[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]


 
                       FISCAL CHALLENGES AND THE
                        ECONOMY IN THE LONG TERM

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

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

           HEARING HELD IN WASHINGTON, DC, FEBRUARY 28, 2007

                               __________

                           Serial No. 110-10

                               __________

           Printed for the use of the Committee on the Budget


                       Available on the Internet:
       http://www.gpoaccess.gov/congress/house/budget/index.html


                                 ______

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                        COMMITTEE ON THE BUDGET

             JOHN M. SPRATT, Jr., South Carolina, Chairman
ROSA L. DeLAURO, Connecticut,        PAUL RYAN, Wisconsin,
CHET EDWARDS, Texas                    Ranking Minority Member
JIM COOPER, Tennessee                J. GRESHAM BARRETT, South Carolina
THOMAS H. ALLEN, Maine               JO BONNER, Alabama
ALLYSON Y. SCHWARTZ, Pennsylvania    SCOTT GARRETT, New Jersey
MARCY KAPTUR, Ohio                   THADDEUS G. McCOTTER, Michigan
XAVIER BECERRA, California           MARIO DIAZ-BALART, Florida
LLOYD DOGGETT, Texas                 JEB HENSARLING, Texas
EARL BLUMENAUER, Oregon              DANIEL E. LUNGREN, California
MARION BERRY, Arkansas               MICHAEL K. SIMPSON, Idaho
ALLEN BOYD, Florida                  PATRICK T. McHENRY, North Carolina
JAMES P. McGOVERN, Massachusetts     CONNIE MACK, Florida
BETTY SUTTON, Ohio                   K. MICHAEL CONAWAY, Texas
ROBERT E. ANDREWS, New Jersey        JOHN CAMPBELL, California
ROBERT C. ``BOBBY'' SCOTT, Virginia  PATRICK J. TIBERI, Ohio
BOB ETHERIDGE, North Carolina        JON C. PORTER, Nevada
DARLENE HOOLEY, Oregon               RODNEY ALEXANDER, Louisiana
BRIAN BAIRD, Washington              ADRIAN SMITH, Nebraska
DENNIS MOORE, Kansas
TIMOTHY H. BISHOP, New York
[Vacancy]

                           Professional Staff

            Thomas S. Kahn, Staff Director and Chief Counsel
                James T. Bates, Minority Chief of Staff


                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, February 28, 2007................     1
Statement of:
    Hon. John M. Spratt, Jr., Chairman, House Committee on the 
      Budget.....................................................     1
    Hon. Paul Ryan, a Representative in Congress from the State 
      of Wisconsin...............................................     2
    Hon. Ben S. Bernanke, Chairman, Board of Governors, Federal 
      Reserve System.............................................     5
        Prepared statement of....................................    10
        Response to Ms. Kaptur regarding the fees paid to Wall 
          Street firms for underwriting Treasury debt............    31


                       FISCAL CHALLENGES AND THE
                        ECONOMY IN THE LONG TERM

                              ----------                              


                      WEDNESDAY, FEBRUARY 28, 2007

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:00 a.m., in room 
210, Cannon House Office Building, Hon. John M. Spratt, Jr. 
(Chairman of the committee) presiding.
    The Committee met, pursuant to call, at 10:00 p.m., in room 
210, Cannon House Office Building, Hon. John M. Spratt, Jr. 
(Chairman of the committee) presiding.
    Present: Representatives Spratt, Cooper, Allen, Schwartz, 
Kaptur, Becerra, Doggett, Blumenaur, Berry, McGovern, Andrews, 
Scott, Etheridge, Hooley, Moore, Bishop, Ryan, Barrett, Bonner, 
Garrett, Hensarling, McHenry, Campbell Tiberi, Alexander, 
Smith.
    Chairman Spratt. The hearing will come to order.
    I am pleased today to welcome the Federal Reserve Chairman, 
Dr. Ben Bernanke, to the first appearance he has made before 
the House Budget Committee for a hearing on fiscal challenges 
and the economy over the long term.
    I am pleased for many reasons not least of which is the 
fact that Dr. Bernanke is from Dillon, South Carolina, which is 
in my congressional district.
    So I claim among other things the value of having his 
presence here today but also the bragging rights for what he 
has accomplished at the Fed where over a year's time, he has 
won high marks for his short hand at the helm.
    Despite historically high budget deficits, interest rates 
and inflation are relatively low and our economy has been 
growing at a fairly good clip or healthy pace even if that rate 
has been slowing down recently.
    Six years ago, we were in surplus. Our budget was in 
surplus and black for the first time in 30 years, not just in 
the year 2000, but in 1998 and 1999 as well. As a result, the 
federal government paid down nearly $400 billion of debt held 
by the public.
    And President Bush came to office with an advantage that 
few Presidents have enjoyed, a budget in balance and surplus by 
$236 billion a year before he took office and in balance that 
year, 2000, without including the Social Security Trust Fund.
    As a consequence, a number of members took up a new idea 
that had a corny name, lock box, but has a serious substantive 
core to it. Basically the idea was that we would quit using the 
Social Security surplus to buy up new Treasury debt and instead 
use it to buy down outstanding Treasury debt.
    The idea was that if we pursued this policy diligently, 
religiously, by 2020 or thereabouts, when 77 million baby 
boomers begin claiming their Social Security and Medicare 
benefits, Treasury would be less encumbered by public debt, 
more solvent, and thus better able to meet the claims of the 
baby boomers.
    And by buying down existing Treasury debt, we would add to 
national savings, roll the cost of capital, and make the 
economy more productive and free us from dependence on foreign 
capital.
    After all, one way to make entitlements more affordable, 
this will make our people more productive, and that was part of 
the idea behind the so-called lock box.
    We said to the President when he began to unveil his 
proposal, which took a different turn and he was relying upon 
projected surpluses of $5.6 trillion, that while we may be 
sitting on an island of surpluses, we were surrounded by a sea 
of debt, long-term debt, and that should be taken into account 
now that we have the wherewithal to begin doing something about 
the problem.
    The President, however, took a different path. He proposed 
a budget that over time included tax cuts close to $2 trillion. 
The numbers that were projected in 2001 did not obtain. They 
were seriously wide of the mark.
    And so six years and $3 trillion in debt later, we find 
ourselves on a path that is described everywhere as 
unsustainable, deficit down a bit, down to $248 billion last 
year. That is good news.
    But, Dr. Bernanke, you warn in your testimony that this 
could very well be the lull before the storm. We are glad to 
have you here today to help us understand the perils of the 
path we are now taking and how we can employ the federal 
budget, which constitutes 20 percent of our GDP, to shore up 
our shortfall in savings and to move our economy and our 
country back towards long-term solvency.
    We look forward to your testimony, and we appreciate your 
coming today.
    Before turning to you for your statement, though, I would 
like to recognize Mr. Ryan, our Ranking Member, for a statement 
of his own.
    Mr. Ryan. I thank the Chairman for yielding, and I am 
pleased to have Chairman Bernanke here today. It is nice to 
have you with us.
    I just wanted to quickly go on the area where the Chairman 
went to. If you could call up chart one, please.


    Mr. Ryan. We are here to discuss in the Budget Committee 
how we balance the budget, and that is a very important and 
worthy goal. But if we simply just balance the budget without 
addressing the underlying fundamentals of our budget issues, it 
will be a temporary thing. If we do not balance the budget 
without actually addressing the systemic spending problems 
underneath our budget, that is the problem that we are 
experiencing.
    If you take a look at entitlement spending under the Bush 
Administration, under the Clinton Administration, under 
Republican Presidents, Democrat Presidents, Republican 
Congresses, Democratic Congresses, we have had this problem in 
front of us for quite some time.
    As you can see, all other spending is getting crowded out 
and we are piling on interest and entitlement spending. And we 
are going to hear a lot of talk about the tax cuts as perhaps 
the route to fix and balance the budget.
    But if we balance the budget without addressing the 
underlying, unsustainable growth rates of entitlement spending, 
we will only balance the budget temporarily and go quickly back 
into deficits because of the growth of entitlements.
    If you go to chart two, please.
    
