[Joint House and Senate Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 109-146
THE ECONOMIC OUTLOOK: APRIL 2005
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HEARING
BEFORE THE
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
APRIL 14, 2005
__________
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
HOUSE OF REPRESENTATIVES SENATE
Jim Saxton, New Jersey, Chairman Robert F. Bennett, Utah, Vice
Paul Ryan, Wisconsin Chairman
Phil English, Pennsylvania Sam Brownback, Kansas
Ron Paul, Texas John Sununu, New Hampshire
Kevin Brady, Texas Jim DeMint, South Carolina
Thaddeus G. McCotter, Michigan Jeff Sessions, Alabama
Carolyn B. Maloney, New York John Cornyn, Texas
Maurice D. Hinchey, New York Jack Reed, Rhode Island
Loretta Sanchez, California Edward M. Kennedy, Massachusetts
Elijah E. Cummings, Maryland Paul S. Sarbanes, Maryland
Jeff Bingaman, New Mexico
Christopher J. Frenze, Director
Chad Stone, Minority Staff Director
C O N T E N T S
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Opening Statements of Members
Page
Hon. Jim Saxton, Chairman, a U.S. Representative from the State
of New Jersey.................................................. 1
Hon. Jack Reed, Ranking Minority Member, a U.S. Senator from the
State of Rhode Island.......................................... 2
Witnesses
Statement of Harvey S. Rosen, Chairman, Council of Economic
Advisers; accompanied by Kristen J. Forbes, Member, Council of
Economic Advisers.............................................. 4
Submissions for the Record
Prepared statement of Representative Jim Saxton, Chairman........ 29
Prepared statement of Senator Jack Reed, Ranking Minority Member. 29
Prepared statement of Harvey S. Rosen, Chairman, Council of
Economic Advisers; and Kristen J. Forbes, Member, Council of
Economic Advisers.............................................. 30
THE ECONOMIC OUTLOOK: APRIL 2005
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THURSDAY, APRIL 14, 2005
United States Congress,
Joint Economic Committee,
Washington, DC.
The Committee met, pursuant to notice, at 9:33 a.m., in
room 2212, Rayburn House Office Building, Hon. Jim Saxton
(Chairman of the Committee) presiding.
Present: Representatives Saxton, Maloney, Hinchey, Sanchez
of California, and Cummings; Senator Reed.
Staff Present: Chris Frenze, Robert Keleher, Brian
Higginbotham, Colleen Healy, John Kachtik, Jeff Schlagenhauf,
Natasha Moore Hickman, Suzanne Stewart, Chad Stone, Matthew
Salomon, Daphne Clones-Federing, Nan Gibson, and Pamela
Wilson.
OPENING STATEMENT OF HON. JIM SAXTON, CHAIRMAN,
A U.S. REPRESENTATIVE FROM NEW JERSEY
Representative Saxton. It is a pleasure to welcome Chairman
Rosen of the President's Council of Economic Advisers before
the Committee this morning. Chairman Rosen's testimony on the
economic outlook continues the productive exchange between the
Council and the JEC that has existed for many years.
A variety of standard economic data show that the U.S.
economic expansion continues to be on track. According to
recent figures, the U.S. economy grew at a rate of about 4
percent last year, after adjustment for inflation. The U.S.
economy has been growing at a healthy pace since the second
quarter of 2003, when the rebound in business investment
started to broaden and bolster the expansion.
The tax incentives for investment adopted in the second
quarter of 2003 played an important role in jump-starting
investment growth. The previous weakness in business investment
was replaced by double-digit increases in equipment and
software investment in six of the last seven quarters.
The acceleration of economic growth is reflected in other
economic statistics as well. For example, industrial production
is trending upward. Over the past 22 months payroll employment
has risen by 3.1 million jobs. The unemployment rate stands at
5.2 percent. Household net worth is at a record level.
Homeownership has hit record highs. Interest rates remain
fairly low by historical standards. Consumer spending continues
to grow, and inflation appears to be under control, with a key
core measure of price changes still below 2 percent on a year-
over-year basis.
In summary, overall economic conditions remain very
positive. Recently released minutes of the Federal Reserve
suggest that the central bank expects this economic strength to
continue. There is justifiable concern about the increase in
oil prices, however it is important to note that this primarily
seems to reflect strong demand from international economic
growth and not a plunge in oil supplies.
Another challenge is the tax bias against savings and
investment embedded in the tax system. Further reducing the
multiple taxation of savings and investment would lessen the
economic burden imposed by the Tax Code and increase economic
growth over the long run. The Administration's proposals to
protect more personal savings from multiple taxation, in my
opinion, are right on target.
The consensus of blue chip forecasts projects that the
economic expansion will continue through 2005 and 2006. This is
very consistent with the Council's projections for economic
growth over the next 2 years or so. The bottom line is that the
U.S. economy remains strong, and that the overall economic
outlook is positive.
At this point, I would like to yield to my friend, the
Ranking Member.
[The prepared statement of Representative Jim Saxton
appears in the Submissions for the Record on page 29.]
OPENING STATEMENT OF HON. JACK REED, RANKING MINORITY MEMBER,
U.S. SENATOR FROM RHODE ISLAND
Senator Reed. Thank you very much, Mr. Chairman. And let me
say how much of a pleasure it is to once again work with you on
this Committee in the 109th Congress. I certainly do look
forward to working with you and all of my colleagues on the
Committee.
It is fitting that this hearing is with the Council of
Economic Advisers, which was created at the same time as the
JEC in the Employment Act of 1946.
I also certainly want to welcome Chairman Rosen and Dr.
Forbes. Thank you very much for your service and also for your
presence here today. I know that your backgrounds are not
necessarily in economic forecasting, but I am confident that
you will be able to give us useful insights on current economic
conditions and where you think the President's policies are
taking us.
I have three major concerns about the economic outlook.
First, I am concerned about what appears to be an extremely
disappointing economic recovery for the typical American
worker. I know that the Administration is proud of the fact
that the economy has created jobs for 22 consecutive months,
but the pace of job creation over that period works out to just
141,000 jobs per month. That is barely enough to keep up with
normal growth in the labor force. Last month indeed we did not
match that pace; only 110,000 jobs were created.
The slow pace of job creation is disappointing, but what is
happening to the take-home pay of the average worker is even
more disappointing. Since May 2003, when the economy finally
began creating jobs, the average hourly earnings of production
workers in nonfarm industries have fallen by .7 percent after
accounting for inflation. In addition, we are finding that the
distribution of earnings is becoming more unequal, and American
families are having to shoulder more risk in today's economy.
I think these issues are the other side of the President's
plan for an ownership society, and I think they are concerns
that need to be addressed.
My second major concern about the economic outlook is the
effects we are seeing in the trade deficit and the foreign
exchange market from the fiscal policy we have been pursuing
over the past 4 years. This week we learned that the trade
deficit is still widening with February's deficit of $61
billion, a record for a single month. The broader current
account deficit rose to a record 6.3 percent of GDP in the
fourth quarter of 2004. The large drain on national savings
from the Federal budget deficit has put us in the position
where we must borrow $650 billion to $700 billion per year from
the rest of the world to sustain our spending. That money will
have to be paid back with interest, which will be a drain on
our national income and our future standard of living.
Finally, I am concerned that the President wants to extend
these policies, which are in many respects fiscally
irresponsible policies, to Social Security. Analysis by the JEC
Democratic staff and others shows that the President's private
accounts would require a massive increase in the public debt
that is not simply a short-run transition cost. Rather, the
additional debt associated with private accounts would reach 35
percent of GDP by 2060. That would be on top of the debt we
already have, which is estimated to be 37 percent of GDP. We
would be at a figure of 70 percent for the debt-to-GDP ratio. I
don't think we have seen figures like that since the end of
World War II.
The President's plan for private accounts makes Social
Security solvency worse by diverting payroll taxes from the
trust fund. That drain on the trust fund moves up the date that
Social Security can no longer pay full benefits and increases
the present value of the 75-year financing gap from $4 trillion
to $5.6 trillion.
Finally, the President's plan for private accounts does
nothing to increase national saving and could lower it still
further. The private saving that would be generated by the
creation of private accounts would be completely offset by the
reduction in private savings from the larger budget deficits,
and people might reduce other private saving, such as their
contributions to 401(k)s and IRAs.
Raising national saving is the key to economic growth and
one of the ways to reduce the trade deficit. Moreover, as
Federal Reserve Chairman Alan Greenspan recently testified, it
is the best way to address the challenges posed by the
retirement of the baby boom generation. Unfortunately, the
President's proposals for large tax cuts for those who are
already well off seem to be taking us in exactly the wrong
direction.
Now, I look forward to your testimony about the economic
outlook today. I must gracefully withdraw, because I have two
hearings on the Senate side. But I am ably assisted by Carolyn
Maloney and Elijah Cummings and Loretta Sanchez, who I am sure
have interesting questions.
Thank you very much.
Representative Saxton. Thank you, Senator.
[The prepared statement of Senator Jack Reed appears in the
Submissions for the Record on page 29.]
Representative Saxton. We have with us this morning the
Chairman of the Council of Economic Advisers of the President,
Harvey S. Rosen, as well as Kristen J. Forbes, who is a member
of the Council. Thank you for being with us this morning.
Mr. Chairman, the floor is yours.
STATEMENT OF HARVEY S. ROSEN, CHAIRMAN, COUNCIL OF ECONOMIC
ADVISERS; ACCOMPANIED BY KRISTEN J. FORBES, MEMBER, COUNCIL OF
ECONOMIC ADVISERS
Dr. Rosen. Thank you, Mr. Chairman. Chairman Saxton and
Members of the Committee, thank you for this opportunity to
testify at the Joint Economic Committee. We appreciate the
long-standing relationship between the Committee and the
Council of Economic Advisers.
The President's economic agenda is ambitious and addresses
a number of issues that are important to maintain the strength
and dynamism of the U.S. economy. I will first talk about the
current State of the U.S. economy and the outlook moving
forward. Then we will highlight two of the President's key
agenda items, Sociality Security and tax reform. Our written
testimony also discusses this year's Economic Report of the
President.
Let me start with the U.S. economy. Economic growth in the
United States is robust and expected to remain strong for this
year and next. Real GDP, the gross domestic product adjusted
for inflation, grew 3.9 percent at an annual rate during the
first four quarters of 2004. Current data indicate this
momentum carried into the first quarter of this year and will
continue. Blue chip consensus forecasts are currently
projecting real GDP growth of 3.9 percent in the first quarter
and 3.6 percent in the second quarter.
The labor market continues to improve, and more Americans
are working than ever before. During the past 12 months, the
economy has added 2.14 million jobs. The unemployment rate has
dropped to 5.2 percent and remains well below the averages for
the 1970s, 1980s, and 1990s.
Core inflation, which excludes volatile food and energy
prices, remains stable. As measured by the core Consumer Price
Index, inflation was 2.4 percent during the past 3 months and
also the past 12 months, well below the 40-year average of 4.6
percent.
Although the recent rise in crude oil prices is creating
headwinds for the economy, we do not expect it to stand in the
way of continued expansion.
Turning now to Social Security, last year's Economic Report
of the President discussed the need to strengthen Social
Security and approaches to reforming this vital program. In the
intervening months a vigorous debate has begun. We welcome this
debate. By now the numbers are familiar. In 1950, there were 16
workers for every 1 Social Security beneficiary. Today, there
are just 3.3 workers for every beneficiary. When today's 20-
year-olds retire, that number will have dropped to two.
