions. We are even looking at what we call tax 
incentives, to incentivize in the Tax Code the ability to buy 
long-term care and have it pretaxed dollars. In other words, if 
you pay for it, you do not have to pay income tax on the 
dollars you spend on Medicare or for long-term care for your 
family member, whether they are a senior or whether they are 
not. Some people are not always senior when they go into long-
term care. We have quite a few people, in fact, that are not 
senior citizens. However, generally speaking, they mostly are.
    We hope we can get that job done. I know we are going to 
get the Medicare prescription drug bill out of the Senate on 
Thursday evening of this week, unless some catastrophe befalls 
us, and we will get it out of the House sometime Friday morning 
by 3 a.m. or 4 a.m., and we will get it to conference. And that 
is where the sticky part starts to get a bill that we can bring 
out of conference and everybody can continue to vote for.
    Presently, I think we have about 80 votes in the Senate or 
up to 80 votes for the bill that is on the floor. And I think 
it is very important to our seniors to understand what we are 
trying to do. You brought that out, and I thought I would just 
mention that.
    I appreciate you all coming because rural America sometimes 
gets left behind and left out, particularly as far as economics 
is concerned. They have been there forever. They did their 
thing the same way, and they are the hardiest of the hardy. The 
salt of the earth are the people that live in rural America. 
And in Kentucky, we have an unusually large portion of our 
families that live in rural America. Your ideas and your 
thoughts on this subject are deeply appreciated.
    Thank you all for coming. This hearing is adjourned.
    Ms. Legg. Thank you, Senator.
    Mr. Smith. Thank you.
    Mr. Haney. Thank you very much.
    [Whereupon, at 2:50 p.m., the Subcommittee was adjourned.]
    [Prepared statements supplied for the record follow:]

                  PREPARED STATEMENT OF HILDA GAY LEGG
                 Administrator, Rural Utilities Service
                     Rural Development Mission Area
                     U.S. Department of Agriculture
                             June 25, 2003

    Chairman Bunning and Members of the Committee, thank you for the 
opportunity to participate in this hearing, ``The Economy in Rural 
America,'' the second in a series of hearings entitled: ``Jumpstarting 
the Economy.'' You are to be commended for this careful and thoughtful 
approach to creating a public forum for both understanding the problems 
and the challenges that we face and seeking answers to those 
challenges.
    As Administrator of the Rural Utilities Service and as a part of 
the USDA Rural Development team, I work with our programs that provide 
financing for infrastructure construction for electric power, 
telecommunications, and water and waste disposal services. I come from 
a background that includes building economic development in Kentucky 
and working with the Appalachian Regional Commission. The programs of 
the Rural Utilities Service are just a part of the Rural Development 
mission area that also finances Rural Housing, Community Facilities, 
Rural Business and Cooperative Services programs.
    Our focus in the Rural Development mission area is to help rural 
areas achieve economic and social gains that are solid and long 
lasting. When you are working to build jobs and economic development in 
small rural communities, you are always looking for the home run that 
brings in hundreds of new jobs. But we must be mindful that quite 
often, the long-term gains are made with adding a few jobs to a small 
business or helping local business leaders target industries that add 
value to the existing community.
    The Federal Reserve Bank of Kansas City's Center for the Study of 
Rural America reports in their May Overview, that the rural economy 
continues to hold steady, with rural jobs growing slightly by 0.7 
percent in February compared with a year earlier. Job growth is 
increasing at a slightly higher percentage in rural areas compared to 
job growth in Metropolitan areas according to the Bureau of Labor 
Statistics. The overall economy appears to be gaining strength, and 
unemployment in both metro and nonmetro areas can be expected to 
decline as growth picks up this year and next year.
    While no one is claiming we are in a boom cycle again, it appears 
that the rural economy is heading in the right direction. President 
Bush's initiatives on tax cuts, business growth, and energy are all a 
vital part of this equation.
    There are a number of things that can be done to help stimulate 
rural economic growth. There is no one answer for fostering rural 
economies because like the rest of the Nation, rural America is very 
diverse. Rural America is an eclectic mix of races, ethnic groups, 
terrain, climate, amenities, businesses, and institutions. While 
agriculture is certainly prominent, no one industry dominates the rural 
landscape, nor does a single pattern of population decline or growth 
exist for all rural areas. Diversity presents opportunities for 
creative answers and unique partnerships.
    At the beginning of the 21st Century, according to the U.S. Census 
and the USDA's Economic Research Service, rural America comprises 2,305 
counties, contains 80 percent of the Nation's landmass, and is home to 
56 million people. Seven out of eight rural counties are dominated by 
manufacturing, services, and other employment not related to the 
production of food and fiber.