    
    Mr. Ryan. This chart, I think, does a good job of 
illustrating the situation we have in front of us. This looks 
at spending in relation to tax revenues, which shows us in two 
ways.
    First, if we keep the current tax laws in place just as 
they are, current tax rates, current child tax credit, current 
marriage penalty relief, and so on, that is the lower line, the 
blue line.
    If we allow all those tax cuts to go away at the end of the 
decade as they are scheduled to expire, meaning a tax hike of 
$153 billion in 2011, tax hike of $254 billion in 2012, and 
larger amounts thereon after, that is the red line. These 
automatic tax increases are insumed in CBO's current law 
baseline.
    Notice that either way, with or without the tax cuts, 
making them permanent or allowing them to expire, they do not 
come anywhere close to balancing the budget over the long run. 
They are quickly outpaced by the spending that we are on auto 
pilot right now with our entitlement programs.
    So clearly what we face is an immense problem of spending. 
This is the problem right at hand right now and it is not going 
away.
    Members of both sides of the aisle are going to debate 
about how just to accomplish and address these challenges. But 
I think it is very important that as we look at the performance 
of our economy, as we look at whether or not high tax rates on 
capital, high tax rates on families and businesses is the right 
way to go to a balanced budget or not, even if we go down the 
route of letting all the tax cuts expire, it does not come 
anywhere close to solving our fiscal problems, which is 
unsustainable entitlements.
    And that is the issue that I think we ought to be 
addressing, and that is the issue I would love to get your 
opinions on, Chairman Bernanke.
    Also, I will just simply say we had an interesting day in 
the stock market yesterday with the precipitous drop. I know 
all of us are very concerned about that, and I think we would 
love to get your reflections should you care to share them with 
us on that point as well.
    And with that, I would like to yield back the balance of my 
time. Thank you, Chairman.
    Chairman Spratt. Thank you, Mr. Ryan.
    Dr. Bernanke, thank you again for coming.
    Before proceeding, let me ask unanimous consent that all 
members be allowed to submit an opening statement for the 
record at this point.
    In addition, Dr. Bernanke, we will be glad to make your 
statement a part of the record so that you can summarize parts 
of it if you please.
    The floor is yours. Thank you again for coming.

  STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS, 
                     FEDERAL RESERVE SYSTEM

    Mr. Bernanke. Thank you.
    Chairman Spratt, Representative Ryan, and other members of 
the Committee, I am pleased to be here to offer my views on the 
federal budget and related issues.
    At the outset, I should underscore that I speak only for 
myself and not for my colleagues necessarily at the Federal 
Reserve.
    My testimony will focus on the long-term budget outlook and 
will draw on the most recent set of long-term projections from 
the Congressional Budget Office issued in December 2005.
    The CBO constructed its projections based on the 
assumptions that real gross domestic product would rise about 
three and a half percent per year in 2005 and 2006 and at the 
rate of 2.9 percent per anum from 2007 to 2015.
    The growth projections through 2015 were in turn based on 
the assumptions that trend labor force growth will average 0.8 
percent per year and that trend labor productivity growth in 
the nonforeign business sector will average 2.4 percent per 
year.
    The CBO has since updated those assumptions for the 
purposes of other analyses, but the revisions were not large 
enough to materially alter the broad contours of the fiscal 
outlook.
    As to the longer-term outlook, the CBO assumed that the 
growth rate of real GDP will average about two percent per year 
starting around 2020. While such projections are subject to 
considerable uncertainty, the CBO's assumptions provide a 
sensible and useful starting point for assessing the budget 
situation over the long run.
    Before discussing the longer-run outlook, I will comment on 
recent budget developments. As you know, the deficit in the 
unified federal budget declined for a second year in fiscal 
year 2006, falling to $248 billion from $318 billion in fiscal 
2005.
    So far in fiscal 2007, solid growth in receipts, especially 
in collections of personal and corporate income taxes, has held 
the deficit somewhat below year earlier levels. Of course, a 
good deal of uncertainty still surrounds the budget outcome for 
the year as a whole.
    Federal government outlays in fiscal 2006 were 20.3 percent 
of nominal gross domestic product. Receipts were 18.4 percent 
of GDP and the deficit, the difference of the two, was 1.9 
percent of GDP. These percentages are close to their averages 
since 1960.
    The on budget deficit, which differs from the unified 
budget deficit, primarily and excluding receipts and payments 
of the Social Security system, was $434 billion or 3.3 percent 
of GDP in fiscal 2006.
    As of the end of fiscal 2006, federal government debt held 
by the public, which includes holdings by the Federal Reserve, 
but excludes those by the Social Security and other trust 
funds, amounted to 37 percent of one year's GDP.
    Official projections suggest that the unified budget 
deficit may stabilize or moderate further over the next few 
years. Unfortunately, we are experiencing what seems likely to 
be the calm before the storm. In particular, spending on 
entitlement programs will begin to climb quickly during the 
next decade.
    In fiscal 2006, federal spending for Social Security, 
Medicare, and Medicaid together totaled about 40 percent of 
federal expenditures or eight and a half percent of GDP.
    In the medium-term projections released by the CBO in 
January, these outlays increase to ten and three-quarters 
percent of GDP by 2017, an increase of about two percentage 
points of GDP in little more than a decade. And they will 
likely continue to rise sharply relative to GDP in the years 
after that.
    As I will discuss, these rising entitlement obligations 
will put enormous pressure on the federal budget in coming 
years.
    The large projected increases in future entitlement 
spending have two principal sources. First, like many other 
industrial countries, the United States has entered what is 
likely to be a long period of demographic transition. The 
result, both of the reduction in fertility that followed the 
post World War II baby boom and of ongoing increases in life 
expectancy.
    Longer life expectancies are certainly to be welcomed, but 
they are likely to lead to longer periods of retirement in the 
future even as the growth rate of the workforce declines.
    As a consequence of these demographic trends, the number of 
people of retirement age will grow relative both to the 
population as a whole and to the number of potential workers.
    Currently people 65 years and older make up about 12 
percent of the U.S. population, and there are about five people 
between the ages of 20 and 65 for each person 65 and older.
    According to the intermediate projections of the Social 
Security Trustees, in 2030, Americans 65 and older will 
constitute about 19 percent of the U.S. population and the 
ratio of those between the ages of 20 and 64 to those 65 and 
older will have fallen to about three.
    Although the retirement of the baby boomers will be an 
important milestone in the demographic transition, the oldest 
baby boomers will be eligible for Social Security benefits 
starting next year.
    The change in the nation's demographic structure is not 
just a temporary phenomenon related to the large relative size 
of the baby boom generation. Rather, if the U.S. fertility rate 
remains close to current levels and life expectancies continue 
to rise as demographers generally expect, the U.S. population 
will continue to grow older even after the baby boom generation 
has passed from the scene.
    If current law is maintained, that aging of the U.S. 
population will lead to sustained increases in federal 
entitlement spending on programs that benefit older Americans, 
such as Social Security and Medicare.
    The second cause of rising entitlement spending is the 
expected continued increase in medical costs per beneficiary. 
Projections of future medical costs are fraught with 
uncertainty. But history suggests that without significant 
changes in policy, these costs are likely to continue to rise 
more quickly than incomes, at least for the foreseeable future.
    Together with the aging of the population, ongoing 
increases in medical costs will lead to a rapid expansion of 
Medicare and Medicaid expenditures.
    Long-range projections prepared by the CBO vividly portray 
the potential effects on the budget of an aging population and 
rapidly rising healthcare costs.
    The CBO has developed projections for a variety of 
alternative scenarios based on different assumptions about the 
evolution of spending and taxes. The scenarios produce a wide 
range of possible budget outcomes reflecting the substantial 
uncertainty that attends long-range budget projections.
    However, the outcomes that appear most likely in the 
absence of policy changes involve rising budget deficits and 
increases in the amount of federal debt outstanding to 
unprecedented levels.
    For example, one plausible scenario is based on the 