Combined with Social Security's benefit structure, these
demographic realities mean that in around 2017, the program
will begin paying out more in benefits than it receives in
revenue. The program's unfunded liability is about $11 trillion
in present value terms. Action is needed to deal with this
problem.
To think about the problems with the Social Security
system, it is useful to begin by noting that contrary to what
many workers believe, their contributions to the system in the
form of taxes are not kept and used to fund their retirement.
This would be known as a prefunded system. Instead their taxes
are used to pay the benefits of current retirees. The viability
of this type of pay-as-you-go system is vulnerable to the
changes in demographics that we are experiencing today.
Compounding this situation is a change made in 1977 where
each generation of retirees receives higher real benefits than
the generation before it. This stems from the indexation of the
initial level of benefits to wages, which over time grow faster
than prices. A person with average wages retiring at age 65
this year gets an annual benefit of about $14,000. But a
similar person retiring in 2050 is scheduled to get over
$20,000 in today's dollars. In other words, even adjusting for
inflation, today's 20-year-old worker is promised benefits that
are 40 percent higher than what his or her grandparent receives
today.
The combination of large benefit increases and a growing
elderly population puts the Social Security system on an
unsustainable path.
President Bush has outlined four key principles for
strengthening Social Security. First, no changes should occur
for current or near retirees. Second, there should be no
increases in the payroll tax rate. Third, the program must be
permanently fixed. Short-term funding fixes are not acceptable.
Finally, the Social Security system should include voluntary
personal retirement accounts. The Nation's retirement system
should ensure that all workers have the opportunity to build
their own nest-egg.
Reforms in addition to personal retirement accounts must
take place in order to restore solvency to the Social Security
system. In his State of the Union Address earlier this year,
President Bush outlined a variety of options advocated by both
Democrats and Republicans that would comply with his
principles. The President is eager to work with Congress to
arrive at a package of reforms that would permanently fix the
system.
Turning now to taxes. This year's Economic Report of the
President highlights the need and opportunities for reforming
our Tax Code. It outlines the pros and cons of various reform
prototypes. The report does not make recommendations, which
will be the responsibility of the tax advisory panel later this
year.
The problems of our current tax system are well known and
well documented. The current system is overly complex and
distorts incentives for work, saving and investment. The
complexity imposes high costs in terms of time and money for
taxpayers to file returns and comply with all the rules.
The distortionary effects of high tax rates on work, saving
and investment lead to inefficient use of resources.
Consequently, taxes reduce economic welfare by an amount that
exceeds revenue collected. Economists call costs above and
beyond the revenue collected the excess burden of the tax
system.
One recent academic study estimated that for the tax
system, the excess burden associated with increasing taxes by
$1 was $0.27 before President Bush took office. In other words,
the total cost of collecting $1 in additional taxes was $1.27,
not counting compliance costs. How much better could we do if
we reformed our tax system? The study estimated that adopting a
reformed income tax system, or one of several alternative
reforms, that would eliminate the tax bias against saving and
investment could reduce this excess burden by 50 percent or
more. Such reforms could also result in substantial
simplification.
The tax relief over the last 4 years has reduced the excess
burden of income tax by also enhancing progressivity, but there
is more to be done. The President has appointed a bipartisan
blue ribbon panel to study tax reform and report back to the
Secretary of Treasury by July 31st of this year. The
Administration looks forward to working with Congress to
achieve the much-needed goal of tax reform.
In conclusion, the U.S. economy is fundamentally sound, and
the outlook is very positive. Challenges remain, however, and
the President has an ambitious agenda to address them,
including proposals to address trade, enact legal reform,
improve access to health care, use our energy resources
efficiently, and rationalize the regulatory system.
Mr. Chairman, I ask that the written testimony be included
in the Committee record. We welcome your questions.
My colleague Dr. Kristen Forbes handles international
economic issues for the Council and will need to leave at
around 10:45. We would appreciate any questions for her to be
asked before that time. Thank you very much.
Representative Saxton. Thank you very much.
[The prepared statement of Harvey S. Rosen appears in the
Submissions for the Record on page 30.]
Representative Saxton. Dr. Forbes, do you have a statement?
Dr. Forbes. No, actually.
Representative Saxton. OK.
We are going to operate the Committee under a 5-minute
rule, so each of the Members will have 5 minutes to ask their
questions, including the Chairman, I might add.
I have noticed that many economic forecasters project first
quarter growth was about 4 percent. The Blue Chip consensus for
2005 quarterly growth rates are as the chart here indicates,
3.9, 3.6, 3.5, and 3.3, respectively.
Can you give us your take on those projections? Do your
projections track along that general line? Would you comment on
that for us?
Dr. Rosen. Yes, sir. Our forecasts for the year were made
last December, based on November data, and at that time we were
projecting GDP growth for the year more or less along these
lines. Unlike the blue chip, we do not periodically update our
forecasts, but what we have noticed is that the blue chip has
not really changed theirs very much. And so it seems to me
that, you know, the economy is on track, and the expansion is
moving forward. And, you know, the blue chip story about the
next year is also quite consistent with what we show moving
forward.
Representative Saxton. And what do you show for 2006?
Dr. Rosen. OK. We have 3.5 for 2006; the blue chip is
showing 3.4, I believe, for 2006. So, you know, I think the
basic point is that the GDP forecasts that we are making are
quite in line with the consensus among the private sector
forecasts, and that consensus is for continued expansion that
is sustainable and solid.
Representative Saxton. And I expect that, given those
positive numbers, that we can expect expansion as well in terms
of job growth?
Dr. Rosen. Sir, yes. We are predicting substantial job
growth. The forecast that we put out back--that we made back in
December, calls for job growth of about 175,000 a month. That
is moving forward nicely. As you mentioned in your remarks,
sir, the record for the last year has been very good on job
growth. The job market is showing strength. The most recent
data we have on that just came out this morning, which is that
new unemployment insurance claims for the past month were at a
level that is another independent piece of information that the
job market is firming up. So yes, we see continued job growth.
Representative Saxton. Thank you.
Dr. Forbes, I have noted that the European Union is in the
process of making changes, reforms if you will, to try to boost
their job growth in particular. But I also noticed that in
countries like Germany and Italy and other European Union
countries, the unemployment rate seems to be significantly
higher than ours. In Germany, I believe it may be in double
digits. I am not sure exactly what the numbers are in Italy.
But there seems to be a systemic set of issues in Europe, and
Japan as well, that appears to be causing a high rate of
unemployment.
Can you speak to what their problems are and perhaps
explain why it is that we are doing so much better than they
are?
Dr. Forbes. That is an excellent question, and actually
very good timing in conjunction with the World Bank/IMF
meetings that are taking place this weekend. There is a lot of
discussion on this topic, and new growth forecasts were just
released for the U.S. and Europe and the global economy. And
the IMF new data released confirms what you just mentioned.
Growth in Europe is expected to be very slow this year. The IMF
projects that growth in the Euro zone will be 1.6 percentage
points. Growth in the U.S. is projected to be 3.7 percent.
Growth in Japan is projected to be less than 1 percent this
year. So the U.S. this year is expected to grow more than twice
as fast as Germany, Italy and Japan.
It is just a remarkable contrast. And at the same time, as
you pointed out, unemployment is very high in Europe.
Unemployment is in double digits in Germany, France and Italy
as compared to 5.2 percent in the United States.
There is a sharp contrast in economic performance in the
U.S. compared to the other developed countries in the world,
and a major reason for this difference is structural rigidities
in Europe; very inflexible labor markets; excessive regulation,
especially in product markets. So it makes it very hard for
companies to compete and do business and hire new workers.
A great example is how hard it is to start a new business.
New businesses--entrepreneurship--has been a key driver of
growth in the U.S. In the U.S., it takes about 5 days to start
a new business. In Germany it takes 45 days to start a new
business. In Japan it takes over 30 days to start a new
business. So it is regulation such as that that makes it hard
to just start a new business in Europe and Japan, which are key
factors causing their slower growth compared to in the U.S.
Representative Saxton. I am just going to take the liberty
here to ask you to comment on the differences in tax systems
among those several countries and our country.
Dr. Forbes. Different countries in Europe and Japan do have
different tax systems. One major difference, though, is that
the tax systems in Europe are more biased toward taxing
consumption. The VAT is more prevalent in Europe than in the
United States.
One big difference is that if you look at the tax rate on
savings in the U.S. versus consumption in the U.S., we tend to
tax savings relatively more; consumption relatively less. In
Europe they tend to tax consumption relatively more and savings
relatively less. That is one area where, according to some
standard economics, there is room for improvement in the U.S.
economy. And those differences in tax rates are one reasons why
savings does tend to be lower in the U.S. and higher in Europe.
Representative Saxton. Thank you. We are going to move on.
We have this 5-minute rule that we use to make sure that
everybody has an equal chance to ask questions, so we will move
at this point to Mrs. Maloney, and we will be back for more
questions in a bit. Thank you.
Representative Maloney. Thank you, Mr. Chairman. And
welcome, Chairman Rosen and Dr. Forbes.
Basically why are we not seeing stronger wage growth? This
week the L.A. Times ran this story: Wages Lagging Behind
Prices. Inflation has outpaced the rise of salaries for the
first time in 14 years, and workers are paying a bigger share
of the cost of their health care.
Then the next day, The New York Times ran this article: The
Falling Fortunes of Wage Earners.
So my first question is why, when we have experienced very
strong growth in labor productivity, why are we not seeing a
stronger growth in wages? Dr. Rosen or anyone.
Dr. Rosen. I will give it a try. From an analytical
perspective, it is a challenging problem to characterize what
has been happening to wages. One has to know what growth of
wages we are looking at, whether before tax or after tax,
whether it includes benefits or not. Personally, I think that
the single best measure for looking at whether, you know, how a
typical person is doing is that person's disposable income, the
amount of money they have left in their pocket, and in the
latest year disposable income per person has gone up by about
2.3 percent. That is progress. I think the President believes
more work needs to be done.
Representative Maloney. But has not, Chairman Rosen, most
of the growth in labor productivity boosted the profits but not
wages?
Dr. Rosen. We have witnessed astounding increases in
productivity in the last several years.
Representative Maloney. But that has translated into
profits but not wages? Is that----
Dr. Rosen. Ultimately that increase in productivity, both
in terms of theory, common sense and historical evidence, will
increase real wages as well.
The other thing, ma'am, I would just want to point out is
that one should also take into account benefits when looking at
compensation. And when we look at compensation per person,
including the value of health benefits and so on, that has been
increasing as well. Again, certainly more needs to be done.
Representative Maloney. But haven't wages been growing more
slowly than prices recently? Haven't wages lagged behind the
increases in prices? That is what these articles are saying.
Dr. Rosen. There are a variety of measures for looking at
what has been happening to the return to labor, and I think the
more comprehensive ones that include benefits and taxes show
some increase, although I think that more work needs to be done
in this area to assure that we have an economy where workers
can realize their full potential and where the productivity
gains will translate into----
Representative Maloney. And you mention that while you are
looking at wages, that you have to also look at the benefits
that they have. So when employers' costs go up because they
have to pay more for health insurance, how does that affect our
measure of wage growth?
Dr. Rosen. When employers' health costs go up, some of that
will be translated into the total compensation package that
workers receive. And another important issue is whether or not
health costs are, you know, increasing at a greater rate than
is reflective of what we are getting out of the increased
health care dollars. And an important issue going forward,
actually, I think, is trying to rein in excessive health care
growth.
Representative Maloney. Because workers are subject to a
squeeze basically in their take-home pay as employers have to
pay more for health insurance, and if employers then are
shifting more of the burden of rising health care costs onto
their workers, does not that reduce the purchasing power and
the take-home pay even more?
