[Senate Hearing 109-695]
[From the U.S. Government Publishing Office]
S. 109-695
STATE OF THE ECONOMY AND BUDGET
=======================================================================
HEARINGS
before the
COMMITTEE ON THE BUDGET
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
----------
September 28, 2006--THE STATE OF THE ECONOMY AND BUDGET
Printed for the use of the Committee on the Budget
THE STATE OF THE ECONOMY AND BUDGET
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COMMITTEE ON THE BUDGET
JUDD GREGG, New Hampshire, Chairman
PETE V. DOMENICI, New Mexico KENT CONRAD, North Dakota
CHARLES E. GRASSLEY, Iowa PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado PATTY MURRAY, Washington
MICHAEL ENZI, Wyoming RON WYDEN, Oregon
JEFF SESSIONS, Alabama RUSSELL D. FEINGOLD, Wisconsin
JIM BUNNING, Kentucky TIM JOHNSON, South Dakota
MIKE CRAPO, Idaho ROBERT C. BYRD, West Virginia
JOHN ENSIGN, Nevada BILL NELSON, Florida
JOHN CORNYN, Texas DEBBIE STABENOW, Michigan
LAMAR ALEXANDER, Tennessee ROBERT MENEDEZ, New Jersey
LINDSEY O. GRAHAM, South Carolina
Scott Gudes, Majority Staff Director
Mary Naylor, Staff Director
(ii)
C O N T E N T S
__________
HEARINGS
Page
September 28, 2006--The State of the Economy and Budget.......... 1, 71
STATEMENTS BY COMMITTEE MEMBERS
Chairman Judd Gregg.............................................. 1, 8
Ranking Member Kent Conrad....................................... 9, 23
WITNESSES
Edwards, Chris, Director of Tax Policy Studies, CATO Institute...72, 75
Hassett, Kevin, Director of Economic Policy Studies, American
Enterprise Institute...........................................59, 62
Lazear, Edward, Chairman, Council of Economic Advisor............25, 32
Orszag, Peter, Deputy Director of Economic Studies, Brookins
Institute......................................................83, 86
HEARING ON STATE OF THE ECONOMY AND BUDGET
----------
THURSDAY, SEPTEMBER 28, 2006
U.S. Senate,
Committee on the Budget,
Washington, DC.
The Committee met, pursuant to notice, at 9:58 a.m., in
room SD-608, Dirksen Senate Office Building, Hon. Judd Gregg
(Chairman of the Committee) presiding.
Present: Senators Gregg, Alexander, Grassley, Allard,
Conrad, Sarbanes, and Murray.
OPENING STATEMENT OF CHAIRMAN GREGG
Senator Gregg. I believe we are going to get started even
though it is a few minutes early, if that is agreeable to
Senator Conrad.
We appreciate Dr. Lazear coming today and we appreciate the
other witnesses who are on our second panel joining us. I would
at the opening make the point that, unfortunately, we did not
receive Dr. Lazear's statement until just a few minutes ago.
That is unfortunate, because the Democratic membership has a
right to the statement 24 hours before the hearing, and the
Administration really doesn't do itself any good by not getting
those statements up here in a timely manner. It is really
unfair to the minority not to get them.
So I would hope that this would not be a recurring event,
and on behalf of at least the majority of the Senate, we
apologize to the minority for not having the statement.
Senator Conrad. Mr. Chairman, might I inquire? What is the
rule of the Committee with respect to testimony before the
Committee?
Senator Gregg. I believe it has to be filed 24 hours before
the testimony is presented. Is that correct? You probably know
more than I do.
Senator Conrad. I think that is the rule, and what is the
consequence for a failure to adhere to the rule?
Senator Gregg. I have no idea.
Dr. Lazear. The consequence is the dissolution of the
hearing, if I am not mistaken.
Senator Gregg. The problem would be then we would never get
anybody to testify. They would never send in their testimony.
Senator Conrad. It may be a valuable lesson to send if we
are going to have these hearings and they are going to be
meaningful. I have not had a chance to read three paragraphs of
the testimony before we hear it here, which makes it difficult
to prepare questions, makes it difficult to prepare a response.
I am not going to insist on imposing the rule here, but I would
send a message that I may not always be so tolerant.
I think we have the rule for a reason and it is a good
reason. So we will go forward. I thank the chairman for his
explanation of the situation as well.
Senator Gregg. I appreciate it and I appreciate the Senator
allowing us to go forward, because I think it would be within
his rights to state that the hearing shouldn't go, and that
would mean we wouldn't be able to give opening statements,
which would mean we would miss potentially thousands of charts.
We do appreciate the minority's allowing us to move forward and
waiving that right.
I want to start my opening statement and talk a little bit
about what this hearing is about, which is the state of the
economy, specifically the effect on the economy of the tax cuts
which were put in place by this Administration. There has
obviously been a lot of representations of what these tax cuts
have and have not done, and I am sure the Senator from North
Dakota will have a differing view than I do, but if we look at
the facts on the ground, and maybe we can put the first chart
up, the economic growth, we have seen now 18 consecutive
quarters of economic growth, significant economic growth. This
came in light of a period when this Administration came into
power, came into office, that was extremely disruptive for our
economy. We have had the internet bubble, which burst which was
a dramatic event economically in and of itself and should have
led to a severe recession. We had the attack of 9-11, which was
a hugely disruptive event to our culture and to our economy.
And those two things coupled together, basically in a regular
economic cycle would have led, I believe, to a very dramatic
and significant decline in the economy and recessionary event
of significant proportions.
[GRAPHIC] [TIFF OMITTED] 30816.064
What happened, however, was that because we put tax cuts
into place, actually at the right time, which was right at the
beginning of this Administration and before 9-11, some of them
anyway and some right after, that we were positioned to give
the economy some lift through tax incentives and create an
atmosphere for more entrepreneurship and more investment, and
as a result, it created more jobs. In fact, over that period,
we have created 5.7 million jobs just in the last 36 months.
That is pretty significant, 5.7 jobs as this chart would show.
That is a pretty significant increase in the number of jobs.
[GRAPHIC] [TIFF OMITTED] 30816.065
The practical effect of that, however, is even more
important, because not only does it give people jobs, what the
practical effect of making these tax cuts has been has been
that revenues have jumped radically over the last 2 years,
especially as the economy has recovered. We have seen the two
largest increases in years of revenue increase in our history,
and the effect of that revenue increase has been that the
deficit has dropped significantly, down from an estimated 450
billion, approximately, to about 270 billion, depending on
where we end up this year. That is because the economy is
moving aggressively forward. People are working and people are
investing and there is a tax atmosphere out here which
encourages that.
[GRAPHIC] [TIFF OMITTED] 30816.094
Now, some have said that during this period, there has been
less of a wage growth. Actually, real compensation under this
timeframe has exceeded the same type of period under President
Clinton's timeframe. Real compensation is a function not only
of actual wages, but it is a function of benefit structure.
[GRAPHIC] [TIFF OMITTED] 30816.095
In addition, some have said that these tax cuts have
inordinately benefited the wealthy. Well, the numbers don't
support that either. In fact, these tax cuts have benefited
dramatically all Americans by generating more economic activity
and more revenue to the Federal Government, and the wealthy in
this country are now bearing a higher percentage of the tax
burden, income tax burden, than those people bore during the
years of the Clinton years. People in the high income brackets
are paying almost 85 percent of the tax burden today, 85
percent.
[GRAPHIC] [TIFF OMITTED] 30816.076
Do you have the comparison of the Clinton years?
During the Clinton years, the people in the high income
brackets bore about 81 percent of the tax burden. Today, people
in high income tax brackets are bearing 85 percent of the tax
burden.
Why is that? It is very simple. When you make taxes fair,
people invest in activity that is taxable. When taxes are
excessively high, people avoid taxes. High income people know
how to avoid taxes. They invest in shelters, basically, in
various vehicles that will keep them from having to bear a tax
burden that they consider to be too high. When you make the tax
burden reasonable, they are willing to take the cost of that
tax burden as a cost of doing whatever their investment is.
So the Federal Government receives more revenue. It is a
very simple function of human nature, and it is reflected
dramatically in these figures, which show that under the
President's tax cuts, we actually now have high income
taxpayers in this country bearing a larger percentage of the
cost of income taxes than they did under the Clinton
Administration.
In addition, another interesting fact is that under the
Bush tax cuts, low income taxpayers, and that was the chart
that was up there before, are actually receiving--low income
taxpayers, the people in the bottom 20 percent, don't actually
pay taxes on the whole, income taxes. They receive earned
income tax credits, basically, which is a payment to them, and
then actually that has increased also under this Presidency. So
the people in the lowest quadrant of income are receiving more
back in benefit than they did in the Clinton years. People in
the highest quadrant of income are paying more as a percentage
of the burden of taxes than they did in the Clinton years.
[GRAPHIC] [TIFF OMITTED] 30816.074
So we have actually, by cutting tax rates and making them
fair and getting people to do more economic activity and
generate more revenue for the Federal Government and at the
same time generating more taxes being borne by high income
people because they are not avoiding taxes, we have actually
made the tax laws in this country significantly more
progressive than they were under the Clinton Administration.
Now, that is counterintuitive to the ``New York Times'', but it
is the fact. The simple fact is that by reducing taxes and
making them fair, we have created an atmosphere where high
income people are picking up more of the tax burden, low income
people are getting more back out of the Federal Government, and
we have created more jobs, more revenue, and more economic
activity than any time in our history.
That is all pretty good news, and I know my colleague from
North Dakota will have a different take on this, but those are
the facts and they are pretty good facts. So I will yield at
this time to my colleague for his perception.
[The prepared statement of Senator Gregg follows:]
[GRAPHIC] [TIFF OMITTED] 30816.063
OPENING STATEMENT OF RANKING MEMBER KENT CONRAD
Senator Conrad. Well, I enjoyed this presentation very
much. They are facts, but I would say highly selective and
leave out a lot of things, and now for the rest of the story.
First of all, I always enjoy these hearings and I
appreciate the chairman calling this one, because this really
is an important discussion for us to have. Let us go back in
history and recall what occurred. It was not the case in 2001
that you were for tax cuts and we were against tax cuts. In
fact, the proposal that I put before our colleagues was for 900
billion of tax cuts. The President proposed about twice as
much.
So the question was, first of all, the size of the tax cuts
and what kind of tax cuts should there be. The tax cuts the
President advocated were much larger in amount, and the
President's tax cuts were much more heavily skewed to the
wealthiest among us. The tax cuts that we proposed on our side
were more affordable, and certainly in light of history, that
is clearly the case, and they were also geared to the middle
class. I would argue that is where we get the biggest bang for
the buck.
The second question is the revenue chart that the chairman
put up, talking about revenues I don't know if you put up a
chart or just talked about revenues going up, but the rest of
the story here is what happened to real revenues adjusted for
inflation since 2000: The fact is we are just now getting back
to the real revenues that we had in 2000. There hasn't been
some giant run-up in revenue. Please. The last few years,
revenue has gone up, but from a very low base, much lower than
the revenue that we had in 2000.
[GRAPHIC] [TIFF OMITTED] 30816.081
So this talk about a dramatic rise in revenues, please. The
fact is we are just now getting back to the real revenues we
had 7 years ago.
Let us go to the question of deficits. The chairman talked
about big improvements in deficits; well, yes, a big
improvement from the worst deficits we have ever had. You know,
2 years ago, the deficits were higher than they are now. They
were the highest they have ever been, but compared to 6 years
ago when we had surpluses, these deficits are terrible, and the
deficits understate the seriousness of the situation.