assumptions that federal retirement and health spending will 
follow the CBO's intermediate projection, defense spending will 
drift down over time as a percentage of GDP, other noninterest 
spending will grow roughly in line with GDP, and federal 
revenues will remain close to their historical share of GDP, 
that is about where they are today.
    Under these assumptions, the CBO calculates that by 2030, 
the federal budget deficit will approach nine percent of GDP, 
more than four times greater as a share of GDP than the deficit 
in the fiscal year 2006.
    A particularly worrisome aspect of this projection and 
similar ones is the implied evolution of the national debt and 
the associated interest payments to government bond holders.
    Minor details aside, the federal debt held by the public 
increases each year by the amount of that year's unified 
deficit. Consequently, scenarios that project large deficits 
also project rapid growth in the outstanding government debt.
    The higher levels of debt in turn imply increased 
expenditures on interest payments to bond holders which 
exacerbate the deficit problem still further.
    Thus, a vicious cycle may develop in which large deficits 
lead to rapid growth in debt and interest payments which in 
turn adds to the subsequent deficits.
    According to the CBO projection that I have been 
discussing, interest payments on the government's debt will 
reach four and a half percent of GDP in 2013, nearly three 
times their current size relative to national output.
    Under this scenario, the ratio of federal debt held by the 
public to GDP would climb from 37 percent to roughly 100 
percent in 2030 and would continue to grow exponentially after 
that.
    The only time in U.S. history that the debt to GDP ratio 
has been in the neighborhood of 100 percent was during World 
War II. People at that time understood the situation to be 
temporary and expected deficits and the debt to GDP ratio to 
fall rapidly after the war as, in fact, they did.
    In contrast, under the scenario I have been discussing, the 
debt to GDP ratio would rise far into the future at an 
accelerating rate. Ultimately this expansion of debt would 
spark a fiscal crisis which could be addressed only by very 
sharp spending cuts or tax increases or both.
    The CBO projections by design ignore the adverse effects 
that such high deficits would likely have on economic growth. 
But if government debt and deficits were actually to grow at 
the pace envisioned by the CBO's scenario, the effects on the 
U.S. economy would be severe.
    High rates of government borrowing would drain funds away 
from capital formation and thus slow the growth of real incomes 
and living standards over time.
    Some fraction of the additional debt that would likely be 
financed abroad would lessen the negative influence on domestic 
investment. However, the necessity of paying interest on the 
foreign held debt would leave a smaller portion of our nature's 
future output available for domestic consumption.
    Moreover, uncertainty about the ultimate resolution of the 
fiscal imbalances would reduce the confidence of consumers, 
businesses, and investors in the U.S. economy with adverse 
implications for investment and growth.
    To some extent, strong economic growth can help to mitigate 
budgetary pressures and all else being equal, fiscal policies 
that are supportive of growth would be beneficial.
    Unfortunately, economic growth alone is unlikely to solve 
the nation's impending fiscal problems. Economic growth leads 
to higher wages and profits and thus increases in tax receipts. 
But higher wages also imply increased Social Security benefits 
as those benefits are tied to wages.
    Higher incomes also tend to increase the demand for medical 
services so that indirectly higher incomes may also increase 
federal health expenditures.
    Increased rates of immigration could raise growth by 
raising the growth rate of the labor force. However, economists 
who have looked at the issue have found that even a doubling in 
the rate of immigration into the United States from about one 
million to two million immigrants per year would not 
significantly reduce the federal government's fiscal imbalance.
    The prospect of growing fiscal imbalances and their 
economic consequences also raises essential questions of 
intergenerational fairness. As I have noted, because of 
increasing life expectancy and the decline in fertility, the 
number of retirees that each worker will have to support in the 
future, either directly or indirectly, through taxes paid to 
support government programs will rise significantly.
    To the extent that federal budgetary policies inhibit 
capital formation and our increases net liabilities to 
foreigners, future generations of Americans will bear a growing 
burden of the debt and experience slower growth in per capita 
incomes than would otherwise have been the case.
    An important element in ensuring that we leave behind a 
stronger economy than we inherited as in virtually all previous 
generations in this country will be to move over time towards 
fiscal policies that are sustainable, efficient, and equitable 
across generations.
    Policies that promote private as well as public saving 
would also help us to leave a productive economy to our 
children and grandchildren. In addition, we should explore ways 
to make the labor market as accommodating as possible to older 
people who wish to continue working as many will as longevity 
increases and health improves.
    Addressing the country's fiscal problems will take 
persistence and a willingness to make difficult choices. In the 
end, the fundamental decision that the Congress, the 
Administration, and the American people must confront is how 
large a share of the nation's economic resources to devote to 
federal government programs, including transfer programs, such 
as Social Security, Medicare, and Medicaid.
    Crucially, whatever size of the government is chosen, tax 
rates must ultimately be set at a level sufficient to achieve 
an appropriate balance of spending and revenues in the long 
run.
    Thus, members of the Congress who put special emphasis on 
keeping tax rates low must accept that low tax rates can be 
sustained only if outlays, including those and entitlements, 
are kept low as well.
    Likewise, members who favor a more expansive role of the 
government, including relatively more generous benefits 
payments, must recognize the burden imposed by the additional 
taxes needed to pay for the higher spending, a burden that 
includes not only the resources transferred from the private 
sector but also any adverse economic incentives associated with 
higher tax rates.
    Achieving fiscal sustainability will require sustained 
efforts and attention over many years. As an aid in charting 
the way forward, the Congress may find it useful to set some 
benchmarks against which to gauge progress towards key 
budgetary objectives.
    Because no single statistic fully describes the fiscal 
situation, the most effective approach would likely involve 
monitoring a number of fiscal indicators, each of which 
captures a different aspect of the budget and its economic 
impact.
    The unified budget deficit projected forward a certain 
number of years is an important measure that is already 
included in the congressional budgeting process. However, the 
unified budget deficit does not fully capture the fiscal 
situation and its effect on the economy for at least two 
reasons.
    First, the budget deficit by itself does not measure the 
quantity of resources that the government is taking from the 
private sector. An economy in which the government budget is 
balanced but in which government spending equals 20 percent of 
GDP is very different from one in which the government's budget 
is balanced but its spending is 40 percent of GDP as the latter 
economy has both higher tax rates and a greater role for the 
government.
    Monitoring current and prospective levels of total 
government outlays relative to GDP or a similar indicator would 
help the Congress to ensure that the overall size of the 
government relative to the economy is consistent with members' 
views and preferences.
    Second, the annual budget deficit reflects only near-term 
financing needs and does not capture long-term fiscal 
imbalances. As the most difficult long-term budgetary issues 
are associated with the growth of entitlement spending, a 
comprehensive approach to budgeting would include close 
attention to measures of the long-term solvency of entitlement 
programs, such as long horizon present values of unfunded 
liabilities for Social Security and Medicare.
    To summarize, because of demographic changes and rising 
medical costs, federal expenditures for entitlement programs 
are projected to rise sharply over the next few decades. 
Dealing with the resulting fiscal strains will pose difficult 
choices for the Congress, the Administration, and the American 
people.
    However, if early and meaningful action is not taken, the 
U.S. economy could be seriously weakened with future 
generations bearing much of the cost.
    The decisions the Congress will face will not be easy or 
simple, but the benefits of placing the budget on a path that 
is both sustainable and meets the nation's long-run needs would 
be substantial.
    Thank you again for allowing me to comment on these 
important issues, and I would be glad to take your questions. 
Thank you again.
    [The prepared statement of Ben S. Bernanke follows:]