Dr. Rosen. I think that rising health care costs is a
serious issue. There are several proposals on the table to try
and deal with this problem. One of the most important, I
think--it is not a proposal, it is enacted legislation--is
health savings accounts, which would allow individuals----
Representative Maloney. And I am very concerned about the
growing wage inequality that this chart shows. And basically
why hasn't the Administration's tax cuts--they failed to boost
the earnings of middle- and moderate-income families, according
to this chart from the Department of Labor. I don't know if you
are familiar with it. They publish the data on the usual weekly
earnings of full-time workers. They show that since the end of
2000, median earnings have increased by just 0.2 percent per
year. After inflation, earnings at the 90th percentile have
risen by 0.9 percent per year, and earnings on the 10th
percentile have fallen by 0.3 percent.
Is this satisfactory as to wage inequality at the same time
that overall wage growth is stagnating so that wages in the
lower part of this distribution are actually falling? Are you
familiar with the chart?
Dr. Rosen. I am not familiar with the specific graph,
ma'am; however, a couple of comments. Again, one needs to be
looking at aftertax measures and all groups--all income groups
experienced tax relief as a consequence of the President's tax
proposals.
The other is that I think that one of the most gratifying
things about the expansion that we have been experiencing the
last year or so is how widespread the benefits have been across
all groups and populations. Unemployment rates have fallen for
college-educated people, high-school-educated people, people
without high school degrees, for all ethnic groups in all
regions, for all income classes. And I think it is a very
important aspect of the expansion to note.
Representative Saxton. Thank you very much. The
gentlewoman's time has expired, and we are going to go at this
point to Mr. Cummings.
STATEMENT OF HON. ELIJAH E. CUMMINGS,
A U.S. REPRESENTATIVE FROM MARYLAND
Representative Cummings. Thank you very much, Mr. Chairman,
and Chairman Rosen, Dr. Forbes.
Tell me, talk about how the economy is affecting jobs in
manufacturing. We are seeing in my district a GM plant closing,
a lot of jobs gone. We look at the South and look at a State
like Ohio and see jobs disappearing. During the election that
seemed to be a major theme. And I am just wondering exactly is
that a fact that we are losing these jobs? And are we getting
any of them back? And if we are getting them back, are we
getting them back with wages as they were, say, before
President Bush came into office?
Dr. Forbes. I would be glad to answer that question.
Manufacturing has faced an extremely challenging few years.
There is no doubt about that. And when you look at why
manufacturing has faced such a challenging few years, and
especially the cause for a lot of the job losses in
manufacturing, it basically comes down to two major factors.
One is short-term causes in the nature of the recession we just
faced. The recession we just went through was largely caused by
a sharp slowdown in investment and by slow growth of exports,
largely due to slow growth abroad. And the manufacturing sector
is most closely linked to investment in the export sector. So
the two sectors of the economy which most influence
manufacturing--investment and exports--were most severely hurt
in the recent recession, and that is the reason for the falling
manufacturing employment over the last few years.
A second major cause for the challenges manufacturing has
faced are longer term, and it is actually a mixed blessing in a
sense. Manufacturing in the U.S. has been very productive.
Productivity growth in the manufacturing sector has been much
higher than in the U.S. economy as a whole, and, as a result,
manufacturing in the U.S. has been able to produce more output
at a lower cost, which is good. It increases the
competitiveness of U.S. manufacturers.
But the flip side of that is that manufacturers in the U.S.
can produce more at a lower cost with fewer workers, and this
is a longer-term trend that not only the U.S. but all developed
economies and even developing economies like China are
struggling with. Even China has lost 15 million manufacturing
jobs since 1995.
So this longer-term issue, higher productivity growth in
manufacturing, which often translates into lower employment, is
a challenge that countries around the world are facing.
You put these two factors together, this longer-term high
productivity growth in manufacturing combined with a shorter-
term nature of our recession, focused on investment and
exports, has meant a very difficult few years for
manufacturing, as you have experienced. So that is the bad
news.
The good news, though, is what has been happening the last
year or so, and the evidence suggests that manufacturing is
turning around in the U.S. as a whole. Manufacturing employment
has increased by 33,000 jobs since February of last year. Many
of the indicators which we track to follow the manufacturing
sector are showing continued strong growth. For example, one
that we follow closely is the ISM Manufacturing Index for
Employment, and that has been above 50 for 20 months. When the
index is above 50, that suggests continued expansion in
manufacturing. So that is another very positive indicator.
Also we are seeing a turnaround in exports. Export growth
has picked up after the recession as growth around the world
has picked up. Also, we are seeing a sharp pick-up of
investment. Investment growth last year, investment of business
in equipment and software, was very, very strong, and early
indicators for this year suggest that investment growth will
continue to be strong.
We are seeing a turnaround in investment and exports, which
are the two sectors most closely linked to manufacturing; this
suggests we should see a continuation of this turnaround we
have seen in manufacturing, and we do expect continued strength
in that sector.
Representative Cummings. Thank you.
Chairman Rosen, you talked about disposable income.
Dr. Rosen. Yes, sir.
Representative Cummings. In your opening statement, you
also talked about things like gas prices, gasoline prices being
volatile. When you talk about disposable income, are you
excluding the costs of gasoline?
Let me tell you why I say that, because it is really
hitting my constituents, as I am sure all over the country,
very, very hard. That is the number one complaint I am hearing
right now. And I realize it is going to change, it goes up and
down. But I am just wondering when you talk about disposable
income in reference to an earlier question, is that included?
Dr. Rosen. Yes, sir. The answer is that disposable income
is computed by taking into account changes in all prices,
including gasoline. So that would be included.
I should go on to say that the increase in fuel prices is
causing distress to families, to businesses, and creating
headwinds for the economy as well. And the President has a
package of proposals on the table to try and address this
problem.
Representative Cummings. Thank you, Mr. Chairman.
Representative Saxton. Mr. Cummings, thank you very much.
Ms. Sanchez.
Representative Sanchez. Thank you, Mr. Chairman. And thank
you both for being before us today.
The first question I have is one that I have been pondering
for a while, and it really has to do, I guess, looking out into
the future; future meaning, you know, you spoke about Social
Security, so I guess future could be 40 years from now. But
this is what I worry about. At a time when the load of workers
versus the people who are retired is becoming smaller, as you
said, and if you go around the country--I mean, it is
incredibly evident in California, but I have been to almost
every State, and I see this trend, and you look at fact that
the children who are in our kindergarten-through-12th system
are increasingly majority Hispanic. In California, in
particular, we see it, and where California goes, so does the
rest of the Nation.
And then when I look at the fact that the Hispanic dropout
rate is about 25 or 29 percent out of high school, and, quite
frankly, I think it is a lot closer to 50 percent, because if a
kid drops out in the 11th grade to get a job at McDonald's,
that is not considered a dropout. At least in California we do
not count it that way.
So when I look at the fact that the workforce of tomorrow
for the United States to a large extent is going to be who we
have in our school systems right now, and I see them dropping
out; and then I see the President's policies with respect to
education, the elimination of GEAR UP, for example, a program
that starts in the eighth grade, and mentors and works with
kids, and makes them take the right classes, Hispanics in
particular, so that they will go on to university; when I look
at the universities today, and I see half of the kids at least
in our graduate programs in math and science are foreigners, at
least half of them--and by the way, most of those classes are
being taught by foreigners--and when we look at the crunch that
we have on H1-B visas and other issues with respect to bringing
foreigners in for these types of work, I guess the question I
have for you is have you thought about the fact that we are not
investing in education to the extent we should be, and that the
kids who are coming up through the system are increasingly kids
that have a known trend of not even graduating high school?
What do you think about the fact that the President is cutting
these programs in education? How do you factor that into the
future--have you factored it into the future in your
calculations as to how productive we will be?
Dr. Rosen. I think that education is incredibly important
for the growth of the economy, for the growth of the economy
and for the welfare of the individuals in that economy. I know
the President believes that as well. And that is one of the
reasons why he endorsed the No Child Left Behind program, which
goal is to increase accountability at schools and to get a
better job for all of American kids.
Representative Sanchez. But, you know, he shorted it $9
billion. I know you do not know education policy. I am just
trying to understand if in your calculations you guys are even
looking at what the future really holds for Americans here. I
am very worried that when I retire, there aren't going to be
our people working jobs because we are not going to have the
education base for it if we are losing all of these
manufacturing jobs, and do not worry, we are going to have the
high-value jobs.
Dr. Rosen. We are certainly concerned about the future
productivity of the labor force, and a vibrant education sector
is critical for that. I mentioned programs at the grade-school
level. Opportunity to go to college, I think, is very important
as well, and to community colleges. California, of course, has
a wonderful community college system.
Representative Sanchez. And we would like to keep it that
way.
Dr. Rosen. I think the Administration has been allocated
funds to help the community colleges, beefed up Pell grants.
Representative Sanchez. I had my community colleges in
yesterday, and I know this is not your area of expertise. Maybe
you could go back to the President and tell him, maybe you
should take a look at this and sit down with the Secretary of
Education. Frankly, my community colleges came in, and they are
beside themselves as to how this President could be cutting
programs and Title III and things that I know are not your area
of expertise. I do not mean to put you on the spot about that.
I am very concerned about the productivity of our workers,
and I know that it depends on the type of education that we are
providing, just as it was for me. And I don't think this
President is doing a good job there. So maybe you could go back
and kind of tell him, look, there are some people very
concerned, we are all concerned, about the productivity of
America.
I have a second question. This has to do with the textiles
dumped by China. Have you figured that in? I think I read, and
I don't know the numbers, but this past month was just--you
know, the gap was very wide. The dumping is just coming in.
Maybe you could talk to us a little bit about that and how you
see that playing out.
And I tell you, I have a large manufacturer in my district
and it is very rare to see: American-made clothes, for example.
I know within a year or two, the CEOs at the top who are making
lots of money are, you know, just scrambling to get their
plants into China and wanting to dump 5,000 workers out on the
streets. So I am very concerned about this textile dump
happening, especially coming from China, but, of course, from
all places.
Dr. Forbes. The increased imports of textiles from China is
something that we have been paying very close attention to and
a concern that has been on our plate for a while. When we
negotiated China's extension into the WTO, we knew this would
be a challenge. We also know that having China join the world
trading system and become a member of the WTO would yield
substantial benefits for the U.S. and the global economy. Right
now China is our fifth largest export market, and we have seen
exports to China increase by 115 percent since the year 2000.
Representative Sanchez. What about the imports from China
coming in? The trade gap is getting wider.
Dr. Forbes. Right. It is important to realize we get
tremendous benefits from trade with China, but as part of China
coming into the WTO, one of the challenges for us was going to
be increased imports from China and especially in textiles. And
we knew that is where we would face large competitive pressure.
So when we negotiated China WTO extension, we actually put
in place a number of mechanisms to try to help ease this
adjustment. We knew it would not be easy, but we specifically
put greater restrictions on China's imports of textiles. So we
phased that in much more slowly than other imports of other
goods to try to give U.S. companies the time to adjust.
Representative Sanchez. But that is over.
Dr. Forbes. Right. Now that is gone. And so we are facing
that challenge. So what we are trying to do now is use some
other mechanisms we included in the WTO negotiation. One was we
negotiated a very specific mechanism, called a safeguard
mechanism, which would let U.S. companies that have faced
increased textiles from China file special cases and get
protection where imports from China would be limited to only
increase by a small percent a year. We have this special
mechanism in place only for textiles because of the concerns
which you raised, and we have already accepted three cases
under the safeguard petition last year. We just accepted
another set of cases to consider to enact these safeguards for.