[GRAPHIC] [TIFF OMITTED] 30816.082
Well, just to make the point, the first year of this
Administration where they inherited the fiscal policies of the
previous Administration, we had a surplus. Now with the fiscal
policies of this Administration, we have run up four of the
largest deficits in the country's history, and the deficit
substantially understates the red ink, because while the
deficit is projected to go up by 260 billion dollars this year,
the debt is going to increase by $560 billion dollars. When you
measure that against GDP, we find that we are over 4 percent of
GDP, debt increasing by over 4 percent of GDP.
[GRAPHIC] [TIFF OMITTED] 30816.083
Let us go to the next chart. Just visually, here is what is
happening to the debt of the country under the policies of our
colleagues on the other side under this Administration: The
debt at the end of the President's first year--we don't hold
him responsible for the first year--was 5.8 trillion dollars;
at the end of this year, eight and a half trillion dollars, and
if we follow the President's plan, 11.6 trillion dollars 5
years from now. That is about a doubling of the debt of the
country and at the worst possible time, right before the baby-
boomers retire.
[GRAPHIC] [TIFF OMITTED] 30816.084
Let us go to the next slide if we could. I asked my staff
to go out and look and find out how much borrowing this country
is doing in comparison to other countries, and here is what we
found: In the last year, according to the International
Monetary Fund, we borrowed 65 percent of all the money that was
borrowed by countries in world, 65 percent. That is utterly
unsustainable. That is what the Controller General of the
United States is telling us, this is an unsustainable path, and
indeed it is. The next biggest country, by the way, in terms of
borrowing was Spain at 6.8 percent, one-tenth of the borrowing
that we are doing.
[GRAPHIC] [TIFF OMITTED] 30816.085
Now let us go to the next one. The ``Wall Street Journal''
of yesterday had this warning from the Economic Forum: ``The
Economic Forum warns that the U.S. has budget deficits that
will bring ill effects.'' And it reads: ``The U.S.'s huge
budget deficit threatens to make the country's economy less
competitive according to the study by the World Economic Forum.
The institute's annual study of global competitiveness says the
U.S. economy is the sixth most competitive in the world,
slipping from first place last year.'' So we slipped five
places in a year. ``Slipping from first place to last in last
year's ranking, a result of mediocre scores from its public
financing.''
They went on to say: ``Serial budget deficits in the U.S.
have lead to rising public debt, which means an increasing
portion of government spending goes toward debt service. That
means less money available for spending on infrastructure,
schools, or other investments that could boost productivity.
Heavy government borrowing, which means competing for money in
financial markets with the private sector, also tends to drive
up businesses' borrowing costs.''
[GRAPHIC] [TIFF OMITTED] 30816.086
Let us go to the question of jobs, the jobs chart if we
could. There is a lot of talk about jobs and how the economy is
improving. The fact is 74 percent of people in this country
believe that jobs are not plentiful or are hard to get. Only 26
believe that jobs are plentiful. That is according to the
Conference Board.
[GRAPHIC] [TIFF OMITTED] 30816.087
Let us go to the next. Consumer confidence has never
recovered under President Bush. In January 2001 when he took
over, consumer confidence was 115.7, again according to the
Conference Board. Now in September of this year, it is 104.5.
That is almost a 10 percent decline. If we compare job creation
under this Administration to the previous Administration for
the first 67 months, we see under the Clinton Administration,
16.6 million jobs were created. Under this Administration for
that same period, 67 months, three million jobs have been
created, about one-fifth of the jobs created, actually less
than one-fifth of the jobs created under the Clinton
Administration in its first 67 months.
[GRAPHIC] [TIFF OMITTED] 30816.088
[GRAPHIC] [TIFF OMITTED] 30816.089
What is most interesting, of course there have been jobs
created now that we are in an economic recovery. That always
happens. What is the real test is how does this recovery
compare to previous recoveries, and by that standard, what we
see is job creation is lagging far behind the average of all of
the major recoveries since World War II. We have had nine major
recoveries since World War II. The pattern of average job
creation is the red line. The black line is job creation in
this recovery, and this recovery is running 6.7 million private
sector jobs short of a typical recovery. Something is wrong.
[GRAPHIC] [TIFF OMITTED] 30816.090
Let us go to the next. Business investment, again looking
at the typical recovery, the average of the nine previous
recoveries since World War II is the dotted red line. This
recovery is the black line. On business investment, we are
running 72 percent behind the typical recovery since World War
II. Something is wrong.
[GRAPHIC] [TIFF OMITTED] 30816.091
Real GDP growth lags behind the typical recovery as well.
The average in the nine recoveries since World War II, GDP
growth of 3.2 percent; this recovery, 2.8 percent.
[GRAPHIC] [TIFF OMITTED] 30816.092
Let us go to median household income. Median household
income in 2000 was $47,599; this year, $46,326. So real median
household income has declined by almost $1300.
[GRAPHIC] [TIFF OMITTED] 30816.093
Look, this recovery--the facts I think are very clear--is
not performing as previous recoveries have, No. 1. No. 2, we
are running up debt at an alarming rate. It took 42 Presidents
224 years to run up a trillion dollars of debt held by
foreigners, U.S. debt held by foreigners. This President has
more than doubled that amount in just 5 years. This is an
utterly unsustainable course, and the question is what are we
going to do about it.
I would suggest to my colleagues neither party can do this
job alone. What we really require is a bipartisan comprehensive
plan to get this country back on track, and I know my
colleague, the chairman, is interested in that approach. I
certainly am, and I hope we can get to it.
I thank the chairman.
[The prepared statement of Senator Conrad follows.]
[GRAPHIC] [TIFF OMITTED] 30816.078
[GRAPHIC] [TIFF OMITTED] 30816.079
[GRAPHIC] [TIFF OMITTED] 30816.080
We will go to Dr. Lazear.
STATEMENT OF EDWARD P. LAZEAR, CHAIRMAN, COUNCIL OF ECONOMIC
ADVISERS
Mr. Lazear. Thank you very much, Chairman Gregg, Ranking
Member Conrad, and Members of the Senate Budget Committee. Good
morning and thank you for giving me the opportunity to speak
with you about the economy and its relation to tax revenues and
the budget.
I would like to begin by summarizing the economy, where we
are right now and where I believe that we are headed. The
economy is strong, in part as a reflection of pro-growth tax
policies. Revenues are up and the deficit is shrinking at a
rapid rate.
Some specifics: Real growth of GDP was 3.1 percent over the
three quarters of 2005. Although it now appears that GDP growth
in the current quarter will be significantly slower than in the
first half of the year, the current forecast indicates that
growth in 2006 will remain about the same as it was last year
and the economy should continue to grow at a robust pace in
2007 and beyond.
Job growth has been strong. The economy has been producing
roughly one and a half to two million jobs per year for a total
of 5.7 million additional payroll jobs since August of 2003. We
expect that trend to continue with some slight moderation.
The unemployment rate, which was 5.1 percent in 2005, is
expected to average 4.7 percent for 2006. The most recently
released jobs report shows that the unemployment rate declined
to 4.7. Additionally, it revealed an increase of 128,000
payroll jobs in August. The continued increase in payroll jobs,
even in an environment with low unemployment rates, suggest
that the labor market continues to be strong and that its
tightness will be reflected in more wage growth as we move into
the coming months.
Nominal wage growth has accelerated over the past year, and
at an annualized rate, it has been 4.1 percent since January of
2006. As I will discuss shortly, this follows the typical
business cycle pattern of productivity increasing, leading to
wage increases with a lag. What distinguishes this period from
the past is that recent large and unanticipated increases in
energy prices have consumed much of the strong nominal wage
growth. Workers' paychecks have gone up, but they have had to
use a portion of that increase for higher energy costs, such as
gasoline and heating fuel.
The increase in the price of gasoline and oil products has
been one of the most notable changes in our economy during the
past year. Since the beginning of August, we have experienced
substantial declines in the price of gasoline and crude oil.
Declines in energy prices are already apparent in the latest
inflation data. Markets are expecting inflation rates going
forward to moderate to around 2.5 percent. This coupled with
continuation of high wage growth should translate into
increased real earnings for the typical worker next year.
The President's goal of cutting the deficit in half by
2009, which drew the scoffs of many, is now likely to be
reached before that date.
One soft spot in the economy is the housing market. It is
important to note, however, that the weakness in the housing
sector does not seem to be spreading to other sectors of the
economy, and recent consumer surveys indicate improving
expectations.
In sum, we expect the average growth rate for this year
will be similar to that for last year. The economy continues to
be robust and healthy.
Underlying these strong numbers is high productivity growth
that has made our economy the strongest and most robust in the
world. It is the common thread that ties together all of the
positive economic news. Productivity growth is closely
associated with economic growth and results in higher worker
compensation and improved living standards. It moderates
inflationary pressure and has proved to be a defining
characteristic of our economy.
[GRAPHIC] [TIFF OMITTED] 30816.055
Figure 1 puts out recent productivity growth in a
historical perspective. The BLS reports that U.S. productivity
growth since the end of 2000 has been 3 percent per year,
outpacing the 2.7 percent average from 1996 to 2000. The
current growth rate in productivity is substantially above that
for the 22-year period that preceded 1995 when productivity
growth averaged only 1.5 percent per year.
Productivity growth is important because it is the basis
for the growth in hourly worker compensation. Figure 2 shows
the relationship. The chart demonstrates the very strong
correlation between productivity increases and improvements in
real hourly compensation. The red line and blue line move
together over any reasonable period of time.
[GRAPHIC] [TIFF OMITTED] 30816.056
A number of observers have pointed out that profits have
grown at a very high rate during this recovery, which is
reflected in Figure 3. The red line is showing that profits
grew at a high rate over the past 3 years. There is a distinct
pattern of profits and employee compensation over the business
cycle. After the recession in the early nineties, corporate
profits rose dramatically and employee compensation lagged
behind. At the same time, productivity grew faster than
compensation.
[GRAPHIC] [TIFF OMITTED] 30816.057
Profit growth outpaced compensation growth until the latter
part of the nineties when corporate profits fell dramatically.
Note that corporate profits actually declined during most of
the period between early 1998 and late 2001.
Just as in the 1990's, the mild recession in 2001 was
followed by productivity growth in 2002, and profit growth was
again very high while employee compensation growth was
relatively low. The pattern that we observed in the past two
recessions and recoveries is evident in earlier recessions as
well going back at least 40 years. The pattern typically works
in the following way: After a recession, productivity growth
increases and hourly compensation tends to remain flat. As a
result, costs stay low and profits rise. As the labor market
gets tight, unemployment rates fall, hourly compensation
increases faster than productivity growth, and so total costs
rise faster than earnings. The result is that labor costs go up
faster than the profit rate, and then the profit rate declines
to more normal levels.
Profits are important because they provide the incentive
for investment in physical capital, and physical capital growth
contributes to productivity growth. With rising compensation,
we forecast that profit rates will decline in the future, but
that this decline will bring them back to normal levels, and so
profit rates will be sufficient to motivate the high levels of
investment necessary to grow our economy.
Whether real growth compensation growth will rise to the
highest levels that we have seen over the previous expansions
remains to be seen, but early indications are that we are on a
similar path.