    Prepared Statement of Hon. Ben S. Bernanke, Chairman, Board of 
                Governors of the Federal Reserve System

    Chairman Spratt, Representative Ryan, and other members of the 
Committee, I am pleased to be here to offer my views on the federal 
budget and related issues. At the outset, I should underscore that I 
speak only for myself and not necessarily for my colleagues at the 
Federal Reserve.
    My testimony will focus on the long-term budget outlook and will 
draw on the most recent set of long-term budget projections from the 
Congressional Budget Office (CBO), issued in December 2005. The CBO 
constructed its projections based on the assumptions that real gross 
domestic product (GDP) would rise about 3\1/2\ percent per year in 2005 
and 2006 and at a rate of 2.9 per cent per annum from 2007 through 
2015. The growth projections through 2015 were in turn based on the 
assumptions that trend labor force growth will average 0.8 percent per 
year and that trend labor productivity growth in the nonfarm business 
sector will average 2.4 percent per year. The CBO has since updated 
those assumptions for the purposes of other analyses, but the revisions 
were not large enough to materially alter the broad contours of the 
fiscal outlook.\1\ As for the longer-term outlook, the CBO assumed that 
the growth rate of real GDP will average about 2 percent per year 
starting around 2020. While such projections are subject to 
considerable uncertainty, the CBO's assumptions provide a sensible and 
useful starting point for assessing the budget situation over the 
longer run.
    Before discussing that longer-run outlook, I will comment on recent 
budget developments. As you know, the deficit in the unified federal 
budget declined for a second year in fiscal year 2006, falling to $248 
billion from $318 billion in fiscal 2005. So far in fiscal 2007, solid 
growth in receipts, especially in collections of personal and corporate 
income taxes, has held the deficit somewhat below year-earlier levels. 
Of course, a good deal of uncertainty still surrounds the budget 
outcome for the year as a whole. Federal government outlays in fiscal 
2006 were 20.3 percent of nominal gross domestic product (GDP), 
receipts were 18.4 percent of GDP, and the deficit (equal to the 
difference of the two) was 1.9 percent of GDP. These percentages are 
close to their averages since 1960. The on-budget deficit, which 
differs from the unified budget deficit primarily in excluding receipts 
and payments of the Social Security system, was $434 billion, or 3.3 
percent of GDP, in fiscal 2006.\2\ As of the end of fiscal 2006, 
federal government debt held by the public, which includes holdings by 
the Federal Reserve but excludes those by the Social Security and other 
trust funds, amounted to 37 percent of one year's GDP.
    Official projections suggest that the unified budget deficit may 
stabilize or moderate further over the next few years. Unfortunately, 
we are experiencing what seems likely to be the calm before the storm. 
In particular, spending on entitlement programs will begin to climb 
quickly during the next decade. In fiscal 2006, federal spending for 
Social Security, Medicare, and Medicaid together totaled about 40 
percent of federal expenditures, or 8\1/2\ percent of GDP.\3\ In the 
medium-term projections released by the CBO in January, these outlays 
increase to 10\3/4\ percent of GDP by 2017, an increase of about 2 
percentage points of GDP in little more than a decade, and they will 
likely continue to rise sharply relative to GDP in the years after 
that. As I will discuss, these rising entitlement obligations will put 
enormous pressure on the federal budget in coming years.
    The large projected increases in future entitlement spending have 
two principal sources. First, like many other industrial countries, the 
United States has entered what is likely to be a long period of 
demographic transition, the result both of the reduction in fertility 
that followed the post-World War II baby boom and of ongoing increases 
in life expectancy. Longer life expectancies are certainly to be 
welcomed. But they are likely to lead to longer periods of retirement 
in the future, even as the growth rate of the workforce declines. As a 
consequence of the demographic trends, the number of people of 
retirement age will grow relative both to the population as a whole and 
to the number of potential workers. Currently, people 65 years and 
older make up about 12 percent of the U.S. population, and there are 
about five people between the ages of 20 and 64 for each person 65 and 
older. According to the intermediate projections of the Social Security 
Trustees, in 2030 Americans 65 and older will constitute about 19 
percent of the U.S. population, and the ratio of those between the ages 
of 20 and 64 to those 65 and older will have fallen to about 3.
    Although the retirement of the baby boomers will be an important 
milestone in the demographic transition--the oldest baby boomers will 
be eligible for Social Security benefits starting next year--the change 
in the nation's demographic structure is not just a temporary 
phenomenon related to the large relative size of the baby-boom 
generation. Rather, if the U.S. fertility rate remains close to current 
levels and life expectancies continue to rise, as demographers 
generally expect, the U.S. population will continue to grow older, even 
after the baby-boom generation has passed from the scene. If current 
law is maintained, that aging of the U.S. population will lead to 
sustained increases in federal entitlement spending on programs that 
benefit older Americans, such as Social Security and Medicare.
    The second cause of rising entitlement spending is the expected 
continued increase in medical costs per beneficiary. Projections of 
future medical costs are fraught with uncertainty, but history suggests 
that--without significant changes in policy--these costs are likely to 
continue to rise more quickly than incomes, at least for the 
foreseeable future. Together with the aging of the population, ongoing 
increases in medical costs will lead to a rapid expansion of Medicare 
and Medicaid expenditures.
    Long-range projections prepared by the CBO vividly portray the 
potential effects on the budget of an aging population and rapidly 
rising health care costs. The CBO has developed projections for a 
variety of alternative scenarios, based on different assumptions about 
the evolution of spending and taxes. The scenarios produce a wide range 
of possible budget outcomes, reflecting the substantial uncertainty 
that attends long-range budget projections.\4\ However, the outcomes 
that appear most likely, in the absence of policy changes, involve 
rising budget deficits and increases in the amount of federal debt 
outstanding to unprecedented levels. For example, one plausible 
scenario is based on the assumptions that (1) federal retirement and 
health spending will follow the CBO's intermediate projection; (2) 
defense spending will drift down over time as a percentage of GDP; (3) 
other non-interest spending will grow roughly in line with GDP; and (4) 
federal revenues will remain close to their historical share of GDP--
that is, about where they are today.\5\ Under these assumptions, the 
CBO calculates that, by 2030, the federal budget deficit will approach 
9 percent of GDP--more than four times greater as a share of GDP than 
the deficit in fiscal year 2006.
    A particularly worrisome aspect of this projection and similar ones 
is the implied evolution of the national debt and the associated 
interest payments to government bondholders. Minor details aside, the 
federal debt held by the public increases each year by the amount of 
that year's unified deficit. Consequently, scenarios that project large 
deficits also project rapid growth in the outstanding government debt. 
The higher levels of debt in turn imply increased expenditures on 
interest payments to bondholders, which exacerbate the deficit problem 
still further. Thus, a vicious cycle may develop in which large 
deficits lead to rapid growth in debt and interest payments, which in 
turn adds to subsequent deficits. According to the CBO projection that 
I have been discussing, interest payments on the government's debt will 
reach 4\1/2\ percent of GDP in 2030, nearly three times their current 
size relative to national output. Under this scenario, the ratio of 
federal debt held by the public to GDP would climb from 37 percent 
currently to roughly 100 percent in 2030 and would continue to grow 
exponentially after that. The only time in U.S. history that the debt-
to-GDP ratio has been in the neighborhood of 100 percent was during 
World War II. People at that time understood the situation to be 
temporary and expected deficits and the debt-to-GDP ratio to fall 
rapidly after the war, as in fact they did. In contrast, under the 
scenario I have been discussing, the debt-to-GDP ratio would rise far 
into the future at an accelerating rate. Ultimately, this expansion of 
debt would spark a fiscal crisis, which could be addressed only by very 
sharp spending cuts or tax increases, or both.\6\
    The CBO projections, by design, ignore the adverse effects that 
such high deficits would likely have on economic growth. But if 
government debt and deficits were actually to grow at the pace 
envisioned by the CBO's scenario, the effects on the U.S. economy would 
be severe. High rates of government borrowing would drain funds away 
from private capital formation and thus slow the growth of real incomes 
and living standards over time. Some fraction of the additional debt 
would likely be financed abroad, which would lessen the negative 
influence on domestic investment; however, the necessity of paying 
interest on the foreign-held debt would leave a smaller portion of our 
nation's future output available for domestic consumption. Moreover, 
uncertainty about the ultimate resolution of the fiscal imbalances 
would reduce the confidence of consumers, businesses, and investors in 
the U.S. economy, with adverse implications for investment and growth.
    To some extent, strong economic growth can help to mitigate 
budgetary pressures, and all else being equal, fiscal policies that are 
supportive of growth would be beneficial. Unfortunately, economic 
growth alone is unlikely to solve the nation's impending fiscal 
problems. Economic growth leads to higher wages and profits and thus 
increases tax receipts, but higher wages also imply increased Social 
Security benefits, as those benefits are tied to wages. Higher incomes 
also tend to increase the demand for medical services so that, 
indirectly, higher incomes may also increase federal health 
expenditures. Increased rates of immigration could raise growth by 
raising the growth rate of the labor force. However, economists who 
have looked at the issue have found that even a doubling in the rate of 
immigration to the United States, from about 1 million to 2 million 
immigrants per year, would not significantly reduce the federal 
government's fiscal imbalance.\7\
    The prospect of growing fiscal imbalances and their economic 
consequences also raises essential questions of intergenerational 
fairness.\8\ As I have noted, because of increasing life expectancy and 
the decline in fertility, the number of retirees that each worker will 
have to support in the future--either directly or indirectly through 
taxes paid to support government programs--will rise significantly. To 
the extent that federal budgetary policies inhibit capital formation 
and increase our net liabilities to foreigners, future generations of 
Americans will bear a growing burden of the debt and experience slower 
growth in per-capita incomes than would otherwise have been the case.
    An important element in ensuring that we leave behind a stronger 
economy than we inherited, as did virtually all previous generations in 
this country, will be to move over time toward fiscal policies that are 
sustainable, efficient, and equitable across generations. Policies that 
promote private as well as public saving would also help us leave a 
more productive economy to our children and grandchildren. In addition, 
we should explore ways to make the labor market as accommodating as 
possible to older people who wish to continue working, as many will as 
longevity increases and health improves.
    Addressing the country's fiscal problems will take persistence and 
a willingness to make difficult choices. In the end, the fundamental 
decision that the Congress, the Administration, and the American people 
must confront is how large a share of the nation's economic resources 
to devote to federal government programs, including transfer programs 
such as Social Security, Medicare, and Medicaid. Crucially, whatever 
size of government is chosen, tax rates must ultimately be set at a 
level sufficient to achieve an appropriate balance of spending and 
revenues in the long run. Thus, members of the Congress who put special 
emphasis on keeping tax rates low must accept that low tax rates can be 
sustained only if outlays, including those on entitlements, are kept 
low as well. Likewise, members who favor a more expansive role of the 
government, including relatively more-generous benefits payments, must 
recognize the burden imposed by the additional taxes needed to pay for 
the higher spending, a burden that includes not only the resources 
transferred from the private sector but also any adverse economic 
incentives associated with higher tax rates.
    Achieving fiscal sustainability will require sustained efforts and 
attention over many years. As an aid in charting the way forward, the 
Congress may find it useful to set some benchmarks against which to 
gauge progress toward key budgetary objectives. Because no single 
statistic fully describes the fiscal situation, the most effective 
approach would likely involve monitoring a number of fiscal indicators, 
each of which captures a different aspect of the budget and its 
economic impact. The unified budget deficit, projected forward a 
certain number of years, is an important measure that is already 
included in the congressional budgeting process. However, the unified 
budget deficit does not fully capture the fiscal situation and its 
effect on the economy, for at least two reasons.
    First, the budget deficit by itself does not measure the quantity 
of resources that the government is taking from the private sector. An 
economy in which the government budget is balanced but in which 
government spending equals 20 percent of GDP is very different from one 
in which the government's budget is balanced but its spending is 40 
percent of GDP, as the latter economy has both higher tax rates and a 
greater role for the government. Monitoring current and prospective 
levels of total government outlays relative to GDP or a similar 
indicator would help the Congress ensure that the overall size of the 
government relative to the economy is consistent with members' views 
and preferences.
    Second, the annual budget deficit reflects only near-term financing 
needs and does not capture long-term fiscal imbalances. As the most 
difficult long-term budgetary issues are associated with the growth of 
entitlement spending, a comprehensive approach to budgeting would 
include close attention to measures of the long-term solvency of 
entitlement programs, such as long-horizon present values of unfunded 
liabilities for Social Security and Medicare.
    To summarize, because of demographic changes and rising medical 
costs, federal expenditures for entitlement programs are projected to 
rise sharply over the next few decades. Dealing with the resulting 
fiscal strains will pose difficult choices for the Congress, the 
Administration, and the American people. However, if early and 
meaningful action is not taken, the U.S. economy could be seriously 
weakened, with future generations bearing much of the cost. The 
decisions the Congress will face will not be easy or simple, but the 
benefits of placing the budget on a path that is both sustainable and 
meets the nation's long-run needs would be substantial.
    Thank you again for allowing me to comment on these important 
issues. I would be glad to take your questions.