So it is something we are looking at. We are using the
mechanisms we specifically put in place, because we were
worried about these surge of imports. But we realize that is
not going to make up for the full adjustment. There will be
increased imports of textiles from China, and so we also have
expanded some of our adjustment programs in the U.S. to help
workers who could lose their jobs because of the textile
imports. In just since January 2002, we have actually expanded
trade adjustment assistance, and we have given special trade
adjustment assistance to 100,000 textile workers to try to help
them get new training and get new skills and adjust to getting
new jobs in new sectors.
We fully sympathize with the challenges you are facing. We
know it is a big concern, and it is something that we have been
working on for years to try to get the mechanisms in place to
try to help ease this adjustment and ease this transition
process.
Representative Saxton. Dr. Forbes, thank you very much.
Ms. Sanchez, thank you.
I am going to go to the gentleman from Binghamton, New
York, Mr. Hinchey.
Representative Hinchey. I would like to have been from
Binghamton, Mr. Chairman. It is a little bit further east of
there.
Representative Saxton. OK.
Representative Hinchey. Good morning, Dr. Forbes and
Chairman Rosen. It is very nice to see you and have an
opportunity to listen to you about the Nation's economy. You
seem, in your testimony to me, Chairman Rosen, to be very
optimistic about the future of the economy as well as its
present conditions, and I certainly hope you are correct. But
when we look at the actual figures, I think that there is
reason to suspect otherwise.
The principal economic strategy of the Administration seems
to be focused almost exclusively on tax reductions that would
benefit primarily the wealthiest, most affluent people in the
country, and the belief that that would somehow favorably
affect others as well. But the consequences of that and other
actions seem to have taken the economy in a very different
direction.
If you look at the history of the budget deficits, for
example, we went from a period of 3, 4 years of continuing
budget surpluses to now a situation where we are facing
continuing and rising budget deficits, record budget deficits
as a matter of fact. The national debt in the last 4 years has
almost doubled. The trade deficit has now reached record
proportions.
So we have records in terms of the annual budget deficits,
the national debt, and the annual trade deficits. In recent
months we have seen records on a monthly basis in terms of the
trade deficits as well.
And in addition to that, we do not seem to be experiencing
a situation where any of the economic benefits are affecting
the majority of people. In fact, the situation seems to be
going in the opposite direction. The median annual income of
the average working family has dropped by $1,400, and the
number of people working in our country as a percentage of the
population has gotten down to the point where it was in 1988.
So there are more jobs being created, but they are not being
created at a pace that is sufficient to employ people in our
economy.
So I am wondering how you respond to those situations. You
made some statements, I think, earlier about the situation here
in the United States, or maybe it was you, Dr. Forbes, with
regard to circumstances here vis-a-vis those in Europe. But
when you look at certain other factors, we have 2 million
people in prison in this country. Europeans do not have
anything like that. Those people are taken out of the picture.
And there are an awful lot of people who simply have dropped
out of the job market. And that number seems to be increasing
as well.
So what do you make of all of those figures and the fact
that there are observers out in the private sector who are
increasingly becoming pessimistic, particularly in regard to
all of that data, coupled with the fact that interest rates are
now going up, and the main factor in our economy, which seems
to have been sustaining whatever growth we have had, the
housing sector, is going to be threatened, the continuation of
that growth in the housing sector is going to be threatened by
these rising interest rates?
Dr. Rosen. One of the issues you mentioned, sir, were the
deficits. OK. I think to begin it is useful to put the deficits
in context. In terms of nominal dollars, they are very high.
When you look at them as a proportion of GDP, which is the way
economists normally do, they are still high, but within the
realm of recent experience.
That said, the deficits are higher than the President wants
them to be, and, therefore, he is committed to halve the
deficit between 2004 and 2009, and the budget that he submitted
several months ago puts us on that path. The path is one that
achieves its goal in terms of spending restraint.
In terms of the effect of the tax cuts on the fiscal status
of the Government, of course a very critical question.
According to the estimates that were done in the last
midsession review, which I think was the last time we did
computations of this kind, about 35 to 40 percent of the--of
the change in the fiscal status of the government was
associated with the tax cut. The rest was due to the slowdown
in the economy and increased spending, much of it for the war
on terrorism.
Representative Hinchey. Or the war in Iraq.
Dr. Rosen. Yes, sir. And as a consequence, one might ask,
well, were running those deficits toward the beginning of the
Administration sensible fiscal policy? I think that the
President decided that it was more important to put people back
to work, put them back to work sooner, get the economy back to
its full employment path sooner by running those deficits. That
is a sensible short-term strategy. Medium-term strategy,
though, as I mentioned before, is to get that down again. And
that is the path outlined in the budget that the President
submitted to Congress.
With respect to the trade deficit, do you want----
Dr. Forbes. Sure. With respect to the trade deficit, you
are correct, the trade deficit is very large in absolute value
as well as a percent of GDP. There are some people who urge us
to reduce the trade deficit, and I agree I would like to see
the trade deficit fall at some point, but we also have to be
careful about how to reduce the trade deficit. There are so
many factors that cause a trade deficit, it is hard to sort out
which are signs of strength and which are signs of weakness.
And again, making the comparison to Europe, which you
raised, in the U.S. we do have a large trade deficit; the
growth is very high. The UK also has a fairly large trade
deficit; growth is fairly high. Australia and New Zealand have
large trade deficits comparable to the U.S. Their growth is
very strong. Germany, Japan, growth is very slow; growth has
been contracting or stagnated. And they have large trade
surpluses. So I don't think anyone would want to get Germany's
trade surplus or Japan's trade surplus if it comes at the
expense of much slower growth.
And there is this relationship where countries which grow
faster do tend to buy more imports from the rest of the world.
Countries which grow slower buy less imports. And therefore,
that can contribute to larger trade deficits for fast-growing
countries and smaller trade deficits for slower-growing
countries.
So I do agree I would like to see the trade deficit fall,
but we do need to be careful about how that is accomplished and
realize that in some ways the trade deficit actually reflects
the strong growth in the U.S. economy compared to strong growth
in our trading partners.
Representative Hinchey. If I may for one second, I think a
lot of it has to do with the propensity of the American
Government and the American people to go into debt, and the
personal debt of this country is at a record level as well as
the Federal Government's debt being at a record level. One
might come to the conclusion that it is not a function of the
strength of the economy, it is the willingness of people to
borrow enormous amounts of money and spend it without any clear
indication that that borrowing is going to stop at any point in
the future, or if it does, it will have cataclysmic results.
Dr. Forbes. You are right. As I said, there are many
factors that cause the trade deficit, and the low level of
savings in the U.S. is a major cause for a trade deficit. Basic
economics is the trade deficit is equal to the shortfall of
national savings relative to investment.
And you are right, if savings increase in the United
States, that would decrease the trade deficit. But I do want to
make the point I think people overstate the relationship
between our budget deficit and our trade deficit. There
definitely is a relationship. Holding everything else equal, a
larger budget deficit means a larger trade deficit. But if you
actually look at the numbers, it is a very weak relationship.
Look at the late 1990's. Our budget deficit actually went from
a deficit to a budget surplus, and our trade deficit----
Representative Hinchey. I am not suggesting any strong
relationship. I am just suggesting that the two things are
working out there, and they both have negative consequences.
Representative Saxton. Thank you, Mr. Hinchey. The
gentleman's time has expired.
Mr. Hinchey brought up a good subject. As I look back at
the last couple of decades in terms of economic growth, we saw
the economy begin to grow strongly in the early 1980s, 1983,
1984, timeframe. And with the exception of a very short and
shallow recession in 1990-1991, and another short and shallow
recession just a couple of years ago, we have seen some fairly
remarkable long-term economic growth during the decade of the
1980's and during the decade of the 1990s. And we see economic
growth taking place again today.
We had some tax relief legislation that we passed in 2001,
2002, and 2003, which appears to have, as you may have
mentioned, Mr. Chairman, some effect on economic growth. Over
the last couple of decades, Dr. Forbes, what do you think has
been the result of tax policy on the economy? This is a fairly
remarkable period of economic activity that we have had over
the last couple of decades. What has tax policy had to do with
that, and, more specifically, the most recent tax relief
programs that Congress has put into place?
Dr. Forbes. Actually I will give that to Harvey Rosen, who
is a leading expert in tax policy.
Dr. Rosen. Mr. Chairman, I think taxes play a very
important role in the growth of the economy; that in order to
have a resilient economy, you have to have people working,
saving, investing, and all of those decisions are in principle
affected by the tax rates they face.
So we need a tax system to sustain growth that provides
good incentives for working, saving, investing and other useful
economic activity.
And I think that one of the reasons why we have done so
well is that in this country, compared to many others, we have
tax rates that are relatively low. I think that we can do
better if we make rates lower yet, particularly on saving and
investment.
In that context, I would like to focus particularly on
business taxation and make a couple of points. First of all, as
Kristen mentioned before, entrepreneurship is really important
when you are talking about growth. And entrepreneurs are--
especially S-corps and sole proprietors are taxed at individual
tax rates. So when we talk about tax relief, we are not only
helping out American families, but we are providing the
wherewithal for businesses to grow.
The second thing I want to point out in the context of
taxation and its relationship to growth, we have to be mindful
of the way the corporate sector is being treated. We have a
very odd system in this country where we double-tax corporate
income. First it is taxed at the corporate rate, and then when
it is distributed to individuals as dividends, it is taxed
again. This creates a bias against the organization in a
corporate form, one of our most productive vehicles for
economic growth. It biases firms in favor of debt rather than
equity finance and creates a variety of distortions that keeps
growth lower than it would have been otherwise.
And one of the, I think, most important aspects of the
President's tax relief is the lowering of taxes on dividends
and capital gains, which is in effect lowering the double
taxation on corporate income.
So in sum I think that the tax environment is important for
growth. It is common sense, it has been documented in economics
literature. And, you know, when the President constituted the
advisory tax panel on tax reform, part of his charge to them
was to consider ways in which the tax system would be
reconfigured so that it would even be more friendly to growth.
Representative Saxton. Would you talk about that for a
moment? What do you think, or what does the Administration
think, that tax policy should be going forward?
Dr. Rosen. The key thing at the moment is that the tax cuts
be made permanent, that the tax relief be made permanent, that
the estate tax be eliminated, and all of those programs be made
for the long term.
With respect to tax reform, I think the President has laid
out certain principles that he thinks should guide the reform.
It should be--it should enhance growth. It should reduce the
complexity of the tax system. He has called the tax system a
complicated mess, and I think many Americans use less gentle
language when they are talking about their tax returns. I guess
tomorrow is Tax Day, so this is on everyone's mind at the
moment.
He has emphasized that future movements of the tax system
should try to enhance fairness, that people should all pay
their fair share. He has emphasized that the system should be
progressive. That is very important to him, that higher-income
people pay a higher share of their incomes.
He has also emphasized that the tax system should take into
account the special role of housing and charitable giving in
the American system.
So, Mr. Chairman, the President has not made any decisions
on a particular prototype, and, in fact, he is awaiting the
recommendations of the tax panel. He has laid out some
principles which show the direction he would like the tax
system to move.
Representative Saxton. Uncertainty in the economy can play
havoc. I have noticed in recent days uncertainty existing in
the economy because of energy prices. Recently we have seen
uncertainty exist in the minds of people who are working in the
economy because of the global war on terror.
Likewise, does not the temporary nature of the tax cuts
that we put in place create uncertainty and play havoc with the
economy?