Tax cuts passed by President Bush and the Congress have
helped the economy grow. Probably most significant was the cut
in dividend and capital gains taxes enacted in 2003. However,
the lowering of marginal tax rates on earned or labor income
was also an important contributor to economic growth.
As budget directors and members of any budget committee
surely know, government revenues tend to move directly with the
state of the economy. When the economy is good, revenues come
in at high rates, and when the economy declines, revenues
decline correspondingly. The period since 2003, which has seen
a growing economy, has also been one which during which
government revenue have increased at high rates. Since 2003,
government revenues are up 34.6 percent and the projected
growth of revenues from 2005 to 2006 is around 11 percent.
Because of this rapid economic growth-together with the
continued efforts of Congress and the President to effect
discretionary spending restraint, the budget deficit is
declining at rates much faster than was anticipated, and we are
on the path to meeting the President's deficit goals ahead of
schedule.
To determine the effect of tax cuts on revenue, we need to
ask what revenues would have been absent these tax cuts. This
question can be answered by providing estimates of what the
revenue would have been had we not had cut taxes. An exercise
of this sort can be done in a number of different ways, and we
recognize the inherent uncertainty associated with the
calculations.
[GRAPHIC] [TIFF OMITTED] 30816.058
In Figure 4, we provide a simple comparison using
historical data showing the path of revenue growth in this
business cycle compared to previous cycles. The solid red line
shows what happens during the current cycle's recovery,
similarly indexed, by way, with a trough in 2002, compared with
previous patterns. With the tax cuts that were enacted in 2003,
receipts were below the average of previous recoveries. These
lower revenues persisted through 2005. But more important than
the level is the growth rate.
Because of the growing economy, which we believe was
stimulated at least in part by the tax cuts and growing taxable
income, preliminary data suggests that revenues grew between
2004 and 2006 at rates higher than were experienced in earlier
recoveries. More refined estimates will be possible when the
tax return information for 2006 is available.
Will the tax cuts pay for themselves? As a general rule, we
do not think that tax cuts pay for themselves. Certainly, the
data presented above do not support this claim. Tax revenues in
2006 appear to have recovered to the level seen at this point
in previous business cycles, but this does not make up for the
lost revenue during 2003, 2004, and 2005. The tax cuts were a
positive step and they have contributed to the enhanced
economic growth, additional jobs, higher real disposable
income, and low unemployment rates that we currently see today.
Our goal is not to maximize the size of government by
generating as much tax revenue as possible, but instead to
provide the revenues necessary to make sure that we can operate
those programs that society deems necessary while at the same
time allowing the private sector to take full advantage of its
growth potential.
[GRAPHIC] [TIFF OMITTED] 30816.059
It is also worth noting that because our revenues are
growing at such high rates now relative to spending, the ratio
of public debt to GDP, which most economists view as the best
indication of our long-run budget situation, is expected to
decline this year. Not only is our debt-to-GDP ratio improving
as a result of our high economic growth and enhanced revenues,
but it is also very close to our 40-year historical average and
lower than at any point in the 1990's.
As a result, our debt situation is favorable relative both
to its past and to the debt situation of other industrialized
countries. This should not be taken as a reason to be
complacent. Indeed, the opposite is true. If we cannot control
our spending both on the discretionary and entitlement sides of
the budget, the pattern we are seeing in the current year could
easily reverse and we could find ourselves in a debt situation
that requires higher and higher interest rate payments relative
to our GDP in the future. This is not a burden that we want to
pass on to our children and grandchildren.
Where do we go from here? I believe it is important to
maintain a positive economic climate so that the labor market
will remain strong, workers can find jobs quickly, and so that,
coupled with declining energy prices, the typical worker's
paycheck will buy more and more goods and services. The best
way to do this is to keep our taxes low, to adopt more pro-
growth tax policies, and to remain open to international trade
and capital flows as well as keeping our economy among the most
flexible in the world.
Thank you for giving me the opportunity to speak to you
today, and I welcome your questions.
[The prepared statement of Mr. Lazear follows:]
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Senator Gregg. Thank you, Doctor.
I am going to reserve my time until the end of the
questioning period, because we have a number of Senators here.
I want them to get their points in.
So let us start with Senator Alexander for the first
questions.
Senator Alexander. Thank you, Mr. Chairman, for your
courtesy.
Senator Gregg. Thank you for coming.
Senator Alexander. In the President's State of the Union
Address, he proposed the American competitive initiative, which
included a proposal to double the Federal investment of basic
research over 10 years and to improve the teaching in math and
science structure so we can keep our edge in science and
technology. A number of Senators, actually 70, 35 Democrats and
35 Republicans, have sponsored similar legislation this year.
Last Tuesday, Senator Frist and Senator Reid, the Republican
leader and the Democratic leader, introduced a comprehensive
piece of legislation that took the President's proposal, all
the various Senators' proposals, and worked it through three
different committees. It was a very remarkable piece, a pretty
good start on competitiveness.
I note that in July, the President of China, Mr. Hu, went
to the Great Hall of the People and assembled the whole
Government of China, Communist Party leaders, his Academy of
Sciences and Engineering, and committed that country to a 15-
year plan to make it a nation of innovation, including
investments in research, remodeling universities, improving
``K'' through 12, and recruiting outstanding scientists from
the United States and back to China to help grow jobs.
So my questions are about this: We talk about pro-growth
policies and we often talk, at least on our side of the aisle,
about tax cuts. I agree those are pro-growth policies. Do you
agree that investments in keeping our edge in science and
technology are also pro-growth for our economy, and do you
expect the President and the Administration to get behind the
Frist-Reid legislation, which can't pass this week, but would
have a very good opportunity, given its broad support, to pass
the Senate in November and then a chance to pass the House in
this Congress?
Mr. Lazear. Thank you. We certainly agree that investment
in education, science, education specifically, but education in
general, is a very high rate of return investment. When we look
at the kinds of things that an economy can do to grow
productivity, to grow GDP, to grow wages, investments in human
capital come in at or near the top. If you look across the
world and you ask which economies are growing, which ones are
progressing at the highest rates, which ones are bringing their
poor into the middle class, they are the economies that have
the highest levels of education. They are the ones that are
making the biggest investment in education.
So I fully subscribe to your view that education and
investing in skills in general is probably one of, if not the
most, important things that we can do to grow the economy. It
certainly has been something that has been on the President's
mind since he began his Administration. ``No Child Left
Behind'', of course, was one of his initial endeavors, and I
think it is a step in the right direction, obviously not the
only step that one needs to take, but I am completely with you
in terms of the importance of the investment.
Senator Alexander. I bring it up this morning because this
is one of those rare occasions where this is not a Republican
bill that was offered to the Democrats which they then amended
or vice versa. This was actually a piece of legislation that
probably two dozen Senators of both parties worked on together
with the Administration about which there is unanimous support
and there is an opportunity for the Administration, if it makes
it a priority in the next few weeks, to make it happen.
One other question: I was listening to the Senator from
North Dakota's comments about the dire straits of the economy.
I asked the International Monetary Fund to give me some
information about the United States' position in the world in
terms of Gross Domestic Product, and they gave this fact: They
said in 1995, the United States produced about 25 percent of
all the Gross Domestic Product in the world for about four or 5
percent of the people, which is our population. Last year,
2005, the United States produced 28 percent of all the world's
Gross Domestic Product for about four or 5 percent of the
people.
Now we hear all these claims that the economy is bad and
jobs are going down and things are terrible, but if those
figures are true, does that not mean that the United States is
not only remarkably rich in terms of Gross Domestic Product,
but over the last 10 years, we have gotten richer even at a
time when China and India and other parts of the world are
growing and Europe is trying to do better? How would you
characterize that growth in our share of the Gross Domestic
Product over the last 10 years?
Mr. Lazear. Yes, sir. I certainly agree that we have had
very strong economic growth. If we compare the United States to
the other G-7 countries, which is usually the comparison that
we think is probably most appropriate, because then we are
talking about countries at a similar standard of living, the
United States is the leading country right now. I always view
that as particularly remarkable, because it is easier to have
high growth rates when you are catching up than it is to have
high growth rates when you are the leader.
If there are other economies that you can mimic, if there
are other economies to which you can converge, that is an
easier task than pushing out the frontier. Our economy has been
particularly successful at pushing out the frontier. I believe
that that is attributable in large part to the flexibility of
the economy, to the fact that we allow for very strong markets,
for essentially unimpeded capital movements, labor markets are
flexible, and very strong entrepreneurship, which I think is an
absolute key to the growth that we see in the United States. We
have rapid and relatively easy business formation in this
country, and that is an important component of our economic
growth.
So those are all very positive features.
Senator Alexander. Thank you, Mr. Chairman.
Senator Gregg. Thank you.
Senator Conrad.
Senator Conrad. Mr. Chairman, I wanted to take a moment, if
we could, because this is going to be Senator Sarbanes' last
hearing in the Senate Budget Committee, and I think we need to
take a moment and reflect on his contributions not only to this
committee, but to the Senate.
Last night, we had a dinner which we recognized the four
members who are retiring this year, Senator Sarbanes being one
of the four. I want to say that I am going to miss Senator
Sarbanes. There has been a no more valuable member on this
committee to me than Senator Sarbanes. He is truly a remarkable
man, not only highly intelligent, but wise and of an
extraordinary good nature.
I note that his wife, Christine, is here. Christine, it is
good to see you as well. The Sarbanes couple are truly a team,
and I have had a chance to travel with them, to get to know
their family. They are really an extraordinary couple and we
deeply appreciate their contribution to this committee and to
the U.S. Senate and to our country.
My favorite story about Senator Sarbanes was told last
night, that he was selected when he was still in high school,
about to graduate from high school, as an all-star and was to
play in an all-star game in Baltimore, and he was to be the
starting shortstop. He went to the game and they had
preparations before the game, and the coach put him at second
base. Paul went to the manager and inquired, you know, I had
been selected for the game as a shortstop, and the coach kind
of put him off and kept putting him at second base, and he went
back to the coach and said, You know, again, I was chosen to be
the shortstop, and the coach finally said to him, Look,
Sarbanes, you are going to play second base; I am playing
Kaline at shortstop. Of course, the Kaline was Al Kaline, one
of the greatest baseball players of all time. You know,
sometimes you draw the short straw.
Senator Gregg. I think Senator Bunning struck Al Kaline out
three times that day.
Senator Bunning. And he was on my team.
Senator Conrad. I think Al Kaline went to the Major Leagues
when he was 18 or 19 years old.
Senator Bunning. Seventeen.
Senator Conrad. Seventeen years old.
So, Paul, you know, maybe you could have had another
career, a parallel career, one in the Major Leagues. Paul, we
are truly going to miss you, and I am going to miss you very,
very much, both as a friend and a colleague.
Senator Gregg. Let me join you, Senator Conrad, in those
thoughts and echo them. Obviously, Paul has been an immense
person in the Senate for many, many years and a brilliant
contributor to our activities. I am going to miss him too,
although I am not going to miss his amendments. I used to
cringe whenever he came to a markup, because I knew his
amendments were just going to be terrorizing us. He will be
missed immensely because he has been a force for positive and
good government, and that is what it is all about.
Senator Sarbanes. Well, thank you. I very much appreciate
the very generous comments of the chairman and of my good
friend, the ranking member. Thank you very much for that.
Senator Conrad. Christine, thank you so much.
And I will defer to Senator Sarbanes for any questions he
may want to ask of the witness.
Senator Sarbanes. Mr. Chairman, I will be very brief, but
having heard Senator Conrad say I am good natured, I don't want
to counter that.