                                ENDNOTES

    \1\ According to the latest estimates of the Bureau of Economic 
Analysis (BEA), real GDP growth was 3.2 percent in 2005 and 3.4 percent 
in 2006, both figures stated on an annual-average basis. The figure for 
2006 is the BEA's ``advance'' estimate; a revised estimate is scheduled 
for release today.
    \2\ Excluding the operations of both Social Security and Medicare 
Part A, the budget deficit in fiscal year 2006 was $459 billion, or 3.5 
percent of GDP. Like Social Security, Medicare Part A pays benefits out 
of, and receives a dedicated stream of revenues into, a trust fund.
    \3\ Net of Medicare premiums paid by beneficiaries and amounts paid 
by states from savings on Medicaid prescription drug costs, these 
outlays were equal to 8 percent of GDP.
    \4\ For example, in 2030, five of the six scenarios imply deficits 
ranging from 1\1/2\ percent of GDP to nearly 14 percent of GDP; a sixth 
scenario is capable of producing a surplus, but it relies on the 
confluence of a very favorable set of assumptions.
    \5\ For more information about this scenario, see the description 
of Scenario 2 in Congressional Budget Office (2005), The Long-Term 
Budget Outlook, December, pp. 5-13 and 48-49, www.cbo.gov/ftpdocs/69xx/
doc6982/12-15-LongTermOutlook.pdf. Consistent with the assumptions used 
by the Medicare trustees, the CBO's intermediate projections for 
Medicare and Medicaid are based on the assumption that, over the long 
run, per beneficiary health expenditures will increase at a rate that 
is 1 percentage point per year greater than the growth rate of per 
capita GDP. Over the past twenty-five years, however, per beneficiary 
Medicare spending has actually exceeded per capita GDP growth by about 
2\1/2\ percentage points per year. Thus, a significant slowing in the 
growth of medical costs per beneficiary will be needed to keep 
expenditures close to those projected in this scenario.
    \6\ To give a sense of the magnitudes involved, suppose--for the 
sake of illustration only--that the deficit projected for 2030 in the 
CBO scenario were to be eliminated entirely in that year, half through 
reductions in discretionary spending and half through increases in non-
payroll taxes. (Of course, in reality the fiscal adjustment would 
likely not occur in one year, but this hypothetical example is useful 
for showing the magnitude of the problem.) This fiscal adjustment would 
involve a cut in discretionary spending (including defense) of nearly 
80 percent (relative to its baseline level) and a rise in non-payroll 
taxes of more than 35 percent. The need for such painful measures could 
be diminished by beginning the process of fiscal adjustment much 
earlier, thereby avoiding some of the buildup in outstanding debt and 
the associated interest burden.
    \7\ CBO (2005), The Long-Term Budget Outlook, p. 3.
    \8\ I discussed this issue in Ben S. Bernanke (2006), ``The Coming 
Demographic Transition: Will We Treat Future Generations Fairly?'', 
speech delivered before the Washington Economic Club, Washington, 
October 4, www.federalreserve.gov/boarddocs/speeches/2006/20061004/
default.htm.

