[Senate Hearing 109-146]
[From the U.S. Government Printing Office]



                                                        S. Hrg. 109-146


 
                    THE ECONOMIC OUTLOOK: APRIL 2005

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

                                HEARING

                               BEFORE THE

                        JOINT ECONOMIC COMMITTEE

                     CONGRESS OF THE UNITED STATES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                             APRIL 14, 2005

                               __________

          Printed for the use of the Joint Economic Committee



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                        JOINT ECONOMIC COMMITTEE


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


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

                              ----------                              


                     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

                              ----------                              


                        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.