Mr. Lazear, what is the view down at the Council of
Economic Advisers? And I understand the chairman and ranking
member touched on this before I got here, but I was planning to
raise it myself. What is your view down there about getting
this testimony to the committee in accordance with our rules
ahead of time, which of course then gives us a better
opportunity to prepare substantively for the hearing? This
isn't the first time this has happened. Is the CEA operating on
a different premise or assumption than the committee is
operating on and, if so, we need to know that, and if not, why
aren't you measuring up to standard?
Mr. Lazear. I will just simply apologize to you, Senator,
and say that it is the first time on my watch and we will check
into it in the future. So you do have my apologies for that
mishap.
Senator Sarbanes. I think I am correct in saying, though,
that it has occurred previously. It now seems to be becoming
standard operating practice at the CEA.
Mr. Lazear. If so, as I said, I don't know about that. I am
relatively new to the CEA, but we will check into it.
Senator Sarbanes. Well, I wish you would do that. I mean, I
think it is a good rule and it is there for obvious reasons,
and most witnesses, at least, comply with it, and I think in
some respects, there is probably more excuse for someone from
the private sector who isn't equipped maybe to produce the
statement the same way as the Council.
While I have you, let me ask you is the Council still out
in the hinterlands in terms of its location? You are no longer
in the Executive Office Building; is that right?
Mr. Lazear. Most of us are not. We do have an office in the
Executive Office Building that we retain. As you probably know,
after 9-11, two-thirds of EEOB was shut down for remodeling,
most of which was security related, and so most of the people
in that building were moved out to neighboring offices, and we
have an office about a block down the street from the EEOB, and
it requires a bit of commuting between the two, but we have
managed to do it.
Senator Sarbanes. Do you have an assurance that you are
going to go back into that building once the remodeling is
complete, or has, in effect, the banishment of the CEA from the
immediate policy confines of the White House been accomplished?
Mr. Lazear. I expect that we will go back, but,
unfortunately, it looks like the remodeling will take us at
least until 2009, probably 2010, possibly 2011. So a promise
from this Administration, unfortunately, would not be worth a
whole lot in terms of committing future Administrations to
moving us back.
Senator Sarbanes. That is like those promises we got from
the President about the deficit early on in the first term of
the Administration. They weren't realized either. Correct?
Mr. Lazear. Well, as I testified earlier, you know, the
deficit numbers have been looking much better than we expected,
and they are moving in the right direction.
Senator Sarbanes. I will spare you quoting the President's
statements during the course of his first term about what was
going to happen to the deficit. Senator Conrad has done a
first-rate job of outlining that problem.
The Federal revenues are what share of the GDP now?
Mr. Lazear. The deficit? I am sorry.
Senator Sarbanes. No. The revenues.
Mr. Lazear. The deficit is approximately 2 percent.
Senator Sarbanes. No. The Federal revenues.
Mr. Lazear. Revenues are about--it would be about 10
percent.
Senator Bunning. No. You have got the wrong question.
Senator Gregg. I think you said what percent of GDP are the
Federal revenues. I think they are about 18.1 percent right
now.
Mr. Lazear. Oh, I am sorry. Revenues are actually above
that. I think we are at 18.2 percent right now.
Senator Gregg. The average?
Mr. Lazear. I am sorry. I misunderstood your question,
Senator. The average, depending on which period you look at, is
about 18.1 percent.
Senator Sarbanes. The chart you showed had revenues back up
at the line recovering. You know that chart you put up there?
Mr. Lazear. This one?
Senator Sarbanes. Yes. That figure in 2006, that would be
at 18 percent of GDP; is that correct?
Mr. Lazear. Actually, that would be using the numbers from
the mid-session review, which is consistent with a $300 billion
deficit. So that is what this number is based on.
Senator Sarbanes. I want to know what percent of GDP is
Federal revenue.
Mr. Lazear. I believe that is 18.2 at that point.
Senator Sarbanes. And back when you started, what it was
it?
Mr. Lazear. Which year, sir?
Senator Sarbanes. 2000.
Mr. Lazear. In 2000, let us see. Do we have that number
here? We can get that number for you. Bear with me for a second
and I will get you the exact number.
Senator Sarbanes. I don't want to impose on my colleagues.
Let me ask you this.
Mr. Lazear. Yes, sir.
Senator Sarbanes. A 1 percent increase in the share of the
GDP in Federal revenues would be worth how much money?
Mr. Lazear. A 1 percent increase of GDP?
Senator Sarbanes. No. Of revenues as a share of GDP, a one
point increase. If it was 19 percent instead of 18 percent, how
much more revenue is that?
Mr. Lazear. About $130 billion, because GDP is 13 trillion,
approximately. So you are talking about 1 percent of that
number, sir.
Senator Sarbanes. Yes. So if it was 2 percent, we would be
close to wiping out the deficit; is that correct, if you added
two points?
Mr. Lazear. That is right.
Senator Sarbanes. What was it back in 2000?
Mr. Lazear. Let me see if I can find that for you. I have
to get my glasses. Pardon me, sir.
OK, 2000 was 20.9.
Senator Sarbanes. So if we were not even at that level, but
somewhere near that level, we would have eliminated the
deficit. Correct?
Mr. Lazear. Well, that assumes that the economy would be
the same. Your assumption is that GDP would be the same and
that we would simply take 20.9 percent of the GDP number that
we have right now. I would not be willing to make that
assumption.
Senator Sarbanes. OK. As a calculation, that would be
correct, would it not?
Mr. Lazear. Again, sir, if you assume that GDP was the
same, then that calculation would be correct.
Senator Sarbanes. Thank you, Mr. Chairman.
Senator Gregg. Our resident all-star Hall-of-Famer, Senator
Bunning.
Senator Bunning. Thank you very much, Mr. Chairman.
In all the charts and figures that the gentleman from North
Dakota showed, there was no inclusion of 9-11, no inclusion of
the Afghan War, no inclusion of the Iraqi War, no inclusion of
Hurricane Katrina or Rita. The income levels did not include
any health care and pension benefits that were added on top of
the income levels. So I want that to be taken into
consideration when you consider the numbers that were expressed
by my good friend from North Dakota.
Earlier this week, the ``Wall Street Journal'' indicated
that more investors are starting to factor in the Fed Fund rate
cuts that the Feds have made. Do you believe this is true and
do you have any comment on the affect on the economy of the Fed
policies of recent years?
Mr. Lazear. Well, as you know, the Federal Reserve had
raised rates for 17 consecutive times and then ceased raising
rates a couple of periods ago.
Senator Bunning. I am very familiar with that.
Mr. Lazear. Inflation now seems to be coming under control.
I think that the numbers that we have seen for the past----
Senator Bunning. Do you believe there was inflation in
those 17 months?
Mr. Lazear. Well, there is no doubt that measured inflation
was higher, quite significantly higher.
Senator Bunning. When they started raising interest rates?
Mr. Lazear. I don't believe when they----
Senator Bunning. Maybe in the last 2 months.
Mr. Lazear. Well, actually no. The last year had higher
inflation than the previous year, but the question that I think
most economists argue about has to do with whether this was a
one-time increase in prices associated with an energy increase
or whether it would be sustained inflation. I think that is the
issue that the Fed has been arguing about as well.
Senator Bunning. Internally?
Mr. Lazear. Well, you know, right, internally. I don't know
what they are arguing about internally, but only the statements
that they have made are statements that I hear. As you know, we
are an independent body and we have no access to any additional
information.
Senator Bunning. You have the minutes of their meetings,
just like we do, a month later.
Mr. Lazear. Correct. That is right, sir. When we look at
what they have been saying, they have had the same kinds of
arguments that I think other economists have had, which is are
we more concerned about inflation or are we more concerned
about making sure that the economy continues to grow at a high
rate.
That is a balancing act that the Fed has to engage in. We
are confident that the Fed attempts to do that the same way
that we attempt to think about these issues. They have the same
data that we have, as you pointed out, and I think the recent
numbers on inflation are encouraging.
Senator Bunning. I have an even more important question.
Some economists suggest that the blame for the American deficit
lies in Asian emerging economies. Asian central banks drive
their currency down by buying American Treasury bonds, reducing
interest rates, and allowing Americans to buy even more Asian
exports. To what degree do you think China's current practices
have contributed to the growing U.S. deficit?
Mr. Lazear. There is no doubt that investment in the
current account surplus to which you refer is the other side of
the current account deficit that we see in terms of trade. So
when we are running a current account deficit, it is
necessarily the case that some other country, at least, is
running a current account surplus. In fact, we have seen this
with China investing at very high levels in U.S. Treasuries.
Senator Bunning. You have to get to the point of my
question though. The basic point of my question is to what
degree do you think China's current practices have contributed
to the growing U.S. deficit, in other words, the undervaluation
of the Won.
Mr. Lazear. Well, as you know, Treasury speaks for us in
terms of the value of the dollar relative to other currencies.
Senator Bunning. We are trying not to let them do that.
Mr. Lazear. I would prefer to defer to my colleague, Hank
Paulson, on speaking about currency.
Senator Bunning. We will have a bill that will change that.
Mr. Lazear. All right. I will wait for it.
Senator Sarbanes. Hasn't he said that it is undervalued?
Mr. Lazear. I am sorry?
Senator Bunning. Paulson has said it is undervalued.
Mr. Lazear. Hank is not shy. I will let him speak for
himself.
Senator Sarbanes. He has made public statements to that
effect.
Senator Bunning. The thing that he really said was that
there wasn't manipulation. He didn't say that it was
undervalued, just to correct the record.
Mr. Lazear. Again, I would rather let the Secretary speak
for himself.
Senator Bunning. All right. I will question him when we see
him.
Thank you, Mr. Chairman.
Senator Gregg. Thank you.
Senator Conrad.
Senator Conrad. Thank you, Mr. Chairman. Let me just go to
a speech that the Controller General of the United States gave,
General Walker, about the situation that we are in as a
country. These are remarks from a speech he gave to the
certified public accounts in August of this year. He said:
``The U.S. Government is on an imprudent and unsustainable
fiscal path.'' Let me go to the second statement there. No. Let
us go to the third one. ``The executive branch is only giving
5-year projections for their budgets. Why? Because we go in the
tank after 5 years; the numbers start looking bad after 5
years.''
Let us go to the next one. This is General Walker again in
a speech to the accountants: ``Right now, the miracle of
compounding is working against us because we are the world's
largest debtor nation, and if interest rates start going up,
the effect that that will have could be dramatic because we are
adding debt at or near record rates, and if interest rates
start going up, since the duration of our debt is pretty short,
we will start feeling it pretty quickly.''
Finally, so the bottom line is, he said, the status quo is
not acceptable. It is not sustainable. Faster economic growth
can help, but there is no way we are going to grow our way out
of this problem. Anybody who tells you we are going to grow our
way out of this long-range problem, No. 1, hasn't studied
economic history, and No. 2, would probably flunk basic math.
The numbers just don't work.``
I would ask you, Dr. Lazear, are there any of these
statements that have been made by Controller General of the
United States that you disagree with?
Mr. Lazear. I think I fundamentally agree with his
statements, but I want to make sure that we interpret the
statements as talking about the long-run situation. It is
absolutely clear to me that the path that we are on in terms of
growth and entitlements, Medicare, Medicaid, Social Security,
cannot be sustainable. We have to think about ways to address
that problem. I think the President has been clear on that as
well.