    Chairman Spratt. Dr. Bernanke, you will receive questions 
on this subject anyway, so I will give you the opportunity to 
take the first pitch.
    Yesterday, we had severe disruption in the stock markets. 
Would you care to make any statement or reflection upon what 
happened yesterday and whether or not it has any connection to 
our fiscal situation?
    Mr. Bernanke. There did not seem to be any single trigger 
of the market correction we saw yesterday. I do not think it 
would be useful for me to try to parse the movement into the 
components associated with different pieces of news or pieces 
of information.
    I will say that the Federal Reserve in collaboration with 
the President's Working Group has been closely monitoring the 
markets. They seem to be working well and normally.
    We have also, of course, been closely monitoring the 
economy, looking at new data and trying to evaluate their 
implications for the forecast.
    And my view is that taking all the new data into account 
that there is really no material change in our expectations for 
the U.S. economy since I last reported to Congress a couple 
weeks ago in the Humphrey Hawkins hearings.
    Chairman Spratt. Do you expect the growth rate in the 
economy to decline slightly?
    Mr. Bernanke. We are looking for moderate growth in the 
U.S. economy going forward. And I would add parenthetically 
that the downward revision of the fourth quarter GDP numbers we 
got this morning is actually more consistent with our overall 
view of the economy than were the original numbers.
    So we expect moderate growth going forward. We believe that 
if the housing sector begins to stabilize and if some of the 
inventory corrections are still going on and manufacturing 
begins to be completed that there is a reasonable possibility 
that we will see some strengthening of the economy sometime 
during the middle of the year.
    Chairman Spratt. Turning now to a different topic. We have 
difficulty explaining to the American public why the deficit is 
such a serious matter. You just touched upon and every 
eloquently touched upon the intergenerational equity aspects of 
the problem.
    But we do not see or feel the effects of it now, and that 
is even more true for the long-term debt, which is substantial. 
When it is discounted back to present value, you can understand 
it in those terms. But, nevertheless, we do not see the 
consequences of it.
    Traditionally it was believed that the federal government 
would, by running large deficits, crowd out private borrowers 
in the credit markets and run up interest rates. We have not 
seen any unusual increase in relative interest rates, and that 
appears to be a result of the fact that we are financing a lot 
of our debt with foreigners.
    Is that a correct perception and, if so, what are the 
consequences of being reliant for financing the federal 
government on foreign capital markets?
    Mr. Bernanke. Mr. Chairman, in the short run, budget 
deficits tend to reduce national saving. And that leads to two 
possible outcomes. One is that domestic investment will fall 
accordingly along with saving. The other possibility is that 
investment will be maintained, but in order to finance that 
investment, we have to borrow essentially abroad, which results 
in a large current account deficit.
    In recent years, it seems more of the latter has been 
happening. We have been borrowing abroad to finance domestic 
investment, and so we have seen not a very significant increase 
in real interest rates. In fact, real interest rates are 
generally low around the world.
    But what we have seen on the other side of the equation, we 
have seen large increases in our foreign debt and in our 
current account deficit.
    Looking forward to the longer run, I guess the analogy I 
would make here is that this is sort of like a snowball rolling 
down the hill. It is already a pretty big snowball, but it is 
going to get a lot bigger a lot faster, and we have an 
opportunity now to try and prevent that cumulative process that 
will go on if we do not take some action.
    In particular, because deficits feed into debt which feed 
into deficits, this could really get out of control over a long 
period of time, and it would have very significant consequences 
for capital formation and for foreign debt and for the 
financial security of Americans, particularly the next 
generation who will be saddled with this growing debt.
    So it is a very significant problem. The real consequences 
will be felt to a greater degree over time and more so a few 
years from now than today, but it is that very fact that we 
have the opportunity to move today that we can perhaps put 
ourselves on a better path and avoid what would have to be much 
more severe and draconian responses ten, fifteen, or twenty 
years down the road.
    Chairman Spratt. One reason we resort to foreign borrowing 
is that we have at the present time a dismally, abysmally low 
savings rate ourselves in the United States.
    What do you think we should do to improve to shore up the 
savings rate in the United States?
    Mr. Bernanke. Well, that is a challenging question. 
Certainly improving budget balance both at the federal and, to 
some extent also, of course, at the state and local levels.
    Chairman Spratt. Because that by itself is dis-saving. If 
you correct that, that in itself----
    Mr. Bernanke. That is correct.
    Chairman Spratt [continuing]. Corrects part of the problem.
    Mr. Bernanke. So the borrowing to finance deficits, if you 
think of it is as being taken out of the pool of saving done by 
the private sector, leaving less left over for capital 
investment. So one way to add to national saving is to try to 
reduce deficits as much as possible.
    The other is, of course, to try and increase saving in the 
private sector. And we have in our country relatively low, in 
fact currently negative, household saving rates.
    There is quite a debate among economists about how best to 
increase those saving rates. I would just point to one 
direction that was included in the recent pension bill that the 
Congress passed and the President signed which is to allow opt 
out 401k programs among employers.
    We have a lot of evidence that people, if they are required 
to opt out of a savings program, that the inertia will win out 
and they will save more. And that is really one of the ways in 
which we probably could increase saving at the private level.
    Beyond that, there are a number of possibilities, including 
tax policies, including financial literacy and others, which I 
can discuss in more detail. I am sure there will be questions. 
But we do not really have a silver bullet for household saving, 
and we should, I think, though, try to encourage it as much as 
possible.
    Chairman Spratt. One final question from me. You made a 
speech recently in which you addressed a concern. To some 
extent, you touched upon it today when you discussed the 
intergenerational equity of deficits. You were concerned about 
the disparities in income in our economy.
    To what extent is this a problem for the economy itself, 
for the country, and what would you recommend that we do about 
that? Are you recommending more progressive tax policies or----
    Mr. Bernanke. Mr. Chairman----
    Chairman Spratt [continuing]. What do we need to do to 
address that problem, and how severe is the problem in your 
estimation?
    Mr. Bernanke. Mr. Chairman, this is not a new issue. We 
have seen increasing income inequality in the United States for 
at least three decades and, according to some measures, maybe 
four or five decades.
    In my speech, I discussed a number of possible sources of 
that increase in inequality. I think one of the most important 
is technology which is increasing the returns to higher 
education. So people who have more education or greater skills 
are seeing much higher incomes relative to those with less 
education and lower skills. And that is generating greater 
inequality in the economy.
    I think this is an important problem both because we do not 
want to see excessive inequality and we do not want to see 
people at the lower end of the ladder not enjoying, you know, 
some of the benefits of our economic growth.
    I think it is also a problem because in order to continue 
to grow, we need to have public buy-in to a continued open and 
flexible economy. And I am afraid that if people begin to feel 
that the economy is not benefiting them, then they will, you 
know, resist the flexibility and dynamism that is so important 
to our economic growth.
    I think the most likely approach for arresting this trend, 
the most beneficial approach would be to strengthen our 
educational and training systems as much as possible and to 
encourage people to get the skills they need to earn higher 
incomes.
    Chairman Spratt. Thank you very much.
    Mr. Ryan.
    Mr. Ryan. Thank you, Mr. Chairman and Mr. Chairman.
    Some people believe that yesterday's market corrections are 
due to a liquidity crunch and they compare it to the 
corrections in 1987 and 1998.
    Do you believe or agree that there is a liquidity problem 
in the world today?
    Mr. Bernanke. No, I do not think so.
    Mr. Ryan. Some also have been pointing to a concern about 
subprime lending. And just yesterday, Freddie Mac said that it 
would tighten its lending standards.
    It seems to some of us that this is a small part of the 
market and unlikely to cause major problems, but I would be 
curious about your take on that.
    Mr. Bernanke. There certainly have been some concerns 
raised about the health of the subprime sector. We have seen 
increasing rate of default. We have seen financial distress on 
the part of lenders. And so that is a concern.
    We are monitoring that situation very carefully, and it was 
one of the factors, I think, which has contributed to some 
unease about the economy, about the market.
    Our assessment, though, while this is a very important 
problem and an issue obviously for many people who are facing 
foreclosure, our assessment is that there is not much 
indication at this point that subprime mortgage issues have 
spread into the broader mortgage market, which still seems to 
be healthy, and the lending side of that still seems to be 
healthy.
    So it is a concern. But at this point, we do not see it as 
being a broad financial concern or a major factor in assessing 
the course of the economy.
    Mr. Ryan. I want to ask a question about sort of fed 
governance. For the 1960s and the 1970s, the fed and central 
banks around the world really sort of used a Phillip's curve to 
dictate monetary policy. And it seems that the evidence, which 
obviously is lagging and takes a while to build up, has come in 
and has more or less clearly debunked the Phillip's curve as a 
primary driver of monetary policy. And there seems to be a 
growing body of evidence that unemployment and inflation are 
not nearly as linked as the Phillip's curve would suggest.
    Do you agree with that, and do you believe that commodity 
prices are a better indicator of inflation and of inflationary 
expectations?
    Mr. Bernanke. It is true that the empirical evidence 
suggests that the link is looser, that there is less 
responsiveness of inflation to employment conditions than there 
perhaps may have been in past decades.
    My own view is that we should take a very eclectic approach 
in thinking about inflation. I look at the state of the economy 
and try to assess whether demand is exceeding supply in some 
sense, whether the financial conditions are promoting growth 
and demand which is greater than the productive capacity of the 
economy. But I also look at a wide variety of indicators 
including commodity prices, including financial indicators like 
bond rates and inflation compensation.
    I do not think we can rely on any single indicator, 
particularly one like the natural rate of unemployment concept. 
It is very difficult to know if--even if there is such a 
relationship, it is very difficult to assess in real time where 
that number might be.
    And so we really have no alternative but to look at, you 