Dr. Rosen. Yes, sir. I think that uncertainty makes it very
hard to make decisions. Many of the most important decisions we
make in life, both as individuals and in our professional
roles, are long-term. If you are starting a business and you
want to know should I invest in this or invest in that, is this
innovation worth following up, you need to know something about
what the returns are going to be over time, and that depends in
large part on the tax system. And if you do not know what the
tax system is going to be, I believe it will tend to inhibit
people from making those sorts of decisions.
So, yes, sir, I think that it would be a wonderful thing to
have a more settled tax system so that people have some
certainty with respect to the tax environment that they will be
facing.
Representative Saxton. Thank you very much.
Mr. Cummings, would you like another round here?
Representative Cummings. Yes, please.
Dr. Rosen, going back to Social Security and private
accounts, it is estimated that we are going to spend billions
with regard to these private accounts. And the President has
been not very clear on where this money is going to coming
from. Do you know? We have been trying to get an answer to
this, and maybe you know, since you are the man for these
issues.
Dr. Rosen. Sir, the personal accounts do involve transition
financing, and here is the way I think about it. Social
Security has promised some benefits to people in the future.
Under the President's proposal, if you voluntarily choose to
set up a personal account, then some of your--some of your
payroll taxes are diverted into your personal account.
Now, this requires some transitional borrowing in order to
help finance current benefits. But really what is going on, I
think, is that we are just putting on the books obligations
that the government already has; that is, we have promised
these benefits in the future. What the transition borrowing
does, the transition funding does, is puts those obligations on
the books and in effect is prefunding those obligations.
Maybe let me put it another way. When we think about
conventional debt finance, the debt is being used to buy more
stuff, whatever the government is buying in terms of goods and
services. Here we are not expanding the size of the public
sector. All we are doing is putting on the books obligations
that have already been made. In a way it is like prepaying a
mortgage. So it is not changing the long-term fiscal stance of
the government.
Now, with respect to magnitudes, there will be substantial
amounts involved. The President's proposal would have the
personal accounts phased in in a way so that--which is prudent,
I think--so that financial markets will have a time to adjust
and, you know, not have undue effects on financial markets.
Representative Cummings. Well, you know, the analysis by
our staff and others--and this is what Senator Reed said
earlier--shows that the President's private accounts plan would
require a massive increase in the public debt that is not
simply a short-run transition cost. Rather the additional debt
would reach 35 percent of GDP by 2060 on top of a debt already
equal to 37 percent of the GDP today. Is that accurate, do you
think?
Dr. Rosen. The numbers do not resonate.
Representative Cummings. Is that because you disagree with
them? What do you mean, they do not resonate?
Dr. Rosen. What it means is from the point of view of the
long-term fiscal stance of the government, the personal
accounts are approximately neutral, and the reason is because
the transition funding that is needed is offset by--for the
people who elect the personal accounts, is approximately offset
by benefit reductions from traditional Social Security that
they will have in the future. So it is a wash.
Basically we are saying, I am going to take some of my
payroll taxes, put it into a personal account. That means that
there is going to have to be some borrowing to make up for the
fact that that money is not available to pay current
beneficiaries, but in the future your traditional Social
Security is going to be reduced by an amount that takes into
account what the government--the government borrowing rate so
that from the point of view of the long-term fiscal stance of
the government, it is about neutral.
Representative Cummings. Well, what are the chances that
that person, the person who participates in these savings
accounts, what are the chances that they are going to get what
they would have gotten had Social Security just stayed the way
it is and we did some things like upping--going above the
90,000 and other things like that and kept it solvent, since
personal accounts do nothing for solvency? I am just curious.
That is the question that my constituents--they are trying to
figure out what is this all about? Will it be a wash? Why are
we going through these changes for a, quote, wash? And they
worry about that, and because they do not know whether these
figures are accurate. They have seen some inaccurate figures in
the past; i.e., the costs of the prescription drug program. So
they are not sitting there just thinking that everything is
accurate.
Dr. Rosen. The promises associated with scheduled benefits
can't be kept. We know that we are $11.1 trillion in net
liability to the system. The personal accounts allow
individuals who voluntarily opt for them to make up for the
fact that these scheduled benefits can't be kept. That is by
investing in a prudent portfolio, diversified assets, that
individuals will be able to make a return that will give them
the chance to make up for the fact that the scheduled benefits
simply can't be kept.
Now, in terms of trying to deal with the solvency problem
by raising the cap, I think it is important to note that
raising the cap by itself, it won't do the trick. That is in
terms of filling the $11.1 trillion shortfall, it just does not
go very far.
Representative Saxton. Since Mr. Cummings has graciously
brought up this subject, we know that Social Security has got
long-term problems as it is currently configured. We know that
it can't sustain--we know that we can't sustain the program
without significant changes.
Could you just take a minute and discuss--you discussed
what the President has suggested, his basic parameters. What
are the options? We hear a lot about the personal voluntary
investment accounts. What are the other options? Can you just
discuss them for a few minutes?
Dr. Rosen. Yes, sir. The President has indicated that when
it comes to reform of the system, he is willing to consider a
wide variety of options; that he wants people to understand
there is a problem, work together to solve that problem. And,
in fact, he mentioned several of those options in his State of
the Union Address that have been proposed over time from people
from both sides of the aisle.
Representative Saxton. Dr. Rosen, excuse me.
Dr. Forbes, I know you have to leave. Feel free when you
have to go.
Dr. Forbes. Thank you. I was going to wait until he
finished and then apologize. Thank you very much.
Dr. Rosen. So, some of the options, you know, that came
up--I feel lonely.
Representative Sanchez. Now we are really going to go after
you.
Representative Saxton. We are still here.
Representative Hinchey. We are your friends. Don't worry.
Representative Sanchez. We are?
Dr. Rosen. Some of the options that came up, that the
President listed in the State of the Union, were reexamining
the indexing system by which benefits are calculated. Another
one that came up was----
Representative Saxton. In plain language that means benefit
cuts?
Dr. Rosen. The--plain language? The--if we were to move
from a system of wage indexing to price indexing, benefits in
real terms would actually increase. They would not be as high
as the scheduled benefits, but the scheduled benefits are not
sustainable. So what we are talking about is cuts relative to
the unsustainable promises that have been made.
Another option that the President discussed was longevity--
or mentioned was longevity indexing, which essentially relates
to increasing the age at which benefits can be received. A
third possibility, I believe, that was listed in the State of
the Union was changing the benefit formula.
So there is a variety of ways in which reform could be
achieved. And as I mentioned before, the President is
interested in getting a dialog going to find a set that will
achieve some kind of bipartisan acceptance.
Representative Saxton. One of the options which the
President apparently believes is off the table is to remove the
cap, which--and I say ``believes it is off the table'' because
that is, in effect, a tax increase. But if Congress were to
decide to remove the cap, what would that do to solve the
problem?
Dr. Rosen. I do not have the specific numbers on what
proportion of the gap----
Representative Saxton. Would it provide a permanent fix?
Dr. Rosen. Oh, no, sir, it would not provide a permanent
fix. The Social Security actuaries have done some estimates. I
just do not have the numbers.
Representative Saxton. Would lifting the cap have any
effect on economic growth?
Dr. Rosen. In general, I think when tax rates go up, the
effect is to reduce labor supply, which would have a negative
impact on growth.
Representative Saxton. Any other options that are out there
that we have not discussed?
Dr. Rosen. Nothing is coming to mind at the moment.
Representative Saxton. So we have a system that is
unsustainable, and the options that have been talked about
involve tax increases and potentially lower levels of benefits.
Dr. Rosen. Relative to the scheduled benefits. And, of
course, the personal accounts, which I think when we are
talking about reform of the system, it is something we should
not just put off to the side, because the personal accounts
will give people the opportunity to make up some of the loss
from the scheduled benefits that are no longer possible. And,
in addition, they have the further advantage, which is by
taking the money, putting it into individuals' accounts with
their names on it and over which they have ownership, it makes
it much less likely that any Social Security revenues coming in
will be spent on other items as opposed to actually being saved
to fund retirement benefits in the future. So I see the
personal accounts as an inherent part of the whole package,
including reform.
Representative Saxton. Thank you.
If my colleagues will give me one of the prerogatives of
the Chair here for one final question. What would happen in the
life of a 30-year-old person who is currently in the Social
Security system who opts to voluntarily set up a savings
program for himself or herself? What would happen long term?
Just kind of walk us through it.
Dr. Rosen. Sure, I would be happy to. You are shaking your
head already?
Representative Sanchez. I just want to hear your response.
I am--speak to it, because I have more important things to ask
you about than to go through this silly Social Security thing,
but let's hear it.
Representative Saxton. My constituents do not think Social
Security is silly, Loretta.
Representative Sanchez. This is being discussed in every
corridor. I would love to hear this answer.
Dr. Rosen. Here is what happens to the 30-year-old. What
she does is she can take 4 percent of her payroll tax, put it
into a personal account. In return, I mean just for fairness,
the benefit that she gets from Social Security, traditional
Social Security, in the future will be reduced by an
appropriate amount.
Then, now she has her own personal retirement account, and
she can invest it as--within certain guidelines. And the
guidelines that the President has proposed are very similar to
the Thrift Savings Plan that we all have as an option. There
are certain broad-based accounts, broad-based securities,
stock, mutual funds, that kind of thing. And then they can
invest in a portfolio depending on their preferences. It has
their name on it.
Now, when they turn 47, unless they specifically opt out,
their assets would be reinvested in what is called a life cycle
portfolio, and what that does, it gradually moves the
composition of your portfolio from the relatively risky assets
like stock into the relatively safer assets such as bonds. So
that we know that over the long term stocks are quite reliable,
but as generating a good rate of return, but we also know in
the short term they can fluctuate. So the purpose of the life
cycle account is to protect you as you near retirement.
Then at retirement, what happens then? Again, the money is
yours, and you can start taking it out, and with the condition
that the money there be taken out in a way so that the
combination of what you are taking out from your personal
account and from traditional Social Security keeps you above
the poverty line. So we are definitely keeping the safety net
in mind.
I should also add that if our hypothetical 30-year-old
unfortunately passes away before she reaches retirement age,
she can bequeath what is in the personal account to her loved
ones.
Representative Saxton. Thank you.
Ms. Sanchez.
Representative Sanchez. Thank you, Mr. Chairman. I have
some questions. And just for the record, I don't think Social
Security is silly. I just think the President's proposals are
pretty ridiculous.
I want to talk to you. I recently spoke to--over an op-ed
piece from one of my former professors, economic professors,
out in Orange County who had written an op-ed, a discussion
piece, in a very Republican newspaper in my area, and he is a
pretty conservative guy, and he said that he thinks that in the
near term we will have a recession, and in the long term we
will have stagflation.
He based it on now that the Feds have a lot of different
situations to deal with versus what we did in the recovery of
2002, which was based on the President's tax cuts, the rapid
increase in our Government spending, and a very good
stimulative monetary policy, and that carry trade allowed us to
have low mortgage rates, run up housing prices, create a strong
refinancing boom, and created strong consumer spending.
But now we have different conditions. Our productivity
growth is slowing. Our employers, therefore, have to hire more
workers to satisfy the demand that they have for their goods
and services. That has an upward pressure in nominal wages at
the same time when employers are gaining pricing power, which
increases the price of goods and services, meaning higher
inflation.
Also the higher energy costs that we see, the higher rates
in construction, housing markets, ARMs kicking in, and no
demand for refinancing, obviously, which all turns to a lower
disposable income or a slowed down or basically a recession.