So I don't think that these statements are at variance with
the Administration's view on it.
Senator Conrad. But it is a very different message that he
is delivering than the message I hear you delivering here
today. I hear you delivering kind a good news message,
everything is going great, but I hear the Controller General of
the United States delivering a very much more sobering message,
one that we are on a course that is utterly unsustainable where
we are piling up debt at a rate that is unsustainable and that
it threatens our future economic strength.
Mr. Lazear. Again, I would distinguish the short run from
the long run, Senator. In the short run, I think things are
getting better, the fact that the deficit has gone down
significantly greater than anticipated. We are now below what I
think is the magic number. The magic number at this point is
about 2.4 percent deficit, which means we are at that number or
below the deficit--the debt-to-GDP ratio is shrinking. So our
public debt-to-GDP ratio will actually be shrinking.
That is true over the short run, but if we allow
expenditures to grow, if we allow the budget to get out of
control in the future and if we believe these projections about
where we are going to go in the future, we will certainly allow
them to get out of control. That will cause some very serious
long-run difficulties, and I certainly agree with that. I think
that that is probably one of the greatest problems that we face
as a country, and we need to address it.
Senator Conrad. Let me say that this analysis of the
deficit as 2.4 percent of GDP to me misses the point. The
deficit is going to go up 260 billion this year. The debt is
going to go up 560 billion, and what people seem to miss here
is that it is the debt that has to be repaid, and this is the
level of debt increase. The debt of this country, gross debt,
at the end of this year will be eight dollars and a half
trillion dollars, and we are going to add 600 billion dollars,
almost 600 billion dollars, this year, 557 billion dollars. We
are going to add, according to projections, 600 billion dollars
or more every year for the next 5 years.
So we are going be at 11 and a half trillion dollars 5
years from now just as the baby-boomers start to retire. That
is what causes so many of us deep concern, and what I hear you
saying is that that concerns you as well.
Mr. Lazear. What I am saying is that we encountered some
unanticipated shocks, some of the ones that Senator Bunning had
pointed out. The question that every society faces when they
encounter an unanticipated adverse event is how do we finance
those over time. No one would ever suggest that you are going
to finance that at one point in time fully by that particular
year's worth of income.
So the question is how do you smooth it over time, and the
issue is are we smoothing too much or are we smoothing too
little or are we just about right.
Senator Conrad. I don't see us smoothing anything. The debt
this year, and you just described the economy as strong, we are
going to increase the debt by almost $600 billion.
Mr. Lazear. That is what it means to smooth. You borrow to
take care of----
Senator Conrad. But sir, sir, not only are we going to add
almost 600 billion dollars to the debt this year, we are going
to add three trillion dollars over the next 5 years. I don't
see where the smoothing is coming. The only thing that is
happening here is we are running on a charge card.
Mr. Lazear. As I said, the number that I think most
economists think about is the ratio of the public debt to GDP.
That is what we think of as the long-term target. Now, we can
disagree over whether we are too high right now, whether we
should be much lower. We are at about our historic average,
slightly about, but pretty close to our historic average. The
historic average, I showed on the chart.
Senator Conrad. The historic average includes World War II.
Mr. Lazear. No, no. Sorry. The 40-year average.
Senator Conrad. I thought you said the historic average.
Mr. Lazear. I am sorry. We only went back 40 years. We used
the same numbers that OMB uses.
Senator Conrad. I just say to you that we are now running
up debt at a rate that is by, I think, most objective
observers' analysis absolutely unsustainable. That is what the
Controller General is telling us, and we are using an
accounting system that you know is cash. If we were going on an
accrual system, the way most of the institutions have to do in
this society, these deficits would be much, much larger.
I thank the chairman.
Senator Gregg. Senator Grassley.
Senator Grassley. Dr. Lazear, your predecessor at CEA, Dr.
Mankiw, wrote a paper entitled ''Dynamic Scoring: A Back of the
Envelope Guide``. That is the name of it. The paper suggested
the dynamic effects of tax cuts on labor will offset about 17
percent of the static revenue loss and the dynamic effects of
the tax cuts on capital will offset about 50 percent of the
static revenue loss.
These results are interesting for two reasons, and I want
you to comment. First, they suggest that while tax cuts do not
pay for themselves from the perspective of the budget, they do
have a significant impact on the economy. Second, in order to
offset 50 percent of the revenue loss, a tax cut on capital
would have to increase GDP by more than one dollar for each one
dollar of revenue loss. Are you familiar with the study and
what are your views, then, on the issue of dynamic scoring?
Mr. Lazear. Yes, sir, I am familiar with the study, and I
would say, Senator, that it is actually consistent with the
numbers that I put up earlier. Actually, if you don't mind, I
will refer back to that for a second.
Nick, if you could put up, I think it is Figure 4.
This makes your point in a slightly different way, but I
think it is completely consistent with what you are saying. If
you look at the effect of the tax cuts, which is the difference
between the red line and the dotted blue line, look at 2003,
and you will see that there is a decline in revenue there; but
what you also see is that the revenue growth between 2004 and
2006 is quite steep. We believe that that revenue growth is at
least in part attributable to the tax cuts themselves, and that
is the dynamic aspect of what we are talking about here.
Now, as a consequence of that, you will also see that the
revenues in 2006 are back to where they would have been but for
the tax cuts. In other words, even if we hadn't cut taxes, we
would be back right at about the same level because of the
additional growth of the economy. Again, that is the dynamic
scoring aspect of this issue.
As you know, we don't do dynamic scoring in most of our
analyses. Treasury right now is undergoing what they call a
dynamic analysis to try to incorporate some of these issues.
CBO is doing the same thing, and a variety of private think
tanks have been working on this as well. So there are a number
of different ways to incorporate these kinds of estimates. I
think, you know, Greg Mankiw's estimates that you mentioned are
one set of estimates, but I think all of us agree that there
are dynamic effects. The question is simply how large are they.
This chart seems to suggest that at least in the short run,
they are pretty significant and it is certainly something we
need to take into account.
Senator Grassley. I yield back the rest of my time.
Senator Gregg. Thank you, Senator Grassley.
Senator Allard.
Senator Allard. Thank you, Mr. Chairman. I want to pursue
this idea of the public debt being held by foreign buyers. What
would happen if the United States prohibited foreign investors
from purchasing our debt?
Mr. Lazear. Well, right now, we are running a current
account deficit, which, again, on the other side of that is the
capital account surplus. We are bringing in a great deal of
money from abroad, which is funding our investment. Our
investment level still happens to be very strong, but that is
coupled with a pretty high level of personal consumption, as
you know. What that means is that we rely pretty heavily on
foreign investment right now as a source of funds. For growth,
for investment, that capital is extremely important to our
economy.
Just to give you a couple of numbers to put this in
perspective, we estimate that about 45 million American jobs
are in firms that are engaged in significant international
trade. We estimate that about one in twenty Americans is
employed in a foreign-owned firm, and so they are an important
source of contribution to the American economy. If that were to
reverse, if that were to come to an abrupt end, obviously it
would have significant impacts, adverse impacts, on the
economy.
Senator Allard. So if you look at, you know, our account
deficits, it seems as though when our economy is doing better,
it increases, and when our economy is doing poorer, like during
the Depression or maybe at the end of the 1970's when we had
the misery index, the account deficits were in the positive
range. So would you say, then, in terms that we have an account
deficit, it can be a sign that our economy is doing great?
Mr. Lazear. Well, again, I would put it a slightly
different way. What I would say is when we have a capital
account surplus which suggests that others are anxious to
invest in the American economy, that is a good sign, because it
tells us that not only are we willing to put money in this
economy, not only do we think that there is a good future, but
people who have no other inherent stake in this economy also
agree with us.
Senator Allard. They will get a greater return on the
investment than a savings account or whatever?
Mr. Lazear. Exactly, and they are not in this game for
charity. They are not in this game for patriotism, but because
they think it is going to bring a higher rate of return. So I
would simply view that as evidence that other people in other
countries agree with our investment sentiments.
Senator Allard. I want to move on to energy. Right now, we
are blessed with a drop in the cost of gasoline at the fuel
pump, but I think that there is still a good deal of
frustration. When the economy looked like it was good, you
would explain it to people and they wouldn't believe you
because every time they would pull up to the gas station to get
a tank of gas, that impacted them so personally in their
checkbook, but now we are seeing that dropping down
dramatically.
The Organization for Economic Cooperation Development has
estimated that a $10 decrease in the price of a barrel of oil
will increase the level of Gross Domestic Product by two-tenths
percent. Since August, the price of a barrel of West Texas
intermediate has declined significantly. Would it be reasonable
to assume that the lower energy prices could provide an
unexpected boost to our current economic growth in the coming
months?
Mr. Lazear. We believe it will be helpful to economic
growth. Whether the number is 2 percent, I have actually seen
numbers as high as--sorry--.2 percent. I have actually seen
numbers as high as .4 percent. You know, I wouldn't want to
venture an exact number, but it certainly is a positive force.
I think that one of the good things about the economy is that
because we have had high productivity growth over the past few
years, we have been able to withstand what really was quite a
significant energy price increase, and we did it without seeing
job loss, without seeing productivity loss, without seeing
output loss.
All of those things are good signs, and I think they are a
testament to the robustness of the economy and the resiliency
of the economy. So going forward, I think that your point is
well taken. As we look to these declines that we are now
seeing, and we are certainly happy that those declines have
occurred, we do expect that this will have a positive affect on
the economy, possibly as early as fourth quarter.
Senator Allard. Yes. I think that the fact that our economy
did so well during a time of very high gas prices speaks very
clearly about the strength of the President's economic
initiative to stimulate the economy and keep it going, because
I can remember the last time we had high gas prices at the
pump, it was, again, during the late seventies, and that is
when it really had an adverse impact.
So thank you for your comments.
Mr. Lazear. Thank you, sir.
Senator Gregg. Thank you.
I had a set of questions I was going to ask you, but we are
running into a time issue here. There is going to be a vote,
and I would like to get the next panel's testimony before we
have to go into potentially a series of votes. So I want to
thank you for coming.
Mr. Lazear. Thank you, Senator.
Senator Sarbanes. Mr. Chairman, could I just clarify one
thing?
Senator Gregg. I would like to move this along, if you
don't mind.
Senator Sarbanes. I won't take long. I want to followup on
what Senator Allard was saying.
Mr. Lazear. Yes, sir.
Senator Sarbanes. I was actually taken aback by your
assertion that other people in other countries are willing to
hold our debt and that shows that they have confidence and
strength in the U.S. economy, which you just made. Correct?
Mr. Lazear. Correct. I am surprised you are taken aback.
Senator Sarbanes. Well, I am taken aback because, as I
understand it, more and more of that debt is being held by
governments, not by individuals, and Senator Bunning made, I
thought, a very effective point, that they are doing that in
order to affect the exchange rate and to gain a trade
advantage. That is why Japan and China have these huge, huge
holdings, and the shift has been from--it doesn't represent a
judgment by private individuals. It represents a governmental
decision in those countries designed, I think, to help them
gain a trade advantage, which is, I think, the point that
Senator Bunning was trying to make.
So they are over there playing a very shrewd game to our
disadvantage, and you are sitting there as the Chairman of the
Council of Economic Advisors telling us that everything is
hunky-dory.
Senator Gregg. I think we will take that as a rhetorical
question.
Senator Sarbanes. OK.
Senator Gregg. Thank you very much for your input and thank
you for your time, Dr. Lazear.