know, many indicators, including the one you mentioned, to try 
to assess where inflation is going.
    Mr. Ryan. In the past in your academic career, you seem to 
be a fan of inflation targeting. We have seen other countries, 
obviously much smaller economies, test inflation targeting with 
some great degrees of success, it seems.
    What is your current impression of inflation targeting?
    Mr. Bernanke. Well, I should say that I view inflation 
objectives and the like as being part of the communication tool 
kit that a central bank may have to try to explain to the 
markets and to the public what its approach is, what its plans 
are, and how it sees the economy.
    We are currently in the Federal Open Market Committee 
conducting a zero-based review of our communications policies, 
looking at, among them, numerical objectives for inflation, but 
many other approaches as well, to try to provide more 
information to the public about our plans and our approach.
    So in terms of the specifics, I think I would leave that 
open because our Committee has not yet decided, you know, what 
approaches we want to take.
    The one thing I would say is that there is certainly a 
strong conviction that maintaining low and stable inflation is 
not--this goes back to the first part of your question--is not 
something that reduces employment and growth. To the contrary, 
an economy that has low and stable inflation is going to grow 
faster and have more stability than one in which inflation is 
high and unstable. We learned that in the 1970s and it has 
become increasingly evident in the last couple of decades.
    So whether or not we have an explicit target or not, it is 
very important for the Federal Reserve to maintain low and 
stable inflation.
    Mr. Ryan. I totally agree with that. I would just simply 
encourage, and I have one quick last question.
    As you continue these deliberations on your communications 
toolbox, that the more explicit expectations that the market 
can see, the better and more stable the market horizon and 
investment horizons are for investors and for the economy. So 
to the extent that you can be more explicit about that, that is 
all to the good, I think.
    One last final question. There is going to be a lot of talk 
this year about whether or not to raise taxes. And you are 
seeing a lot of speculation as to whether or not Congress is 
going to affirmatively allow some tax cuts to expire, such as 
the growth tax cuts, dividends, cap gains, top marginal income 
tax rates, things like that.
    Is there a chance that this discussion itself could have a 
negative impact on the market? And we have also had surging 
revenues. Would you care to comment on that as well?
    And then I yield.
    Mr. Bernanke. Congressman, as you know, the Federal Reserve 
is nonpartisan. And I talk about many, many issues. I realize 
some of them are very broad. But I do think it is important for 
me, and this is something that is going to be relevant to 
today's discussion, I think it is important for me not to 
implicitly or explicitly endorse any spending or tax program 
for or against.
    So I hope you will understand if I do not make an 
assessment of that.
    Mr. Ryan. All right. Thank you.
    Chairman Spratt. Mr. Cooper.
    Mr. Cooper. Thank you, Mr. Chairman.
    And thank you, Chairman Bernanke, for your excellent 
testimony.
    On page nine, you say, ``A comprehensive approach to 
budgeting would include close attention to measures of the 
long-term solvency of entitlement programs, such as the long 
horizon present values of unfunded liabilities for Social 
Security and Medicare.''
    Last year, this Committee passed unanimously--in fact, it 
was the only unanimous thing the Committee did--my amendment 
that would encourage us to look not only at the unified budget 
deficit but also at, for example, accrual measures of our 
fiscal position so that we would have better perspective on 
where we are. So this Committee has been trying to focus on a 
broader set of measures.
    It worries me, though, that we are in the situation of the 
average American who does not know they have high blood sugar 
levels, which means possible diabetes, because in this country, 
there is sadly, tragically for many people, a seven-year delay 
between onset of high blood sugar and then actual diagnosis of 
the disease, because, as Chairman Spratt noted, there are no 
symptoms. You cannot tell that you have high blood sugar.
    The average American just looking at the unified budget 
deficit cannot tell we have got a major problem. That is why we 
need broader measures, so that we might be encouraged to take 
action.
    Several of us have been working on those measures, for 
example, highlighting the Treasury Department's financial 
report of the United States, which uses accrual accounting and 
which shows that the deficit last year was not 1.9 percent of 
GDP. It was closer to three or four percent of GDP.
    But even that measure does not take into account some of 
the most important programs that we have in this country like 
Social Security and Medicare.
    So in your testimony, you mentioned the unfunded 
liabilities of Social Security and Medicare. Does that mean 
that you count these as liabilities?
    Mr. Bernanke. Let me first start by agreeing with your 
basic thrust that the unified budget deficit has its value 
because it says some things about the current economy, but it 
is not a full measure of the fiscal obligations that are being 
taken on.
    As I am sure you know, the Advisory Board to the Treasury 
has promoted this accrual accounting approach to the deficit, 
and that gives you the bigger number you mentioned. And what 
they have done there is they have included not only the current 
spending, but they have, you know, taken on board the accrual 
of obligations to future pensions for federal government 
workers and veterans and the like, and those are legal 
obligations that any private company would include as part of 
its liability assessment in a given year.
    The FASB is currently looking at whether to include a 
measure of the accrued liabilities to Social Security and 
Medicare as part of a broader measure yet of the accrual-based 
deficit and there they are confronting exactly, I think, the 
issue that you are talking about.
    First of all, projecting those liabilities, of course, is 
difficult, but that does not stop accountants usually from 
trying to incorporate them.
    The other question is whether or not there are legal 
liabilities in the sense that, of course, Congress can and has 
in the past changed benefit schedules from what had originally 
been planned. And so in that sense, perhaps these are not 
liabilities in the strict legal sense of the word. And that is 
part of the reason why they have not been incorporated in these 
accrual measures.
    But I would say that there certainly is a sense that if 
there is no change in policy that automatically we will be 
incurring these large entitlement costs and our short-term 
unified budget deficit does not in any way reflect the fact 
that as we move along, we are getting older, and those 
obligations, at least implicit obligations, are getting larger 
and larger.
    Mr. Cooper. Thank you.
    In my short time remaining, it seems to me to be the 
biggest single disconnect in all of American politics, the fact 
that all of us on both sides of the aisle praise these programs 
and promise benefits. And, yet, when you actually look at the 
budget of the United States and the common deficit measure, 
these entire programs are largely excluded, ignored.
    So not only are these unfunded obligations or liabilities, 
they are also largely uncounted obligations. And in order for 
us to have a chance of delivering the benefits that we 
promised, we are going to have to start counting them. That is 
why I am so strong an advocate for these broader measures, so 
that we have a chance to fulfill the promises that all of us 
have made to our constituents.
    But I thank you for your great service and your steady hand 
at the fed.
    Mr. Bernanke. Thank you.
    Chairman Spratt. Mr. Barrett.
    Mr. Barrett. Thank you, Mr. Chairman.
    Chairman, thank you for being with us today. I am going to 
throw three questions at you and then give you all the time to 
answer them.
    Number one, savings. I know other countries do this, but we 
lose a lot of savings time between zero and 18 or zero, date of 
birth, and when they enter the job market.
    Would it not be a smart thing to do to set up some type of 
personal retirement account through incentives or whatever that 
would allow members, citizens to start some type of savings, 
give breaks if they add to it along? Something to think about 
there.
    Number two, in your testimony, right at the end, you say if 
early--talking about entitlement spending, by the way--if early 
and meaningful action is not taken, the U.S. economy could be 
seriously weakened, and you go on. Of course, I know you are 
talking about Medicare and Medicaid.
    Can we continue, question two, can we continue down the 
road of doing a little bit here and a little bit there? Are you 
talking about major course adjustments and do you not think or 
do you think that we need some type of overall national road 
map to say, hey, these are problems, we cannot do hit-and-miss 
operations anymore, we need a national goal that all of us can 
buy into and work on?
    Last one, there is a direct correlation, I know you know, 
between the tax burdens and economic growth. Some people seem 
to think the average level is about 35 percent all government 
levels.
    How close are we to that level right now when we look at 
state, local, federal, the whole nine yards? It is all yours.
    Mr. Bernanke. Thank you.
    On savings for young people, obviously it would be great to 
get young people saving. There have been some proposals. Again, 
I am not going to try to address very specific proposals. But 
there have been proposals about giving money to children, you 
know, creating an account at the time that they are born.
    I think it is a problem that kids do not know enough about 
saving. They do not know enough about money in general. The 
Federal Reserve is very interested in financial literacy, 
teaching that in the schools, trying to get kids involved in 
saving and understanding that. I do not have a magic bullet 
again, but I think that starting young and trying to broaden 
the base.
    You know, there is a certain part of our population where 
these financial matters are just second nature, you know, but 
many people who do not really get exposed to them and find them 
difficult and mysterious and to their detriment. And to the 
extent that we could help people learn about how to save, how 
to budget, we are doing a great service.
    On the size of the entitlements, these are very large 
deficits. It is hard to find good ways to measure it. The 
trustees have the present value of the infinite horizon deficit 
for Medicare at about $72 trillion, to give you an idea of the 
enormous amount of money that is.
    That does not include the fact that we already have a 
baseline level of finance in the budget for Medicare. If you 
take that out, it is still about $54 trillion. So these are 
enormous amounts of money.
    It is important, I think, to note that the Medicare part is 
probably four or five times as big as the Social Security part. 
So as difficult as it has been to address Social Security, 
Medicare is a bigger problem.
    And I do think we are going to have to, you know, think 
hard about the structure of those programs. And in the case of 
Medicare, think also about the healthcare sector more generally 
and the cost that it is creating.
    It was implicit in my comment about looking at multiple 
indicators that to the extent that Congress can look beyond the 
next couple of years and perhaps have some kind of plan or some 
kind of, you know, benchmarks moving forward that that might be 
quite useful.
    In particular, this is just going to get harder politically 
because you are going to get to the point where you will be 