    In Secretary of Agriculture Ann Veneman's book ``Food and 
Agriculture Policy,'' published last year, it is pointed out that 
despite seven out of eight rural counties being dominated by nonfarming 
activities, this in no way diminishes the importance of ranching and 
farming in many rural areas. However, in many communities, this 
diversity provides a strength that will hold up in times of too much 
rain or not enough rain.
    The economic resources of many rural communities draw from three 
basic assets: Natural attractions for tourism and retirement; low-cost, 
high-quality labor and land for manufacturing; and natural resources 
for farming, forestry, and mining. This is quite different from a half 
a century ago when a quarter of our population was engaged in farming 
and ranching.
    The role of the Rural Development mission area of USDA is to 
provide an effective set of tools to help these diverse rural 
communities improve their economic growth. One challenge we face is 
infrastructure. On the national level, we have seen a serious downturn 
in infrastructure development, especially in the telecommunications 
field. In more urban areas, there was a great deal of ``dark'' or 
unused fiber optic laid with the belief that ``if you build it, they 
will come.'' On the other hand, very little dark fiber exists in rural 
America.
    The fact is we had to relearn an old lesson, that a good business 
plan is necessary, no matter what the technology. High-speed 
telecommunications services are mandatory for new jobs for not only the 
future, but also today. Just like a good road, fiber optics requires a 
use for it to be beneficial to add to economic structure of a rural 
area. There is no doubt, without that infrastructure being built, 
``they will not come!'' Modern infrastructure is necessary to bring in 
many things that are needed: Businesses, quality housing, modern 
schools, quality health care, dependable electric power, safe drinking 
water, and ecologically sound waste disposal. In the same manner, 
without houses, businesses and strong communities, there is no need for 
modern infrastructure. Just to install broadband telecommunications 
capability without a plan for its use, it is high stakes rolling of the 
dice.
    Rural America finds itself in the midst of a revolution of change 
in the areas of telecommunications and electric infrastructure. The 
Telecommunications Act of 1996 has created an interesting and 
complicated landscape. Many of the larger providers have chosen to 
place their resources in the more densely populated areas of the 
country. But we see a vast number of entrepreneurs, from the small 
traditional telecommunications companies to new start-up businesses, 
stepping bravely into this new and hopefully competitive marketplace. 
The general investment community is very hesitant today to finance any 
telecommunications development needs, and this has made our job at the 
USDA far more challenging. We want to provide funding for high-speed 
telecommunications development, but we also want to continue our 
history of high-quality loans that are a good use of taxpayer dollars 
entrusted to us by the Congress.
    Today's high-speed telecommunications offer as much new opportunity 
to rural communities, businesses, schools, and health care facilities 
as the availability of electric power and telephone service did some 
half century ago. Along with this infrastructure is the need for high-
quality education. If rural America is to continue to provide a high-
quality workforce, a base of customers with good incomes, then 
educating and training that workforce is vital to economic development.
    We are seeing examples of economic development that is making a 
difference in the lives of rural citizens. When Secretary Veneman and 
Under Secretary Tom Dorr announced the new Broadband Loan program this 
January, we heard testimony via telecommunications video conferencing 
with a businessman and a farmer in Kansas as to what the availability 
of high-speed technology meant to them.
    For Osborne Industries, a local agricultural services manufacturing 
company, a high-speed connection better enables them to manage and 
market their products competitively in domestic and international 
markets far from Osborne, Kansas. The local farmer told how he was not 
only better able to follow markets and weather information, but also 
his wife was able to further her education through telecommunications 
without long drives and time away from her family. Use of telemedicine 
is bringing improved quality health care that is often life saving to 
rural citizens.
    Clean, safe drinking water and ecologically sound waste disposal is 
an equally vital aspect of both rural health needs and quality of life 
for rural citizens. There is no more basic human need than clean, safe 
drinking water. USDA, through the Rural Utilities Service, provides 
loans and grants to over 8,000 small municipal and rural water systems. 
If you are going to recruit a business to a small community, the first 
question they will ask is in regard to the availability of water and 
waste infrastructure. If the business involves manufacturing, the need 
is ever greater.
    We see the development of renewable energy not only to improve the 
availability of energy to rural residents, but also as a rising 
economic opportunity. The future development of ``power farming'' will 
be a new crop in many cases for farms and rural residents. Ethanol, 
solar, and wind are the most economically competitive energy sources at 
this time, but development of bio-energy projects continues to improve 
the economic future for farms and rural businesses. Use of traditional 
farm crops such as soybeans and corn for industrial bio-products will 
increase the demand for those crops over time.