Mr. Lazear. Thank you.
Senator Gregg. We will now turn to our second panel, which
is made up of three distinguished scholars from three very
distinguished policy groups. We have Dr. Kevin Hassett, who is
Director of Economic Policy at the American Enterprise
Institute; Mr. Chris Edwards, who is Director of Tax Policy
from CATO Institute; and Peter Orszag, who is the Deputy
Director of Economic Studies at Brookings Institute. All three
have a long track record of substantive and thoughtful input on
American policy on a variety of different levels, and we
appreciate these three witnesses taking the time to come here
today to testify.
We will start with you, Dr. Hassett.
STATEMENT OF KEVIN HASSETT, DIRECTOR OF ECONOMIC POLICY
STUDIES, AMERICAN ENTERPRISE INSTITUTE
Mr. Hassett. Thank you very much, Chairman Gregg and
Ranking Member Conrad. I would also like to take a moment to
thank Senator Sarbanes for his public service and say that I
have testified many times over many years and I have always
found our exchanges to be stimulating and challenging, and he
really will be missed.
I am going to abbreviate somewhat my remarks compared to
what I handed in and try to give you the highlights, and I will
skip over a good deal of what I have written about the outlook
as it coincides fairly closely with what Chairman Lazear
stated. The one thing I would like to add is the final
concluding point from my overview of the economic outlook,
which is that right now, it seems like the forecasters that I
trust the most, like Moody's Economy.com and so on, just non-
political economists, think that we are heading for a
successful soft landing, and I think that if we do head for
that, it is just worth mentioning on the record that that is an
impressive policy accomplishment for the Federal Reserve.
Indeed, if we look back at last summer, in stopping where
they did, the Federal Reserve officials took something of a
calculated risk. Inflation pressures were still present. Growth
was still strong, and in similar circumstances in the past, the
Fed has continued to tighten. I think right now, their judgment
not to do so looks pretty good given the data that we have seen
since then, and I think a tip of the cap is in order for Mr.
Bernanke and his colleagues.
I mentioned in my written testimony that I wanted to bring
a somewhat different light on the question of the distribution
of growth. There has been concern in my circles that the
current economy may somehow be different than economies in the
past and that economic growth might not be shared as equally as
it has been in the past. There are a number of statistics that
are consistent with that perspective. Between 2000 and 2006,
for example, real wages which exclude benefits increased .6
percent per year while real hourly compensation, which includes
benefits, increased 1.3 percent per year.
Additionally, the Census Bureau recently reported that real
median household income grew only 1.1 percent from 2004 to
2005. It also reported that this was the first year since 1999
in which such an increase was reported. These statistics have
received a great deal of attention in the press, and on their
face, the data would suggest that ordinary Americans are not
sharing in the economy's growth, and that would be quite a bit
of a break from past experience.
It is important to note, however, that, first of all, these
measures don't take the Tax Code into account. In my testimony,
I have a couple of charts from a chapter in a book edited by
Rebecca Brank and Sheldon Dansinger that I wrote with my co-
author at AEI, Anne Moore. As of 2004, for example, the total
income and payroll tax liabilities for the two sample families
in my testimony declined sharply over the last decade, and
accounting for those changes in taxes is important as we think
about what is going on for the median person.
There are also a number of other factors that we need to
account for when we are thinking about how the middle person is
doing, because no person stays right in the middle every year.
Economists have long believed that one of the things to look at
when you are assessing the welfare of individuals is their
consumption. Just because GDP has been rising a lot lately, so
has aggregate consumption. It has grown 17.24 percent since
2001. This is interesting because consumption very often in the
statistics is much more equally distributed than income and
wealth.
So what my staff and I did is we went back to the consumer
expenditure survey and took the share of consumption that goes
to the middle class and then used that share to try to estimate
their consumption in recent years given the increase in liquid
consumption. I think that those data reject the view that we
are evolving toward an economy where we are significantly less
friendly toward the middle class. Indeed, the rate at which
consumption by the middle class is increasing has even
accelerated in recent years. There is a figure in my testimony
that indicates that.
I think that we should also recognize as we look at these
data that we did have an adverse shock to inflation. The real
growth at the top line consumer price index was 1.7 percent for
2001 to 2002, but it accelerated all the way up to 3.8 percent
between 2005 and 2006, marking the highest increase in the last
15 years.
Inflation surprises have, of course, occurred before, and
when they do, we know what happens. Real wage growth is lower
than expected, but then as those wages are re-contracted as
workers go back and say, Hey, that deal I made last year wasn't
so good because of inflation surprised on the up side, then
their wages catch back up. In addition, energy prices have
surprised on the down side lately, as was mentioned by Chairman
Lazear, and those reductions should pave the way for further
real wage gains, but it is worth emphasizing that the pattern
that we see in the consumption data is consistent with a view
that workers recognize that their wages are going to catch up
and smooth their consumption through the negative surprise.
In the near-term budget outlook section of my testimony, I
talk about what has been going on with the near-term budget.
Figures 5 and 6, I think are notable for thinking about how we
got to the place we are where we have a deficit. The dotted
line in Figure 5 shows the latest projections for outlays in
2006 and compares them to past CBO projections for spending in
that year. Going back to the first year, such a forecast is
available, in 1996.
I think the chart tells an unambiguous story, that spending
was much higher than projected back at the end of the Clinton
Presidency or the beginning of the Bush one. While it is
important to note that these projections keep real
discretionary spending constant going forward, the numbers are,
nonetheless, startling. 2006 outlays, for example, were $479
billion higher than the CBO projected outlays would be, you
know, for that year back in 2001. Since the 2006 looks like it
will be 260 billion or so, one could conclude that we could
currently have a surplus if government had stayed on the
spending course that was incorporated into that outlook.
Figure 6 provides a similar comparison, this time for
revenues. As I am running out of time, I won't go through the
details, but if you look at the revenue chart, then what you
see is for some years, revenues are lower than they thought
they would be in 2006 for some past projections, and for some
years, they are higher. So there is ample room for debate in
there between supply side optimists and pessimists about
whether the tax cuts paid for themselves, but I think that even
the supply side pessimists would have to concede that relative
to the times when we had large surpluses, revenues have
surprised less on the down side than spending did on the
upside.
In the remainder of my testimony, I have a discussion of
the literature on budget rules. I know that members on both
sides of the aisle in this committee, at least, are in favor of
some kind of new budget legislation. I think the literature
suggests that those work.
In the final section of my testimony, I talk about the
longer-term outlook and agree with Senator Conrad that it is
really quite troubling and discuss why I think the
misconception about what a tax increase or a benefit cut really
is when we are talking about entitlements might be an
unnecessary obstacle to bipartisan agreement about how to
afford. I think not moving forward is not an option and the
fact that cleaning up these misconceptions might help move
toward bipartisan agreement, I think is an optimistic sign.
And that is how I close my testimony. Thank you.
[The prepared statement of Mr. Hassett follows:]
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Senator Gregg. Thank you, Doctor. I appreciate that, those
thoughts.
Mr. Edwards.
STATEMENT OF CHRIS EDWARDS, DIRECTOR OF TAX POLICY STUDIES,
CATO INSTITUTE
Mr. Edwards. Thank you very much, Mr. Chairman, and thanks
for hold the committee, as with other members, and thanks for
having me testify today.
The economy is certainly continuing a solid expansion, and
we do appear to be in the middle of a long boom like we enjoyed
in the eighties and nineties. I suspect that a lot of the
current good economic performance mainly has to do with
America's entrepreneurs and dynamic global markets and not so
much with Federal policymakers; however, Federal spending and
taxation does play an important role in aiding or impeding
growth.
The Federal Government extracts $2.7 trillion in taxes and
borrowing from the private economy every year. That has two
basic impacts. The first basic impact is that it shifts
resources from the more productive private economy to the less
productive government economy. The large increases in spending
in recent years will reduce growth because current taxes will
have to be higher than otherwise.
The second basic impact of all that spending is that the
method we use to extract the taxes from the economy is
particularly damaging with a complex Tax Code. So to sustain
our current strong expansion, I think they need to look at both
limited spending and going to a simpler, more efficient Tax
Code.
Those opposed to recent tax cuts argue that tax cuts
financed by deficits don't do much for the economy, and it is
true that recent tax cuts would have had more tick if we had
limited spending as well and matched tax cuts with spending
cuts. There is a crucial point to make here though, that all
tax cuts are not created equal. About 45 percent of recent tax
cuts since 2001, you can call a social policy tax cut, such as
the child tax credits. Those sorts of tax cuts do not reduce
distortions in the Tax Code and don't really have much of an
impact on GDP. They simply push tax burdens on to future
generations.
About 55 percent of recent tax cuts since 2001, however,
you can call supply side tax cuts, such as the dividend and
capital gains tax cuts. Those reduce distortions in the Tax
Code, boost GDP growth, and they also don't lose the Federal
Government as much money as the static revenue calculations
suggest.
The greatly different impacts of different types of tax
cuts can be seen in a joint committee taxation study last year.
They did a micro simulation analysis of different types of tax
cuts to see what the GDP impact would be. They found that a
corporate tax rate cut boosted GDP growth in the long run twice
as much as an individual income tax cut, and they found that a
corporate tax cut boosted GDP four times as much as an
expansion in the personal exemption, which is sort of like a
social policy tax cut.
So if you look at recent tax cuts, there is no doubt in my
mind that the dividend and capital gains tax cut have helped
the economy grow strongly and we certainly can see the impacts
on Wall Street. Dividend payouts by large corporations have
soared since the dividend tax cut passed in early 2003.
Regardless of whether one supports recent tax cuts, it is
clear that we have a gigantic long-term spending problem. The
GAO, basic GAO, sort of business-as-usual scenario shows
Federal spending rising from 20 percent of GDP this year to
about 45 percent of GDP by 2040, and the long-term problem is
actually really worse than that, because we risk here, moving
forward, sort of an economic death spiral. If Congress tries to
jack up tax rates to meet rising spending, that will cause
greater tax avoidance, slower growth, and less tax revenue,
perhaps prompting Congress to jack up taxes even higher than
the GAO numbers indicate.
So what we need to do is we have got a bleak future here
for young Americans unless we do some serious spending reforms.
We need tougher budget rules, and I certainly laud the chairman
for his SOS bill. I guess it is S. 3521. He has got some great
ideas regarding limiting entitlement spending and discretionary
spending. I think an even more basic idea we should consider is
putting an overall cap on total growth and total outlays by the
Federal Government every year.
A number of States have such caps, and it just seems like
such a simple and obvious idea, we ought to consider it
Federal. The idea is you would cap total outlays every year by
some indicator, like personal income, or it could cap total
outlays with some fixed percentage number, like four or 5
percent. That would make it very easy for Congress to plan
their outlays in the future, and it would make it very easy for
the public and groups in the private sector to see whether
Congress is cheating or whether they are following their budget
rules. With a cap in place, Congress could consider their
annual budget resolution. They would look at where the spending
cap that is in the statute of law was and it could include
reconciliation bills in your annual resolution to get spending
under the cap. If the end of the fiscal year comes around and
Congress hasn't met the cap, the President would be required to
sequester spending, sort of like under GRA's role in 1990 in
the Budget Enforcement Act.
So it is clear budget rules are clearly not working. We
have got non-stop deficits. In most years over the recent
decade, we have had large deficits. We have got these gigantic
unfunded obligations that have built up. We clearly need to
experiment with new types of budget rules. I think the ideas in
the chairman's SOS bill are great, but I also think we need to
look at a cap on overall Federal outlays.