That is what Esse Adibi is saying. And in the long run he is
not very optimistic because of the budget trade deficit
situation going on, the adjustment of our currency, which you
would think would be helping us on that trade deficit, but the
trade deficit continues to grow anyway.
Which points to probably, well, currently a lower standard
of living--if you go to Europe, you are not going to buy what
you used to buy a year ago or 2 years ago; a much larger
currency adjustment than is probably needed; the accompanying
inflation that we just talked about, that I just spoke about;
the implication of a lower dollar, which would force the Feds
to increase interest rates. So higher inflation, higher
interest rates, stagflation.
What do you think of that? What do you think of his not
very optimistic outlook with respect to what is going on right
now versus, you know, your very glowing everything is all
right, do not worry about it? And I did not add to that the
entitlement programs which are--we just spoke about Social
Security, but also Medicare, where this Republican Congress,
you know, added a Part D that is not sustainable, in my
opinion, and does not bring value to the actual consumer.
Dr. Rosen. We certainly monitor the economy very closely to
see whether there are risk factors that might work toward
lowering growth as we move forward. As we noted at the
beginning of the testimony, our forecasts about what is
happening moving forward are not idiosyncratic. So it is not
like CEA has some rosy scenario, and the rest of the world
disagrees. The consensus of the private sector forecasters is
not for recession and stagflation; rather it is for sustainable
growth moving forward.
One of the most important things that you raised is the
condition of household balance sheets, which is always a matter
of importance when you are trying to figure out where the
economy is going to be.
Representative Sanchez. It has to be scaring you to death
those ARMs out there.
Dr. Rosen. Well, here is what you see. If you look at the
ratio of households' debt obligations to their disposable
income, it has been quite steady. In other words, household
balance sheets seem to be in pretty good shape.
Representative Sanchez. But these will kick in. They
haven't kicked in yet.
Dr. Rosen. Well, the obligations that people face could go
up or down, depending on the course of interest rates. We are
predicting mild increases in interest rates. But I think the
fact is that we are not observing problems with consumers with
respect to their balance sheets at this time.
Representative Sanchez. What do you consider ``mild
interest rates,'' Mr. Chairman? I'm sorry, ``mild interest rate
increases''?
Dr. Rosen. What I am talking about is that we have been
forecasting interest rates in the middle 4.5 percent range,
whereas the long-term average is about 6.6. So interest rates
are below historical averages. Mortgage rates are below
historical averages, and we do not see threats to consumer
balance sheets on this basis.
Representative Saxton. Mr. Chairman, we are going to move
over to Mr. Hinchey, but on the way to doing that, these red
bars on this chart indicate the consensus forecast for the
economy. Can you comment on what consensus forecast means? Who
is this that is saying that we are going to have 3.9 to 3.3
percent growth?
Dr. Rosen. Yes, sir. There is a group of business
economists who represent either major consulting firms or major
businesses, and they submit their forecast to a central group
who then just reports them all. So you can literally get the
page with what is it 30 or 40--50--there are 50 of them, and
the consensus is the median or the average of them. So this is
distilling the opinions of people who do this kind of thing for
a living.
Representative Saxton. Thank you.
Mr. Hinchey.
Representative Hinchey. Thank you, Mr. Chairman.
We have had an interesting discussion on Social Security,
which reflects, I think, the attention that you paid to that
subject in your testimony. But it is interesting, in looking at
your testimony, that there is no mention in your testimony of
budget deficits, the looming Medicare crisis, which is much
larger and much more imminent than any problem in Social
Security. No mention of lack of health insurance, the wage
disparities that we are confronting in our country, the
increases in poverty rates or rising energy costs, all of which
impact severely on our economy. I am not going to ask you to go
into detail on those subjects, but at some point I would be
very interested in hearing what you have to say about it.
I would like to just go back to Social Security, since so
much time and attention has been paid to that today. You
mention at some point an $11 trillion deficit. Now, that
projection, I assume, is somewhere out here--into infinity; is
that right?
Dr. Rosen. Yes, sir.
Representative Hinchey. Is it customary for us in the
Federal Government to project programs into infinity?
Dr. Rosen. I think different times it is----
Representative Hinchey. I don't think it is. I think it is
unusual to project the needs of any program out to infinity.
Normally what we do is project them out over 20 or 30 or 50-
year basis.
And you mentioned a number of things in response to the
chairman's question that could be done to deal with the Social
Security problem, and those things have been done in the past.
In 1983, for example, there were changes made which raised the
retirement level and also brought more money into the system by
raising the cap. And I think that your response saying that
raising the cap would not solve the problem is not correct. If
you eliminate the cap, it certainly would solve the problem.
And it would solve the problem far into the next century; not
just the 21st century, but on off into the 22nd century based
on the demographics that we are familiar with.
There are other ways to deal with it, too. If you were, for
example, or if we were, for example, to repeal the tax cuts,
the President's tax cuts that go to the wealthiest 1 percent of
Americans, that would essentially solve the problem for the
rest of this century.
So there are some very simple things that we could do to
deal with whatever problem is perceived in Social Security, but
it is interesting that we are talking about a program whose
solvency under the most pessimistic cites is secure until at
least 2041, and the CBO says 2052. And interestingly enough, if
we have a higher growth rate, it would go beyond that.
In your testimony and your statements here today, I believe
that you are suggesting that we are going to continue to
experience a growth rate of something in the neighborhood of
3.7 percent. Am I right about that?
Dr. Rosen. That is for this year, sir.
Representative Hinchey. For this year, 3.7 percent. What
are you projecting for next year?
Dr. Rosen. Next year, 3.4, 3.5? What are we saying?
Representative Hinchey. Can I have a lapse of my time,
here, Mr. Chairman?
Dr. Rosen. 3.5 for this year, and 3.4 for next year. So we
are a little bit more modest than the consensus forecast.
Representative Hinchey. In your estimates with regard to
the problems in Social Security, what are the estimates of
economic growth used for the Social Security estimates into the
future?
Dr. Rosen. The Social Security actuaries make those
estimates. I don't know specifically what figures they have.
Representative Hinchey. I understand that the figures that
they use are less than 2 percent. I believe the figures they
use may be 1.7 percent. I am not absolutely positive about
that, but I am sure it is less than 2 percent, and I think it
is 1.7.
You are projecting economic growth at the rate of 3.4 and
3.5. But when you are looking at Social Security, the Social
Security actuaries, your testimony and a lot of the actions
that are being contemplated by the Administration and Members
of Congress are based upon the numbers used by the actuaries at
Social Security who predict that they system will run out of
funds in 2041 you essentially cut in half the growth rate. You
are not playing with a straight deck here. You are loading the
dice. You are giving people false information.
So you are going to have to settle, I think, on one of
those figures or the other. Either the economy is growing at
the same rate for Social Security as it is for everything else,
1.7 or 3.4 or 3.5, or it is not. But it cannot be growing at
two different rates.
Dr. Rosen. A couple of points, I guess. One is that in
recent reports, the Social Security actuaries looked at long-
term calculations as a function of different assumptions in the
growth rate. And what they found, it does not move those long-
term net liabilities around very much. And the reason is
because if the economy is growing faster, and people have
higher wages, then we know, according to the Social Security
benefit formula, that just means people get higher benefits.
Representative Hinchey. Excuse me for interrupting. There
is no argument with that, but that does not address the
disparity in the statistics. If you are using two separate
growth rates, you will have to come to a conclusion as to which
number you are going to estimate that the economy is going to
grow at. And in the case of Social Security also, if you have a
growth rate of 3.4, 3.5 percent over the course of the next
decade, then the extended life of Social Security is not going
to be 2041. In other words, the money is not going to run out
by 2041. It is not going to run out based upon the formula that
the actuaries use, if they use 3.4 or 3.5 for a growth rate.
That money will extend Social Security viability out into 2050
or 2055 easily and beyond.
And also if you have the growth rate in the economy which
you are predicting now, not Social Security, but you are
predicting now for the President in the economy, then the
amount of money that people will be collecting--let's use the
pessimistic numbers of the actuaries of Social Security--the
fund stops growing and becomes stagnant, runs out of funds
about 2041. Benefits paid after 2041, according to the
actuaries, would be 73 percent of what they would be under 100
percent. But 73 percent of benefits in 2041, based upon the
index currently in effect, has a higher buying power than 100
percent of benefits in 2005.
Dr. Rosen. I think, sir, you raise a key point at the
beginning, which is what time horizon should we look at when we
are thinking about the Social Security system. I think that
since this is driven to a large extent by demographics, we know
which way the demographics are going. We know that if you fix
it--we know what the lines look like after 1975 and 1976, and
revenues are staying below the cost line.
Representative Hinchey. Those lines depend upon which
numbers you use to create those lines. And if you are going to
use different numbers to create the lines for the economic
growth and for the strength of Social Security, you are going
to come up with very different results.
So, the lines that you are talking about are projections.
And no one knows for sure what those lines are going to be.
Those projections are based upon numbers that you create now.
And you are creating those numbers--you are creating one set of
numbers, the actuaries are creating a different set of numbers,
but you are using your set of numbers to predict how good the
economy is now and how good it is going to be for the duration
of this Administration. But when you talk about Social
Security, you put your numbers aside, and you pick up the
actuaries' numbers, which are much more pessimistic about
economic growth, and therefore you can predict that Social
Security is in trouble. But if you used your numbers in terms
of growth of economy, you would have to predict that Social
Security is much more strong than is being predicted now by the
Administration.
Representative Saxton. Mr. Hinchey, your time has long
since expired. Let's give the chairman a chance to answer this
question.
Dr. Rosen. We always use the Social Security actuaries'
numbers when we are analyzing Social Security. I think
otherwise we would really have problems in terms of deciding
which number to use for which kind of analysis.
Representative Hinchey. Very interesting.
Representative Saxton. Mr. Chairman, thank you very much
for being with us today, and we look forward to working with
you in the future. The hearing is adjourned.
[Whereupon, at 11:12 a.m., the hearing was adjourned.]
Submissions for the Record
=======================================================================
Prepared Statement of Hon. Jim Saxton, Chairman,
U.S. Representative from New Jersey
It is a pleasure to welcome Chairman Rosen of the President's
Council of Economic Advisers (CEA) before the Committee this morning.
Chairman Rosen's testimony on the economic outlook continues the
productive exchange between the Council and the Joint Economic
Committee that has existed for many years.
A variety of standard economic data show that the U.S. economic
expansion is on track. According to recent figures, the U.S. economy
grew at a rate of about 4 percent last year, after adjustment for
inflation. The U.S. economy has been growing at a healthy pace since
the second quarter of 2003, when the rebound in business investment
started to broaden and bolster the expansion.
The tax incentives for investment adopted in the second quarter of
2003 played an important role in jumpstarting investment growth. The
previous weakness in business investment was replaced by double-digit
increases in equipment and software investment in six of the last seven
quarters.
The acceleration of economic growth is reflected in other economic
statistics as well. Industrial production is trending upward. Over the
last 22 months, payroll employment has risen by 3.1 million jobs. The
unemployment rate stands at 5.2 percent. Household net worth is at a
record level. Homeownership has hit new record highs. Interest rates
remain fairly low by historical standards. Consumer spending continues
to grow. Inflation appears to be under control, with a key core measure
of price changes still below 2 percent on a year-over-year basis.
In summary, overall economic conditions remain very positive.
Recently released minutes from the Federal Reserve suggest that the
central bank expects this economic strength to continue. There is
justifiable concern about the increase in oil prices, but it is
important to note that this primarily seems to reflect strong demand
from international economic growth, not a plunge in oil supplies.