    The challenges remain. Some areas of rural America are seeing 
population growth and with it, economic development. Other areas, such 
as the Great Plains and parts of Appalachia continue to experience out-
migration. This places strains on local economies and under cuts the 
tax base for local and State government. Many of our Native American 
tribal reservations, as well as other pockets of other rural areas, 
still face high unemployment and poverty, coming from isolation, lack 
of infrastructure, and the need for innovative leadership. As a Nation, 
we are as strong as our weakest link. Low percentages of unemployment 
sound a little hollow to that person that is unemployed. That person's 
unemployment level is 100 percent.
    It is always easy to look at national numbers and percentages, 
while forgetting the individual needs of rural citizens and 
communities. USDA, like any other Federal agency, does not have easy 
answers. We do find that by working with our rural partners of 
community leaders, we can make gains in rural communities and that 
turns that big ship in a different direction, one degree at a time. The 
USDA Rural Development field staff, in State and local offices, still 
serves as our front line in working directly with rural leaders for 
stronger communities.
    Building quality infrastructure, housing and businesses based on 
long-term plans and good business models makes an economy grow. Local 
leadership and citizen commitment is a key ingredient to making these 
programs work.
    In an article in the Economic Review, First Quarter of 2003, Jason 
Henderson and Nancy Novack do a good job of summing up what must be 
done in rural areas for economic growth to occur. ``To compete in the 
future, rural industries will need to be innovative in finding business 
solutions that go well beyond low-cost land and labor. Success will 
depend on management skills in addition to production capabilities. New 
products will need to be developed. New technologies will need to be 
adopted to increase production efficiencies and create a new 
competitive edge for rural industries.''
    This will require strong education to be available to keep up with 
a changing world. It will require available capital for business 
development. And it will require strong rural leadership to make these 
things happen at the local level. Partnerships with other local 
communities, on a regional basis, and often with the larger 
metropolitan areas will be key in rural economic growth of the future.
    I appreciate Chairman Bunning's leadership and the support of 
Congress as you work to continue to make rural America a strong and 
vital place to live and work.
    Thank you.

                               ----------
                  PREPARED STATEMENT OF M. SCOTT SMITH
   Dean and Director, College of Agriculture, University of Kentucky
                             June 25, 2003

    Mr. Chairman and Members of the Subcommittee, thank you for the 
opportunity to share these remarks on rural economic development. I 
serve as the Dean of the University of Kentucky's College of 
Agriculture and the Director of the Kentucky Cooperative Extension 
Service. Rural economic issues largely define the mission of our 
organizations.
    Rural counties and small cities in Kentucky, and throughout the 
Nation, face daunting economic challenges. The recent economic slowdown 
compounded with significant changes in agriculture are threatening job 
and income security. The current economic climate has had a 
particularly negative effect on rural areas compared to metropolitan 
areas, and on rural economies like Kentucky's compared to the rest of 
the United States.

 Nationally, manufacturing employment from 2000-2002 has 
    declined 10.1 percent in rural areas, compared to 7.3 percent in 
    metro areas. (Drabenstott, 2003)
 The rural service sector is also struggling to maintain 
    employment.
 Rural construction activity is slow.
 And rural recreation and tourism has not fully recovered from 
    9/11.
 On top of this, in tobacco states like Kentucky, the shrinking 
    quota and the changing program will continue to have dramatic 
    effects, not just on farmers but on entire rural communities.

    Although the farm economy was generally described as recovering in 
2001 and 2002, much of this advance was due to transfer payments. We 
all appreciate the uncertainty and undesirability of relying on farm 
programs to sustain the rural economy. However, even in the best of 
times for agriculture, farm-level advancement, while remaining crucial, 
cannot by itself support the full weight of rural development. Consider 
that an increasing fraction of farm families are economically dependent 
upon off-farm rural employment opportunities. Farm and rural nonfarm 
economies are more than ever interconnected.
    Unfortunately, declines in the manufacturing sector could make 
business recruitment a realistic option for fewer and fewer rural 
communities. In such circumstances, retaining local businesses, 
creating new local enterprises, and creating new sources of local 
income become indispensable to improving the local economy. To do this 
both rural businesses and farms will need greater technical assistance 
to identify new income opportunities and enhance their products and 
services.
Integrative, Comprehensive Strategies
    Rather than speak about the specific policy strategies or the 
economic issues in rural development, I would like to take this 
opportunity to comment on the general characteristics of at least one 
promising rural economic development initiative in Kentucky.