Thanks for having the hearing. I am happy to answer any
questions.
[The prepared statement of Mr. Edwards follows:]
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Senator Gregg. Thank you, Mr. Edwards. I appreciate those
comments.
Dr. Orszag.
STATEMENT OF PETER ORSZAG, DEPUTY DIRECTOR OF ECONOMIC STUDIES,
BROOKINGS INSTITUTION
Mr. Orszag. Thank you, Mr. Chairman and Members of the
Committee.
Today as a Nation, we are neither paying our way nor
investing sufficiently in our workers. The Nation's net
national saving rate is hovering around 2 percent of national
income. I would say there is no good outcome that comes from
the world's leading economic power only saving 2 percent of its
income. It means that we either only invest 2 percent of our
income, which will starve workers in the future of the
productive capital that they need to have higher wages, or it
means that we borrow the difference from foreigners, which is
increasingly what we are doing. That, however, is not a free
lunch. We owe the money back. We are mortgaging our future
income by borrowing such massive amounts from foreigners.
Roughly half of the public debt now is owned abroad.
The second problem is stagnant real income and more risk
for middle class families. Family incomes are basically flat.
If you look at the consumer expenditure survey itself, which
Dr. Hassett already mentioned, and just look at consumption
levels in that survey, consumption levels for the middle
quintile are also flat. Across a wide variety of indicators,
outcomes for middle class families look like since 2000 they
are basically stagnant.
At the same time, families face increased income risk. The
probability of a 50 percent decline in income over a 2-year
period has more than doubled since the early 1970's. So middle
class families and lower income families are facing both
stagnant real incomes and increased risk, and we need to
address that problem too.
Unfortunately, the tax cuts have exacerbated both problems.
By 2015, they will have contributed roughly $5 trillion to the
Nation's debt. That is 25 percent of our GDP, and ultimately
because the tax cuts have to be paid for, they will reduce real
incomes for the vast majority of families, more than three-
quarters of families, once you take into account the necessary
spending reductions or other revenue increases to offset the
cost of the tax cuts.
But everyone says, Well, maybe those costs are worth it
because the tax cuts boost growth, and it is true that in the
short run, they have had some modest effect on economic
performance, but we could have gotten that same kick much more
cheaply if we had pursued other policies; and, more
importantly, over the long term, the vast bulk of the studies
suggest that because the tax cuts are deficit financed and
because they were not particularly well designed to promote
economic growth, their long-term impact on the economy is
negative, not positive.
So we have both problems being exacerbated. Ultimately, the
tax cuts increase national debt, reduce national saving, impair
long-term economic performance, reduce incomes for most
families, and also reduce after-tax income volatility, which
families are also struggling with. So what should we do instead
of that approach? And I think Senator Alexander actually
touched upon it. There is a better way in which we invest in
education, research, technology, and increase national saving.
The basic alternative view in which the way to promote
economic growth, broad-based participation in that growth, and
improved economic security is the basis for a new project at
Brookings that I direct called the ''Hamilton Project`` where
we are putting out a lot of ideas about exactly how to go about
doing that.
So what do we need to do? First, increase national saving,
obviously, we need to get the fiscal deficit under control,
because the fiscal imbalance is a major contributor to that low
national saving rate that I mentioned. I am sure we will talk
about ways to get the fiscal imbalance reduced. Beyond that, we
need to raise personal saving, and by far, the best way to
raise personal saving in the United States is to make it easier
and more automatic for households to save.
I would note that there was legislation introduced
yesterday that Senator Conrad was a cosponsor of, along with
Senator Smith and I believe two or three other Senators on a
bipartisan basis, to create an automatic IRA so that workers
that go to work at firms that don't sponsor a pension plan
would automatically be enrolled in an IRA. The evidence is
overwhelming that these sorts of ``EZ-Pass'' approaches or
automatic saving approaches work and we should be pursuing them
much more vigorously.
In addition to that, in my written testimony, I provide
another idea that I think is worthy of attention. We in the
United States spend roughly $500 billion a year through the Tax
Code providing incentives for health care, retirement,
homeownership, and other socially beneficial activities. Almost
all of that is done in the form of deductions or exclusions,
which link the size of the tax break to someone's marginal tax
bracket. Not only does that skew the benefits toward higher
income households, but it is economically inefficient, because
unless you think that high income households are more
responsive to that incentive or generate larger benefits when
they do respond, it doesn't make any sense to provide a larger
tax break to one particular set of households than another.
In a recent paper with Fred Goldberg, who was the IRS
Commission under the first President Bush, and Lily Batchelder
of New York University we argued that basically all of those
tax incentives should be reconsidered and done on a uniform
credit basis rather than with a deduction or exclusion, which
would both be fairer and more efficient, and there are very few
opportunities that we face in the United States to improve both
equity and efficiency, and I would urge you to seriously
consider that as an approach.
So the bottom line is there is a much better way to promote
economic growth than tax cuts that run up the deficit, reduce
national saving, and ultimately will impair incomes for most
families.
Thank you, Mr. Chairman.
[The prepared statement of Dr. Orszag follows:]
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Senator Gregg. That you, Doctor.
Senate Bunning.
Senator Bunning. You surprised me, Mr. Chairman.
Senator Gregg. I thought I would let you start. We are
going to have a vote here, and I want to make sure everybody
gets a chance.
Senator Bunning. Looking to the tax burden as a share of
GDP, we see a definite trend of receipts heading back to their
historical levels of about 18 percent of GDP. If we keep the
tax rates where they are, then the projections are that
receipts will stay near this historical range; however, if we
raise taxes by allowing recent tax cuts to expire, the
projections are that we will see the tax burden rise to over 20
percent of GDP.
Can you comment on what impact the tax burden of this level
would have on the economy? Is, as some of our colleagues
suggest, the only path to fiscal restraint a return to record
levels of taxation?
I ask all of three of you that question.
Mr. Edwards. I would say the way to think about
particularly the supply side tax cuts that have been passed in
2001 and 2003 is that they are long-term reforms that do good
things for long-term growth in the U.S. economy, and the Joint
Committee on Taxation study that came out last year that I
cited in my testimony is a good example of that. A cut to taxes
on capital income boost long-run growth even taking into
account other affects, like changes in interest rates.
Something I would point out about recent tax cuts that have
been about 2 percent, that account for about 2 percent of GDP,
I went back and I looked at how big the tax increases in 1990
and 1993 were. You may remember that.
Senator Bunning. Yes, I remember that.
Mr. Edwards. George Bush I and President Clinton both
increased income tax rates, particularly at the top end. The
1993 and 1990 tax hikes are essentially a wash with the 2001
and 2003 tax cuts. They are both about 2 percent of GDP. So one
way to look at recent tax cuts is that it really is getting
back to where we were in the late 1980's after the 1986 Tax
Reform Act. In fact, our top income tax rate is still higher
than it was in 1986.
So, you know, looking at this over the long term, we don't
think recent tax cuts were large in the share of GDP.
Mr. Orszag. Senator, what I would say is that there are
obviously two main factors to take into account when evaluating
the impact of that kind of change on the economy. The first is
how you raise the money, and the second is what you do with it.
If we raise the money in an efficient way and we use it to
invest either in reducing the deficit or in things like
preschool education, for example, I think the net effect would
be positive. It is just the flip side of the studies suggesting
that the long-term impact of the tax cuts is negative. In other
words, what you ask is the flip side of a tax cut, so consider
a tax cut that reduces marginal rates. It may have some benefit
on the economy because it strengthens incentives to work and
invest, although my view is that evidence on that suggests
those effects are relatively weak, but to the extent that it is
financed by a deficit, there is a drag on the economy from that
deficit, and most of the studies suggest that the net effect
is, if anything, negative. So you could turn that on its head
to answer your question.
Senator Bunning. We all realize if we don't do something
about automatic spending increases with our Medicare, Medicaid,
and Social Security, that by the year 2030, we won't have any
excess money to spend for Federal Government. We will have
spent everything on entitlement programs, or at least we won't
be able to defend our country. Do you have any suggestions what
to do as far as entitlements are concerned?
Mr. Hassett. I guess Peter has a plan on Social Security
that I am sure he will be able to talk about.
Senator Bunning. Well, I have a lot of plans, but I can't
get anywhere with them.
Mr. Hassett. I think that the key is that it is important--
the first key is to recognize that it is important to start
soon, because whatever you are going to do is going to involve
reducing benefits, reducing net benefits to current recipients,
and the longer we give individuals a chance to plan ahead for
that, the more they can change their saving today and be
prepared.
I think Senator Gregg's SOS bill has some ideas about how
to fold the entitlements into the real budget process, and I am
quite confident that in the end, if we don't double the size of
government, that we are going to end up adopting a bill that
looks something like his.
Mr. Orszag. Senator, I think the real key here is health
care. That is the major driver of the long-term fiscal
imbalance. There is both a sort of problem and an opportunity.
The problem is that I don't think that you are going to be able
to make a significant change in the health care obligations of
the Federal Government without a significant change in the rate
of growth in the private sector health care also. The systems
are too linked. Costs per beneficiary in public programs have
tracked cost per beneficiary in the private sector over long
periods of time, and the patients are being treated at the same
hospitals. You can't just rip the systems apart.
The opportunity is that there are significant possibilities
for restraining cost growth in health care without impairing
health outcomes. For example, costs vary across the United
States, different regions of the United States, for reasons
that don't have anything to do with outcomes. They are not
correlated with how healthy people actually are or what their
responsive to health care is. It seems like it comes down to
things like doctor practice norms in different regions, that in
some regions, doctors order all sorts of test that aren't
actually necessary. In other regions, they don't do that.
Senator Bunning. That is called covering your backside.
Mr. Orszag. It is, but there are major opportunities for--
basically, we are at the flat part of the health expenditure,
health outcome curve. So there are major possibilities to
restrain cost growth without actually hurting people and
perhaps actually even helping them, and that strikes me as the
most important thing for the United States to tackle in terms
of getting our long-term fiscal house in order.
Senator Bunning. That is my time, but go right ahead.
Mr. Edwards. I think entitlements ought to be cut and we
ought to have phase-in cuts to all the major entitlement
programs. I think Social Security, a simple long-term valued-
added there would be to switch from wage indexing to price
indexing for initial benefits. That would slowly over decades
reduce benefits, which I think is a very fair thing to do. We
know we have got a big problem. If you let young people know
now that benefits are going to be cut in one, two, three
decades down the road, they can plan ahead and save more.
On Medicaid, I think we ought to do the same thing with
Medicaid that we did for welfare reform in 1996, turn it into a
Federal block grant. That way, we can control the Federal
contribution to the program over time. Medicare, I think the
CBO Budget Options book has a number of good ideas for
increasing deductibles for Medicare.
I think all these changes could be made on a progressive
basis if you want some sort of bipartisan compromise. You could
have progressive price indexing for Social Security benefits.
Senator Bunning. You also realize if we mean-tested all of
these programs, the weeping and gnashing of teeth we would have
at these seats that are sitting up here. That would be a very
good solution in every instance if you give a warning out front
that this is going to happen.
Thank you all very much.
Senator Gregg. Thank you, Senator.
Senate Conrad.