Another challenge is the tax bias against saving and investment
embedded in the tax system. Further reducing the multiple taxation of
saving and investment would lessen the economic burden imposed by the
tax code, and increase economic growth over the long run. The
Administration's proposals to protect more personal saving from
multiple taxation are right on target.
The consensus of Blue Chip forecasters projects that the economic
expansion will continue through 2005 and 2006. This is very consistent
with the Council's projections for economic growth over the next two
years or so. The bottom line is that the U.S. economy remains strong
and that the overall economic outlook is positive.
__________
Prepared Statement of Hon. Jack Reed, Ranking Minority Member,
U.S. Senator from Rhode Island
Thank you, Chairman Saxton. It is a pleasure to be here at the
first hearing of the Joint Economic Committee in the 109th Congress,
and I look forward to working with you. It is fitting that this hearing
is with the Council of Economic Advisers, which was created at the same
time as the JEC in the Employment Act of 1946.
I want to welcome CEA Chairman Rosen and CEA member Forbes. I know
that your backgrounds are not in economic forecasting, but I am
confident that you will be able to give us useful insights on current
economic conditions and where you think the President's policies are
taking us.
I have three major concerns about the economic outlook. First, I am
concerned about what continues to be an extremely disappointing
economic recovery for the typical American worker. I know that the
Administration is proud of the fact that the economy has created jobs
for 22 consecutive months. But the pace of job creation over that
period works out to just 141,000 jobs per month. That is barely enough
to keep up with normal growth in the labor force. Last month, we did
not even match that pace, as only 110,000 jobs were created.
The slow pace of job creation is disappointing, but what is
happening to the take-home pay of the average worker is even more
disappointing. Since May 2003, when the economy finally began creating
jobs again, the average hourly earnings of production workers in
nonfarm industries have fallen by 0.7 percent after accounting for
inflation. In addition, we are finding that the distribution of
earnings is becoming more unequal and American families are having to
shoulder more risk in today's economy. I think these issues are the
darker side of the President's plan for an ownership society, and I
think they are concerns that need to be addressed.
My second major concern about the economic outlook is the effects
we are seeing in the trade deficit and the foreign exchange market from
the irresponsible fiscal policy we have been pursuing over the past
four years. This week we learned that the trade deficit is still
widening, with February's deficit of $61.0 billion a record for a
single month. The broader current account deficit rose to a record 6.3
percent of GDP in the fourth quarter of 2004. The large drain on
national saving from the federal budget deficit has put us in a
position where we must borrow $650 to $700 billion per year from the
rest of the world to sustain our spending. That money will have to be
paid back with interest, which will be a drain on our national income
and future standard of living.
Finally, I am concerned that the President wants to extend this
fiscal irresponsibility to Social Security. Analysis by the JEC
Democratic staff and others shows that the President's private accounts
plan would require a massive increase in the public debt that is not
simply a shortrun transition cost. Rather, the additional debt
associated with private accounts would reach 35 percent of GDP by 2060,
on top of a debt already equal to 37 percent of GDP today.
The President's plan for private accounts makes Social Security
solvency worse by diverting payroll taxes from the trust fund. That
drain on the trust fund moves up the date that Social Security can no
longer pay full benefits and increases the present value of the 75-year
financing gap from $4.0 trillion to $5.6 trillion.
Finally, the President's plan for private accounts does nothing to
increase national saving, and could lower it still further. The private
saving that would be generated by the creation of private accounts
would be completely offset by the reduction in public saving from the
larger budget deficits, and people might reduce other private saving
such as their contributions to 401(k)s and IRAs.
Raising national saving is the key to economic growth and one of
the ways to reduce the trade deficit. Moreover, as Federal Reserve
Chairman Alan Greenspan recently testified, it is the best way to meet
the fiscal challenges posed by the retirement of the baby boom
generation. Unfortunately, the President's policies of large tax cuts
for those who are already well off and private accounts that add to the
debt and worsen Social Security solvency seem to be taking us in
exactly the wrong direction.
I look forward to your testimony about the economic outlook, and I
will listen with interest to anything you can tell me that will allay
my concerns about that outlook.
__________
Prepared Statement of Harvey S. Rosen, Chairman,
Council of Economic Advisers; and Kristen J. Forbes, Member, Council of
Economic Advisers
Chairman Saxton, Vice-Chairman Bennett, Ranking Member Reed, and
members of the Committee, thank you for the opportunity to testify at
the Joint Economic Committee. We appreciate the long-standing
relationship between the Committee and the Council of Economic
Advisers.
The President's economic agenda is ambitious and addresses a number
of issues that are important to maintain the strength and dynamism of
the U.S. economy. Today we would first like to take a few moments to
discuss the current state of the U.S. economy and the outlook moving
forward. Then we will highlight two of the President's key agenda
items--Social Security and tax reform. We will conclude with a summary
of the 2005 Economic Report of the President.
THE U.S. ECONOMY
Economic growth in the United States is robust and is expected to
remain strong for this year and next. Real GDP, the gross domestic
product adjusted for inflation, grew 3.9 percent at an annual rate
during the four quarters of 2004. Current data indicates this momentum
carried into the first quarter of this year and will continue. Blue
chip consensus forecasts are currently predicting real GDP growth of
3.9 percent in the first quarter and 3.6 percent in the second quarter.
Housing starts remain high. New orders for core capital goods suggest
solid investment spending going forward.
The labor market continues to improve and more Americans are
working than ever before. During the past 12 months, the economy has
added 2.14 million jobs. The unemployment rate has dropped to 5.2
percent and remains well below the averages for the 1970s, 1980s and
1990s.
Core inflation, which excludes volatile food and energy prices,
remains stable. As measured by the core consumer price index, inflation
was 2.4 percent during the past 3 months and also the past 12 months--
well below the 40-year average of 4.6 percent. Although the recent rise
in crude oil prices is creating headwinds for the economy, we do not
expect it to stand in the way of continued expansion.
The Administration forecast remains on track according to data
received since the macroeconomic forecast was finalized in December of
2004. We predicted that real GDP would grow at a 3.5 percent annual
rate during 2005. Now, four months later, the latest forecast from the
Blue Chip consensus panel is 3.6 percent, in line with the earlier
Administration projection. In December the Administration forecast that
unemployment would fall to 5.2 percent by the end of 2005--a level
reached in March.
This strong economic performance of the United States is
particularly impressive when compared to the performance of other
large, developed economies. The United States had the fastest annual
rate of GDP growth of any member of the G-7 in both 2003 and 2004, and
is expected to continue to have the strongest rate of economic growth
in 2005. The United States is expected to grow over twice as fast as
Germany, Italy, and Japan in 2005.
STRENGTHENING SOCIAL SECURITY
Last year's Economic Report of the President discussed the need to
strengthen Social Security and approaches to reforming this vital
program. In the intervening months a vigorous debate has begun. We
welcome the debate.
By now the numbers are familiar. Population growth is declining but
life expectancy continues to increase. In 1950 there were 16 workers
for every one Social Security beneficiary. Today, there are just 3.3
workers for every beneficiary. When today's 20-year-olds retire, that
number will have dropped to two.
Combined with Social Security's benefit structure, these
demographic realities mean that in about year 2017 the program will
begin paying out more in benefits than it receives in revenue. This
means the Federal government will have to redeem the IOUs in the Social
Security Trust Fund, forcing cuts in other programs, tax increases, or
more borrowing.
These numbers have changed little in the past four years since
President George W. Bush has been in office. For example, in the last
Social Security Trustees Report under the Clinton Administration the
program shortfall was projected to begin in 2016, compared to the
current projection of 2017. In total, the program's unfunded liability
is about $11 trillion in present value terms. Action is needed to deal
with this problem.
To think about the problems with the Social Security system, it is
useful to begin by noting that, contrary to what many workers believe,
their contributions to the system in the form of taxes are not kept and
used to fund their retirement. This would be known as a pre-funded
system. Instead, their taxes are immediately used to pay the benefits
of current retirees. The viability of this type of pay-as-you-go system
is vulnerable to the changes in demographics that we are experiencing
today.
Compounding this situation is a change made in 1977 where each
generation of retirees receives higher real benefits than the
generation before it. This stems from the indexation of the initial
level of benefits to wages, which over time grow faster than prices. A
person with average wages retiring at age 65 this year gets an annual
benefit of about $14,000, but a similar person retiring in 2050 is
scheduled to get over $20,000 in today's dollars. In other words, even
after adjusting for inflation, today's 20-year-old worker is promised
benefits that are 40 percent higher than what his or her grandparent
receives today.
The combination of large benefit increases and a growing elderly
population puts the current Social Security system on an unsustainable
path.
President Bush has outlined four key principles for strengthening
Social Security. First, no changes should occur for current or near
retirees. Social Security is secure today. It is for future generations
that changes must be made. Second, there should be no increases in the
payroll tax rate. The tax has already been increased 20 times since the
program's creation. Third, the program must be permanently fixed.
Short-term funding fixes are not acceptable. Finally, Social Security
should include voluntary personal retirement accounts. The Nation's
retirement system should ensure that all workers have the opportunity
to build their own nest egg.
Roughly half of Americans are now investors. For example, millions
of Americans have become accustomed to IRAs, 401(k)s and other defined
contribution pensions. They don't have to rely on their employer to pay
their pension when they retire, they can take their account from job to
job, and they manage it, own it and can pass it own to their children.
President Bush believes every worker--not just a middle or upper income
worker--deserves the opportunity to have his or her own nest egg.
Under the President's proposal for personal retirement accounts,
any worker born after 1950 would have the option of putting up to four
percentage points of their 12.4 percent payroll tax into the accounts.
The accounts would be phased-in over time. Contributions would be
initially capped at $1,000 per year. The amount contributed to the
accounts would be used to determine how much a worker's traditional
Social Security benefit would be offset.
Investment options and management of the accounts would be similar
to that of the Federal employee retirement program, known as the Thrift
Savings Plan (TSP). Workers would be permitted to allocate their
contributions among a small number of very broadly diversified index
funds patterned after current TSP funds. A centralized administrative
structure would be created to collect personal retirement account
contributions, manage investments, maintain records, and facilitate
withdrawals at retirement. The Social Security Administration's non-
partisan actuaries estimate that the ongoing administrative costs for
these TSP-styled accounts would be roughly 30 basis points. Private
mutual funds cost roughly three times as much.
Personal retirement accounts in Social Security would not be
accessible prior to retirement. Once retired, workers would not be
allowed lump sum withdrawals that would result in their moving below
the poverty line.
This proposal holds much promise. In addition to helping to pre-
fund the system and allowing every worker the opportunity to own a nest
egg, personal retirement accounts provide the possibility to earn a
greater rate of return than what Social Security can actually fund for
future retirees. The accounts can also help increase national savings
as they reduce the likelihood that Social Security surpluses will be
spent on other programs.
Other reforms to Social Security must take place in order to
restore solvency to the Social Security system. In his State of the
Union Address earlier this year, President Bush outlined a variety of
options advocated by both Democrats and Republicans that would comply
with his principles. The President is eager to work with Congress to
arrive at a package of reforms that will permanently fix the system.
TAXES
This year's Economic Report of the President highlights the need
and options for reforming our tax code. It outlines some pros and cons
of various reform prototypes. The report does not make recommendations,
which will be the responsibility of the tax reform advisory panel later
this year.
The problems of our current tax system are well-known and well-
documented. The current system is overly complex and distorts
incentives for work, saving and investment. The complexity imposes high
costs in terms of time and money for taxpayers to file returns and
comply with all the rules.