    Complex, multidimensional problems demand integrative, 
comprehensive strategies. Multiple ingredients must be assembled for 
success: Infrastructure, leadership and entrepreneurship, access to 
capital, a skilled and highly productive workforce, access to and 
ability to use information age technology. Service, manufacturing, 
Government, and farming sectors all have to be considered. New bridges 
between new partners will be essential.
    One Kentucky program meeting this description is the Kentucky 
Agricultural Development Fund. Uniquely among the States, Kentucky has 
invested 50 percent of its share of the National Tobacco Settlement, 
well over one hundred million dollars to date, in programs supporting 
agricultural and rural development. This massive and innovative program 
has benefited from the full participation of State government, farm and 
community organizations, the University's Land Grant system and 
hundreds of local leaders. Beyond investing in the on-farm 
profitability and diversification, the Fund has supported projects in 
value added and alternative products, agri-tourism, rural 
infrastructure, entrepreneurship and leadership development, marketing, 
and resource conservation. This is surely one of the Nation's most 
comprehensive and ambitious rural development initiatives.
Broadening the Land Grant Mission
    Finally, I want to touch on the role of organizations like mine, 
the Land Grant colleges, in rural economic development. As many public 
universities around the Nation, including the University of Kentucky, 
are mandated to become an even greater force for economic development, 
some States are implementing a new and broader mission for the Land 
Grant system of Cooperative Extension and Experiment Station research. 
This new Land Grant approach fosters research and development and 
technology transfer in a wide array of enterprises including, but 
certainly not limited to, farming. In Kentucky, we are building rural 
research and extension partnerships in engineering, health, business 
management, and even fine arts. Our diverse partners in these areas 
understand the power of the Statewide, county level Cooperative 
Extension network for rural development and the connection of this 
network to University information and expertise. Just as the Land Grant 
institutions led the advancement of the Nation's farming economy in the 
last century, they can serve the broader mission of rural economic 
development in years to come.
    I thank you for the opportunity to comment and for your thoughtful 
deliberations on the crucial and challenging issue of rural economic 
development.

                               ----------
                    PREPARED STATEMENT OF MARK HANEY
            Vice President, Kentucky Farm Bureau Federation
                             June 25, 2003

    Mr. Chairman and Members of the Subcommittee, I appreciate the 
invitation to make brief comments on the status of the rural economy to 
the Subcommittee on Economic Policy. My name is Mark Haney, I am Vice 
President of the Kentucky Farm Bureau and I am also a Board Member on 
the Monticello Banking Company-Somerset Bank. I own and operate a 70-
acre apple and peach orchard in Somerset, Kentucky, where we 
manufacture and market our own value-added frozen apple pies. My 
farming operation also entails 90-head cow/calf operation and a 38,000 
pound tobacco allotment. Somerset lies in southeastern Kentucky.
    I am excited that the Members of the Subcommittee chose to have a 
separate hearing on the status of the rural economy. Because rural 
America enjoys different advantages but also different challenges in 
building a vibrant economy.
    Let me briefly mention the current status of agriculture since the 
well-being of rural economies depends so heavily on that sector. 
Because of poor crop yields and shifting farm policy, farmers are 
coming off of a very difficult year in 2002, in which U.S. net farm 
income fell from $45.7 billion dollars to $30.2 billion dollars. Please 
consider that this total loss of $15.5 billion is not just a loss to 
farm families but also to many rural financial institutions.
    Fortunately, economic aspects of the 2003 crop year seem to be 
looking up on a national scale. Since this point last year, grain 
prices have been on the rise. Last month's projections estimate that 
U.S. net farm income is expected to rebound 53 percent to $46.2 billion 
in 2003. While this short-term increase should make many bankers smile, 
please consider that it is an increase to already unacceptable levels 
we have seen in the last decade.
    While agriculture is one segment of the rural economy that is not 
thriving, other factors are contributing to its current sluggish 
conditions. First, rural America is struggling to equip itself with the 
Nation's newest form of infrastructure, telecommunications. In this 
era, access to broadband Internet service and mobile cellular towers is 
nearly as important in securing jobs and recruiting business as four 
lane roads. Many State legislatures are considering programs to enhance 
the ability of rural residents to gain greater access to 
telecommunications, but while we wait, large businesses find it a 
difficult choice to locate in rural areas.
    Second, the physical infrastructure of rural America needs 
improvement. While State legislatures deal with slumping budgets, 
improvements to roads and bridges wait. Proponents of many worthwhile 
new projects are being told to wait for years until economies balance. 