Senator Conrad. You have heard presentations that I have
made here about the unsustainable nature of our current fiscal
policy. I think, basically, in different words, you have all
basically agreed with it, that long term, we are on a
unsustainable course. Let me ask you in order, Kevin, starting
with you, if I could, if you could wave a magic wand to deal
with the long-term imbalances, can you just give us a couple of
sentences on what you would do?
Mr. Hassett. Thank you for the opportunity, Senator. Yes. I
would take Social Security and, as Chris suggested, index it,
the prices, so that, again, people have a long time to see the
reduction in benefits when they retire. On health care, I think
that what we need to do is move toward a system where copays
and so on by participants in the program depend their usage of
health care in the previous year by participants in the
program. I think we need to build a kind of sense of community
that when they are seeking health care as an elderly person,
they are asking something of their community, something that
you want to provide to others so that you don't consume more
than you need.
But I think that we need to move toward a system where the
health system itself is more--that the fees of it are more
related to what people do so people can see the effect they
have on everybody else whether they consume a lot of health
care. So I would like to tie those two over time, but again, I
would not want to do it overnight. We would have to move
gradually toward that system.
Senator Conrad. Chris.
Mr. Edwards. One way to think about what the Federal
Government does is, and there has been a few major studies on
this in the past, is look at who gets the benefit of Federal
spending. CBO did a nice study about a decade ago that looked
at who gets all the benefits of Federal Government spending in
terms of income distribution. It turns out that the Federal
Government does not slant its spending toward the bottom end
like a lot of people think it does. The distribution spending
is actually right across the board from the wealthiest to the
poorest.
So I think the only way to get a good bipartisan compromise
on spending cuts is cut the corporate welfare, cut the business
benefit, cut benefits of Medicare, Social Security, etc. for
higher income people and give people warning that benefits will
likely be phased down, but it seems to me that is the type of
approach we need for the long run.
Senator Conrad. OK. Peter.
Mr. Orszag. Senator, I would lock you all in a room and not
let you out until you had come up with a solution.
Senator Gregg. That is my bill. That is my bill.
Mr. Orszag. And I can go through my litany of what I think
you all should do, but I think the main problem at this point
is one of political will and that if you all got in a room and
were not allowed out until you actually had a solution, that
would make far more movement toward an answer than my trotting
out all by Brookings studies.
Senator Conrad. Let me ask you, though, if we were locked
in the room and you were the only advisor allowed in, what
would you recommend to us be the focus?
Mr. Orszag. OK.
Senator Conrad. Where would you start?
Mr. Orszag. I would start with health care, in order,
health care, revenue, and then Social Security, and that
reflects the relative importance of various factors in
contributing to the long-term deficit.
So on health care, I would be looking at ways of changing
those practice norms. I would be looking at more personal
responsibility, because I think that is an important component
of improving health outcomes and restraining cost growth. I
would be looking at preventive care. I would be looking at a
whole variety of things. We don't have all the answers there.
Senator Conrad. Let me stop you and ask you how about the
chronically ill. We know that about 5 percent of Medicare
beneficiaries use half of the money. It seems to me, you know,
in business school, I learned to focus like a laser on that
kind of statistic. How about the notion of focusing on the
chronically ill to better coordinate their care as a way of
saving money and getting better health care outcomes?
Mr. Orszag. Certainly, you know, when looking to close a
budget gap, it helps to look where the money is, and that is
certainly an area that would be worthy of scrutiny along with,
and relatedly, long-term care. I think there is a lot more that
could be done, for example, with private long-term care
insurance to make that market work better also. So health care
is, obviously, a big component.
On revenues, I think that we could very easily reverse at
least part of the tax cut and do some other steps on an
individual income side. I would replace the estate tax with an
inheritance tax so that Paris Hilton could not inherit hundreds
of millions of dollars tax free, and I would also re-examine
the base of the corporate income tax in a world in which
capital is increasingly mobile. I think there are changes that
could be made to the corporate tax that would also sure up that
revenue for the Federal Government.
Finally, after you have solved all of that, I would be
willing to let you out of the room, but if you wanted to keep
going, there are changes that could be made with regard to
Social Security also.
Senator Conrad. Would everyone agree that the long-term
shortfall--this is my last question, Mr. Chairman--the long-
term shortfall in Medicare is far greater than the projected
shortfall in Social Security? Isn't it really like seven times
as much?
Mr. Edwards. It is more a variable too though. For Social
Security, we know with much greater certainty what the future
benefit burdens are. Health care, we might be lucky. Technology
might save us. We don't know for sure.
Senator Conrad. You know, you can also make an argument
that technology may increase our costs. When I look at the
breaking of the genetic code and the new technology that is
flowing from that, it is incredibly exciting. It extends life.
It improves quality of life. It also probably is going to
increase costs, at least in the short run.
I want to thank the witnesses. I thank all of you. You
really are thoughtful people, and it is valuable to the
committee to have you here.
Senator Gregg. Thank you, Senator.
I thank the witnesses. The points that you have made, I
pretty much agree, except for a couple of yours, Dr. Orszag.
Mr. Orszag. Right.
Senator Gregg. But, basically, the thematic, if I could try
to define the thematic statement here, it is that we have got
to get control over our entitlement accounts. Getting control
over our entitlement accounts is going to take discipline and
it is going to take political will and it is going to take the
primary area of focus on health care and how we deliver health
care in this country as we move into a generation which is
going to double the size of retirees.
Social Security is a very definable world. It only has like
six moving parts, and they are very correctable. All we need is
the political will. We know how to correct it. We change the
benefit. We adjust the COLA so it is an accurately accounting
to COLA and you address the fact that people are working
longer, and you have basically solved the problem of Social
Security.
But the issue of health care is much more complex and it
gets to the question which the Senator has made, the point the
Senator has made, which is you have got a very small percentage
of the beneficiaries using the vast majority of the resources.
You have got the technology issues. You have got the matrix,
which is so complex.
I have ideas on all these areas, and I appreciate you,
Doctor, mentioning my SOS bill, which basically goes to what
you suggested, Doctor, which is that we should have a system
here where the procedure drives the policy, where you basically
do put everybody in a room, give us some ideas, and basically
the people in the room would be us, and then require us to act
on those ideas. So I agree with that.
But to get to a couple of philosophical points which were
made here on tax policy, we have some disagreements. I am
sensing that some of you or maybe all of you--in fact, you, Dr.
Orszag, if I understand your position correctly, there are some
tax cuts which make more sense than other tax cuts, and
certainly that was the point that was made by other witnesses,
that there are some tax cuts that make sense from the
standpoint of growing the country's economy and creating more
incentive for savings that are better than other tax cuts, and
so I would like to get your thoughts as if we are going to
focus on tax cuts which produce more economic activity and, as
a result, produce a better economy which means more jobs, and
in my opinion, more revenue. What are the tax cuts that we
should be focused on and are all tax cuts the same?
I have a prejudice here. I can give you my answer, but I
would be interested in your answer. Why don't we start at this
end and go this way this time.
Mr. Orszag. Not all tax cuts are the same. I would note,
though, that the context in which tax changes occur is very
important. Given the very low level of national saving and
given the very large fiscal imbalance that we face, it is not
at all clear to me that tax cuts should be anywhere near the
top of the agenda at this point, but if you wanted to focus on
tax changes, what I would actually do is come back to the idea
that I mentioned before, which is we are spending $500 billion
a year very inefficiently through the Tax Code in providing
incentives for retirement and health, homeownership, and other
things that we are trying to encourage. I would significantly
re-examine that entire activity.
Senator Gregg. You said go from deductions to credits.
Mr. Orszag. I said go from deductions to credits.
Senator Gregg. Of course, the bottom quintile of the
taxpayers in this country don't actually pay any taxes. They
actually get a refund. The bottom 20 percent would not be
affected by that either. Just as a distributional event, it
would have no affect on the bottom 20 percent.
Mr. Orszag. Well, for example, let us take retirement
savings. On a revenue neutral basis, you could take the tax
preferences for 401Ks and IRAs and transform them into a 30
percent match that went into someone's account regardless of
whether they owed personal income taxes or not, and that would
raise the incentive to save for over 80 percent of households
and would be much more effective at actually urging new
savings.
Senator Gregg. And the cost would be the same, is what you
are saying.
Mr. Orszag. Right.
Senator Gregg. That is interesting.
Mr. Edwards. I agree partly with Peter. In fact, the
approach taken in the two plans under President Bush's tax
commission, his report that came out, I guess, last November
was converting a lot of the deductions, like the mortgage
interest deduction, into credits. I think that is actually a
pretty good idea, using the revenue that you save to lower the
tax rate. That would make the Tax Code more efficient. It would
target some of these deductions and credit that the Congress
likes to put into the Tax Code at the bottom end to limit their
cost, and that is reasonable.
I think looking forward, the big crunches in the revenue
system in the coming years are the expiration in the Bush tax
cuts, the gigantic AMP problem, of course; but the third one
that will become more and more and more important in the coming
years is the absurdly high corporate tax rate the United States
has. The data from 2005 show that the average corporate tax
rate across the 25 European Union countries was 27 percent. Our
Federal rate is 35 percent. Our State and local rates go up to
about 10 percent in New York City.
We have got a terrible problem here. We all know we have
got problems with the competitiveness of the big corporations,
the automobile companies, airlines, and others. I think the
corporate tax rate is really something we really have to look
at. In look at Senator Kerry, when he was running for
President, he had a corporate tax reform plan. So I think that
really is something we need to look at going ahead. Global
capital will only get more mobile. So the problem will become
greater and greater over time.
Senator Gregg. We have an answer that is call New
Hampshire. There are no sales or income tax.
Mr. Hassett. Thank you, Senator. I actually agree with both
Chris and Peter on their main points. I think that if you want
to think about what a good tax cut is, think a good tax cut is
one that will help the economy. It is something that lowers the
margin rate. It is something that moves us toward a consumption
tax. Right now, the place the U.S. tax policy is most out of
whack with the rest of the world is the corporate tax code.
Senator Kerry did recognize that and suggested a reduction in
the rate. I think that a reduction in the rate that is
significant is really important, because right now, our firms
have an incentive to locate their activity overseas to pay a
lower tax, and you can spend a gazillion dollars in enforcement
to try to stop that, or you can just lower the rate a little
bit so we are in line with everyone else.
I think that the kind of tax reductions that don't have an
affect on the economy very often are there for other reasons,
and you might still want to do them. For example, the child
credit might stimulate fertility, but it is not going to
stimulate the economy.
With Peter's $500 billion point, I thought that I would
finish with a point of, perhaps, rare consensus which I think
is worthy of note for the committee, and that is that many of
these base narrowing features of the Code, like the mortgage
interest deduction, don't really have their intended
consequence. The mortgage interest deduction really doesn't
stimulate homeownership, because the people who are going to
own a home anyway are the ones who take it. So if you think
that you should have a subsidy in homeownership because you
want to get people in homes to build communities and make them
join the school committees and so on, then you need a different
animal than what we have.
So I think if we look at our Code right now, it is a mess
because we have a lot of things that narrow the base that don't
do what we intend, and that is really an opportunity for
significant reform.
Thanks.
Senator Gregg. Thank you.
Your testimony has been excellent and very valuable, and I
hope somebody will take it beyond us, because I think we are in
agreement with it, and we need to convince other folks of
taking advantage of it. We are in general agreement with it.
There is a vote on. So we are going to have to end this
hearing. Again, thank you for taking the time. Thank you for
your input. It has been superb. I appreciate it.
The hearing is adjourned.
[Whereupon, at 11:56 a.m., the hearing was adjourned.]