The distortionary effects of high tax rates on work, saving and
investment impose high costs of another kind: deadweight economic
losses from distorted economic decisions and the resulting inefficient
use of resources. These distortions cause reductions in economic
welfare that exceed the amount of tax collected. These costs above and
beyond the revenues collected are called the ``excess burden'' of the
tax system.
One recent academic study estimated that for the tax system in
effect before President Bush took office, the excess burden associated
with increasing taxes by one dollar was about 27 cents. In other words,
the total burden of collecting $1.00 in additional in taxes was $1.27,
not counting compliance costs. How much better could we do if we
reformed our tax system? The study estimated that adopting a reformed
income tax system, or one of several alternative reforms that would
eliminate the tax bias against saving and investment, could reduce this
excess burden by 50 percent or more. Such reforms could also result in
substantial simplification.
We should note, however, that significant progress has been made.
In the last four years tax rates have been cut, the double tax on
corporate income has been reduced, fairness has been improved for
families, and this has been done while enhancing the overall
progressivity of the tax system.
The 2001 and 2003 tax relief bills reduced marginal tax rates and
created a low 10 percent rate. These lower rates improve economic
incentives because taxpayers get to keep more of each additional dollar
that they earn, save or invest.
The 2003 tax bill reduced the double tax on corporate income by
reducing the individual income tax rates for both dividends and capital
gains. Corporate income is taxed first under the corporate income tax
and then a second time under the individual income tax as dividends or
capital gains. Consequently, the total Federal tax rate on corporate
income can be very high. For example, in 2000, the total Federal tax
rate on a dollar of corporate income paid out as a dividend could be as
high as 60.75 percent (calculated as the 35 percent corporate rate plus
an individual tax rate of up to 39.6 percent on the 65 cents of after-
tax corporate income available for dividends).
Economists are in broad agreement that this double taxation creates
serious economic distortions. Indeed, historically the United States
was almost alone among advanced countries in failing to provide some
form of relief from double taxation of corporate income.
Proponents of the tax relief argued that it would lead to more
dividends being paid by corporations. Was this prediction correct? One
study found that the percentage of publicly traded firms paying
dividends began to increase precisely when the new law became effective
in 2003. This percentage had been declining for more than 20 years. The
study found that nearly 150 firms started paying dividends after the
tax cut, adding more than $1.5 billion to total quarterly dividends.
Many firms already paying dividends raised their regular dividend
payments, and others made special one-time dividend payments to
shareholders. Overall, the response has been substantial. Another study
estimated that over time, dividends will increase by 31 percent, about
$111 billion in additional annual dividends at 2002 levels.
Looking more broadly, the U.S. Treasury Department has estimated
that the tax relief passed in 2001 and 2003 increased real GDP by as
much as 3 percent, and that without it, the unemployment rate would
have been nearly one percentage point higher at the end of 2003. As
many as 2 million fewer jobs would not have been available.
But there is more to be done in the tax area. As mentioned earlier,
the President has appointed a bi-partisan blue ribbon panel to study
tax reform and report back to the Secretary of the Treasury by July
31st of this year.
The 2005 Economic Report of the President discusses a number of
other issues as part of the President's economic agenda. We will
briefly summarize the issues below and encourage you to read the text
for any issues that you find particularly interesting.
EXPANDING INDIVIDUAL CHOICE AND CONTROL
Property rights are the key ingredient to expanding individual
choice and control. They provide the crucial link between people's
effort and their reward. They are the instrument society uses to
establish people's control over things. In practice, these go by many
names, such as deeds, titles, permits, vouchers, allowances, or
accounts. Patents and copyrights are also property rights, establishing
control over inventions, books, songs, and other creative concepts. The
essential idea is the same in each case: the owner of the property
right controls how something valuable is used.
Using property rights to address policy problems is consistent with
the principles of a free society because it assigns decision-making
authority to individual decisionmakers, rather than to central
authorities. By giving firms, individuals, and families the authority
to make decisions about the use of their own resources, property rights
give control to those entities that have both the best information and
the strongest incentives to use those resources efficiently.
Property rights solve the ``tragedy of the commons'' problem by
encouraging owners to reduce the intensity of resource use. If an open
access resource, such as fisheries or the air, is overused, assigning
property rights to that resource will encourage its conservation.
Ownership of a resource also encourages owners to invest in and improve
the resource.
Property rights have important economic effects because they
underpin market operation. Markets are socially beneficial because they
allocate resources to their highest valued use and because they provide
valuable price signals to both buyers and sellers. Without well-defined
and enforced property rights, markets will work poorly or will not work
at all.
Property rights analysis can illuminate similarities in policy
solutions that may at first seem very different. There are numerous
examples of the success of property rights in addressing policy
problems, including air pollution, overfishing, and poorly performing
public schools. Property rights have facilitated cleanup of the air at
low cost, have allowed fish stocks to recover, and have improved the
performance of schools in those areas where they have been used
effectively. Property rights can be used to help address other policy
issues.
The President's agenda already uses property rights to expand
individual choice and control through a variety of proposals, including
the recently passed Health Savings Accounts and Millennium Challenge
Accounts, and his proposal for personal retirement accounts in Social
Security.
INNOVATION AND THE INFORMATION ECONOMV
The information technology sector has been a vibrant part of our
economy and there is every indication that it will continue to be. The
continued strength of this sector depends on fostering an environment
in which innovation will flourish.
In a free market, innovators compete to lower the cost of goods,
improve their quality and usefulness, and develop entirely new goods
that promise quantum leaps in consumer welfare. People are motivated to
invest in developing new ideas and the infrastructure to enter new
markets by the prospect of earning returns on their investment.
Government thus has an important role to play in defining property
rights in intellectual and physical capital so that people will be
spurred to invest and innovate, as well as ensuring the development of
an environment in which public safety and national security are
protected.
Government efforts to hasten the spread of innovative technologies
should focus on lowering regulatory barriers that impede market
provision. But government should avoid ``picking winners'' among
emerging services. Doing so could entrench services that may become
outdated as the marketplace evolves and hinder people from choosing the
services they truly prefer. At this time, it is hard to predict the
range of technologies that will emerge to deliver high-speed data
services, or even what the scope of these services will be. As people
vote with their dollars, the market winners that emerge will be those
technologies and services that deliver customers the greatest value.
MODERN INTERNATIONAL TRADE
Open markets and free trade raise living standards both at home and
abroad. The President's policy of opening markets around the world is
based on this solid foundation. As international trade has grown in
both volume and scope, however, so too have concerns that traditional
ideas about trade policies no longer apply to today's trade
environment.
Free trade allows countries to mutually benefit from specializing
in producing goods at which they are adept and then exchanging those
goods. This rationale remains the same, even with advances in
technology and new types of trade.
The Administration's pursuit of trade liberalization is based upon
a long history of intellectual support for free trade. Modern trade
theory begins with the nineteenth century's David Ricardo. Ricardo's
central insight--his elegant model of comparative advantage--is the
starting point from which to explain the gains from trade. Ricardo's
model of comparative advantage addressed the question of how a home
country could compete with a foreign trading partner that is better at
producing everything. Ricardo showed that even if a foreign country
could produce each of two goods for less than the home country could
(that is, the foreign country has an absolute advantage in the
production of the goods), there could still be mutual gains from
trading the two goods. The key to the argument is that it is relative
costs of production (comparative advantage) that matter, not absolute
advantage.
The best evidence indicates that the United States enjoys such a
comparative advantage in services trade. The United States exports more
services than it imports, and this surplus in services' trade has been
growing in recent years. Moreover, U.S. services exports tend to
involve relatively highly-skilled and highly-paid occupations, such as
engineering, financial services, or architectural services. While
services' trade may not have been envisioned in the time of Ricardo,
the principle of comparative advantage still holds. Any move toward
economic isolationism would thus threaten the competitive gains made by
U.S. exporters while harming U.S. consumers and firms that benefit from
imports.
IMMIGRATION
In recent decades the United States has experienced a surge in
immigration not seen in over a century. Immigration has touched every
facet of the U.S. economy and, as the President has said, America is a
stronger and better Nation for it. Immigrants today come from countries
around the world and work in diverse occupations ranging from
construction workers and cooks to computer programmers and medical
doctors.
Immigrants have settled in all parts of our Nation and have
generally succeeded in finding jobs quickly, helped in large measure by
the flexibility of the U.S. labor market. One indicator of this success
is that foreign-born workers in the United States have a higher labor
force participation rate and lower unemployment rate than foreign
workers in most major immigrant-receiving countries.
While flexible institutions may speed the economic integration of
the foreign-born, the distribution of the gains from immigration can be
uneven. Less-skilled U.S. workers who compete most closely with low-
skilled immigrants have experienced downward pressure on their earnings
as a result of immigration, although most research suggests these
effects are modest. Also, communities contending with a large influx of
low-skilled immigrants may experience an increased tax burden as
immigrant families utilize publicly provided goods such as education
and health care.
U.S. immigration policy faces a complicated set of challenges,
perhaps more so now than ever before. Policy should preserve America's
traditional hospitality to lawful immigrants and promote their economic
contributions. Yet these goals must be balanced with the Nation's many
needs, including the imperative for orderly and secure borders. These
challenges have only grown in a post-9/11 world. The persistence of
undocumented immigration and problems with employment-based immigration
suggest that the United States needs to better enforce immigration laws
and do more to address the demand for immigrant workers and the need
for national security. The President's proposed Temporary Worker
Program and increased funding for internal enforcement recognize these
problems and would implement necessary reforms.
THE GLOBAL HIV/AIDS EPIDEMIC
Societies worldwide face the challenge of curbing the acquired
immunodeficiency syndrome (AIDS) epidemic. The disease has already
killed over 25 million people, and currently over 40 million people are
living with the human immunodeficiency virus (HIV), the virus that
causes AIDS. The impact of HIV/AIDS varies across the world, both in
terms of the scale of the epidemic and the ability to treat infected
individuals.
Less-developed countries are particularly hard-hit on both
accounts. Almost two-thirds of all people with HIV live in sub-Saharan
Africa, a region that makes up only one-tenth of the world's
population. At the same time, few infected individuals in the region
receive adequate treatment for the disease. In addition to the
devastation from the immense loss of life, the disease also has
economic consequences that intensify the humanitarian crisis.
AIDS is a global problem with far-reaching consequences. While the
disease's impacts on human health and mortality are widely recognized,
the AIDS epidemic also has devastating economic consequences that
exacerbate the humanitarian crisis.
A comprehensive and integrated approach of prevention, treatment,
and care is essential to quelling the epidemic. In poor countries,
treatment affordability and the lack of health care infrastructure are
major concerns. Compassionate pricing policies and aid from developed
nations can play an important role in expanding access to treatment.
To continue the development of better treatments and to work toward
eradication of HIV/AIDS, drug companies need to maintain the highest
possible quality of research. Intellectual property laws are important
in ensuring appropriate incentives for innovation to create the next
generation of therapies and to develop a safe and effective vaccine.
Understanding the unique challenges presented by this epidemic is
essential to designing policies to prevent the spread of the disease
and to treat those who are already infected. President Bush has made
fighting the worldwide AIDS epidemic a priority of U.S. foreign policy,
and he has taken bold action against the crisis through his Emergency
Plan for AIDS Relief.
CONCLUSION
In conclusion, the U.S. economy is fundamentally sound and the
outlook is very positive. Challenges remain, however, and the President
has an ambitious agenda to address them, including proposals to improve
trade, enact legal reform, improve access to health care, use our
energy resources efficiently, and rationalize the regulatory system.
Mr. Chairman, we appreciate this opportunity to testify and welcome
any questions. Thank you.