Examples such as weekly garbage collection, animal removal, and 
maintenance of roadside vegetation that seem insignificant to most 
Americans is not available in many rural areas. Eastern Kentucky has 
placed great emphasis on maintaining the environment through the 
leadership of Congressman Hal Rogers and his PRIDE program. With this 
project, we have done a good job of cleaning up unsafe dumps and 
litter. I think that we need to consider a greater nationwide focus on 
these kinds of ideas.
    Last, the lack of availability of affordable health care plagues 
rural communities, but I know that rural America does not suffer from 
this alone. Rural America is built on small business that often cannot 
afford group policies to insure their employees. The Kentucky Farm 
Bureau strongly believes the Associations Health Plans legislation that 
recently passed in the House will help to remedy this burden. Also, I 
think we must pay attention to the lack of adequate long-term care for 
seniors; since outlets for special needs assistance in nursing homes 
are sometimes hours from rural communities.
    Despite burdens that make it difficult for rural economies to be 
vigorous; rural areas do have some advantages not provided to our urban 
friends. Rural investments tend to be more stable than the fluctuating 
stock market more commonly used in urban areas. Rural Americans 
typically have their savings tied to fixed assets such as land, 
buildings, and equipment. In other words, we do not get rich quick but 
we do not get poor quick either.
    The sense of community in rural America helps its residents endure 
tough economic situations. The hard times do not come and go as often 
in rural areas but stay longer when they hit. Although agriculture can 
be a very competitive business you will frequently see farmers working 
together to help each other get their crops planted or harvested before 
seasonal deadlines hit. The entrepreneurial spirit is also creating new 
ideas and strategies for enhancing economic development through tourism 
and other value-added businesses in rural communities across the United 
States.
    Finally, our natural resources provide us opportunities not granted 
to urban areas. From coal in the Appalachian region to oil fields in 
the southwest, but most obviously the fertile land from which we derive 
the world's food supply, our resources provide the backbone for our 
economies. That is why it is evermore important to be mindful of the 
impact unreasonable environmental regulations can have on rural 
America. What works for downtown Philadelphia, Pennsylvania, does not 
always work for Inez, Kentucky. Some environmental regulations can 
strip rural communities from the staple of their economies.
    Please allow me one minute to mention an issue that is of utmost 
importance to the rural economy in Kentucky and other States in the 
Southeast region of the country. The status of the tobacco industry is 
in complete disarray. Tobacco, historically, the States largest cash 
crop has had a profound effect on the State's rural economy. Kentucky 
is a rural State. And agriculture is the largest economic contributor 
to the State's economy. According to most recent statistics, 13.6 of 
25.4 million acres, or 53 percent, is declared farmland. The average 
farm size in Kentucky is 155, compared to the same national statistic 
of 436. These numbers indicate Kentucky to be a very small-scale 
agricultural State. Kentucky ranks fourth in the United States in total 
number of farms. All characteristics of Kentucky's agriculture--size, 
scale, and frequency of farms--is largely influenced by a strong 
reliance on the production of tobacco.
    Kentucky's geographical characteristics, climate, and soil types; 
especially in the eastern portion of the State, are an ideal match for 
the very specific requirements in the production of the crop. 
Throughout Kentucky's history, the production of 
tobacco has been the strongest financial resource to a vast majority of 
rural communities throughout the Commonwealth. For most of the 20th 
Century, tobacco markets and warehouses were as prevalent as U.S. Post 
Offices in the downtown areas of rural Kentucky.
    Rural communities in Kentucky are currently witnessing a dramatic 
revolution. Due to a variety of factors, the demand for tobacco has 
decreased from 704.5 million pounds in 1997 to 289.5 million pounds in 
2003. This is a 59 percent decline over 7 years. Since tobacco 
production operates within a supply management, quota system, lease 
costs have skyrocketed from a 26 cents per pound average to a 62 cents 
per pound average over a similar time period. Current concepts for 
Federal legislation can take a large step in helping stabilize the 
tobacco industry and thus rural economies throughout the Bluegrass 
State. It would give farmers the resources to retire or venture into 
more promising industries while still being able to remain in the rural 
areas that they were born and raised in. Tobacco buyout legislation 
will not only help our economies but also can have a nationwide health 
benefit if it is tied to the FDA's regulation of tobacco products. I 
will not spend anymore of your time on the details of tobacco buyout 
legislation, but I encourage you to work with the Senators from tobacco 
States who will most assuredly be contacting you about this issue.
    Thank you again, Mr. Chairman, for the opportunity and for taking 
an interest in rural areas. I look forward to answering any questions 
you or the Members of the Subcommittee have.
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