affecting the benefits of people who are, you know, close to 
retirement. If you make changes now that take place decades in 
the future, you know, you will not be affecting anybody's 
benefits who are either retired or close to retirement. And you 
can phase them in gradually. You can give people time to plan. 
So I think working well in advance is a much better way to deal 
with this.
    On taxes, the federal share of GDP and revenues is about 18 
and a half percent. For state and local governments, it is nine 
to ten percent. So we are somewhere in the 27, 28 percent range 
right now.
    I do not know if there is a magic number where economic 
growth is affected, but it is true that on the revenue side, 
that higher taxes do have disincentive effects and do have some 
adverse effects on the economy. And the question, of course, 
you always have to ask is whether the spending programs have 
enough benefits to outweigh those costs to the economy.
    Mr. Barrett. Thank you.
    Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Allen.
    Mr. Allen. Mr. Chairman, thank you for being here. I have a 
quick comment and then I want to pursue this same line.
    You conclude your testimony by saying decisions the 
Congress will face will not be easy or simple, but the benefits 
of placing the budget on a path that is both sustainable and 
meets the nation's long-run needs would be substantial.
    It seems to me we were once on a path, though not perfect 
and not likely to grapple with all the problems of Medicare and 
Medicaid, it was a lot closer to that goal than we are today. 
And that was the last four years of the 1990s when we were 
running surpluses and in much better fiscal condition than we 
are today. And I think the policies that drove us in the 1990s 
are worth looking at again.
    But my question really goes back to these healthcare 
issues. This is the Budget Committee. We deal with the federal 
budget. But you just said that with respect to Medicare, we 
need to look at healthcare more generally.
    And most of the health policy experts I know would say that 
the cost drivers in Medicare and Medicaid are pretty much the 
cost drivers in the private commercial system as well, and that 
if you look at other countries, we have essentially, you know, 
one of the least cost-effective systems in the developed world.
    So the question is probably, how much does it matter 
whether we pay for healthcare through the public sector or the 
private sector?
    Imagine this. Imagine that we could take care of our small 
businesses who are having trouble providing coverage, to help 
Ford and GM and other large businesses that are finding it hard 
to compete in the global economy, suppose we develop a simpler 
healthcare system which covered more people but held down the 
cost.
    If more of that were paid through the public sector, would 
it make--and I am not asking you to evaluate a particular 
plan--but would it make any real difference, because if you had 
a cheaper system with essentially more money available in the 
private sector for investment but more of the healthcare sector 
being taken care of through the public programs, you would wind 
up with a more cost-efficient system overall but a little 
larger public component.
    Do you have any reason to think that would have a material 
effect, positive or negative, on our global competitiveness?
    Mr. Bernanke. Congressman, I have many views about the 
healthcare sector, and I hope you do not expect me to give them 
all----
    Mr. Allen. I do not. I do not.
    Mr. Bernanke [continuing]. In a minute or two. We have a 
very good healthcare system. Let me just say that. And we have 
the most technologically-advanced system in the world. And on 
average, we get our money's worth in the sense that studies 
have shown that the benefits in terms of reduced mortality from 
heart attacks and so on, you know, that the cost, you know, is 
justified.
    Having said that, I think we could be much more efficient. 
I think we could get more or less the same health benefits at 
lower cost. And there are a number of issues there. There is 
health IT. There is transparency. There is a whole variety of 
things that we could probably do.
    One of the issues that is important, I think, is that our 
system promotes perhaps overuse of insurance by some people. I 
mean, we have some people with no insurance and we have some 
people who have first dollar insurance. And first dollar 
insurance has the problem that no one cares about the cost. It 
is going to generate higher cost and people are going to use 
high technology solutions which may not be essentially 
necessary.
    So I think there are ways that we could go about making the 
system more efficient, reducing costs, and rationalizing the 
healthcare system overall. And I think independent of the 
fiscal situation, that is just very important to do and we 
should be trying to do that.
    In terms of the government's role, you can point to a few 
things like potentially reduced administrative costs. I would 
raise the concern about a system where the middle class person 
pays taxes for services received by middle class people because 
by doing that, you are raising the tax burden, the overall tax 
burden, and, therefore, the marginal tax rate. And that is 
going to have incentive effects and efficiency effects on the 
economy.
    So I think in terms of the efficiency impact, I think you 
are better off focusing on those with lower incomes and those 
who are sick who need more help and not necessarily using taxes 
to pay for the average person's healthcare.
    Chairman Spratt. Mr. Garrett.
    Mr. Garrett. Thank you. Thank you, Mr. Chairman and Mr. 
Chairman.
    Your testimony is much like testimony of other experts that 
we have had before this Committee in the last month and a half, 
and that is it is all ominous and discouraging. I am sure well-
intended though. Ominous in the sense of the problem that lays 
before us and that is not just a short-term, but it is a long-
term one.
    And in dealing with the problem, it seems very basic then 
that you either have to address--some of your suggestions are 
on the spending side of the equation or very simply on the 
revenue side of the equation.
    And so I am just going to take one little narrow approach 
just for a minute here. If we look in part to the revenue side 
of the equation, there are some from both sides of the aisle, 
mainly I will say the other side of the aisle, that suggest 
that we solve that problem by raising our taxes. And I am not 
going to give you a specific tax right here.
    But basic economic thought would be, correct me if I am 
wrong, that if we raise taxes on one sector, for example, the 
business sector, at the end of the day, businesses do not, in 
essence, pay taxes. It is the consumer who ends up buying that 
product that ends up actually paying that tax, whether that is 
a rich consumer or poor consumer.
    Is that a correct basic economic thought of how taxes get 
flowed down to the bottom line?
    Mr. Bernanke. Businesses are not people. Corporations are 
fictional people but not real people. And somebody, either the 
shareholders, the customers, the workers, or somebody, is going 
to bear the ultimate burden, the ultimate incidence of taxes.
    Mr. Garrett. One of the questions here was with regard to 
the housing market and the huge effect that it plays. And on 
the subprime market, there was a question already. And 
somewhere I have here an article that talks about that. Well, 
the headline in this paper was ``U.S. Mortgage Crisis Goes Into 
A Meltdown.''
    And they had the head of the Pacific Capital said the 
sector was in an unstoppable meltdown that is, ``It is a self-
perpetuating spiral. As subprime companies tighten lending, 
they create even more defaults.''
    And one of the Governors of the Board, Governor Susan 
Schmidt Bies, stated that although she did not see much total 
large impact, she did say that there are ``hidden problems 
caused by sellers pulling property off the market. The 
percentage of homes where nobody is living in them is at a 
record level so the potential for inventory correction is still 
very high,'' she said.
    With that all being said, is there an additional problem 
that we could see if we took action now looking at either that 
market or the overall market and said to address these 
mandatory problems, Social Security, et cetera, besides just 
the ones you talked about, to address that problem from a 
revenue side, we are going to raise taxes at least on that 
sector? Could that exacerbate the problem on the housing 
sector?
    Mr. Bernanke. I would have to know more about what taxes 
you have in mind. If you raise taxes on housing, you would 
reduce the price of housing generally speaking.
    I guess I would just want to respond to your initial 
comments and say that we are concerned about the subprime 
mortgage sector. We are watching it very carefully. We think 
there has been some bad underwriting in that sector.
    We have attempted to provide some guidance to lenders about 
proper procedures for underwriting and disclosing subprime 
loans. And we are going to provide additional guidance, I 
believe soon. So that is a significant problem. And there are 
obviously some financial losses associated with it.
    But as Governor Bies said and as I said earlier, so far, 
there seems to be no indication that those problems are 
spreading either into the broader financial markets or that 
they are having significant effects on housing or housing 
demand in the broader economy. But we will be watching that 
obviously very carefully.
    Mr. Garrett. Okay. And my last question is on that sector. 
If we were to impose a tax just on the--not the middle class, 
but the first time entering market in the housing market, 
specifically those markets that is where the securities are 
picked up through the GSEs, and that is where the market goes 
into, the mortgages going into, if we were to place a tax on 
that sector of the market where we are already having problems, 
such as a tax on the mortgages, could that exacerbate the 
problem then?
    Mr. Bernanke. If there is a tax on the new home buyer or on 
mortgage interest, naturally it would affect behavior.
    Mr. Garrett. And, again, whether it is directly on me the 
borrower going to the bank and have a tax just on me or the 
overall GSE, wherever you place the tax, that eventually----
    Mr. Bernanke. I see. If you are talking about the GSE 
situation, I understand. I think it would depend. I think there 
is an interesting and serious question about, as I mentioned 
before, the incidence of a tax on a business goes to lots of 
different people. It goes to shareholders. It goes to workers. 
It goes to customers and so on.
    And so I think one of the important questions in addressing 
the issue you are talking about would be what is the incidence 
of that tax. Is it mostly on the shareholders? Would it affect 
the cost of mortgages? Would it affect something else? So I 
think that is the question one would have to address.
    Mr. Garrett. Okay. So I have 53 seconds left. I will try to 
pin that down a little bit more.
    At the end of the day, even if initially the burden is 
placed on the shareholders, that leads to the natural 
inclination of people not to want to invest so heavily in that 
company or entity no matter which one it is. And eventually 
that raises the cost of doing business for that particular 
entity. They may have to borrow at other rates, at higher 
levels.
    So eventually, although the shareholders may actually pay 
the cost today, that corporation ends up having to bear the 
burden itself. But as you said, they do not bear burdens. They 
pass it on to somebody else. So today the shareholder pays it.
    But eventually if higher interest rates that they have to 
charge again goes down to the ultimate user, and that is the 
consumer; is that not correct?
    Mr. Bernanke. Well, in the case of the GSEs, as you know, 
although there is no official government guarantee behind the 
GSEs, there is a perception in the market that there is such a 
guarantee. And as a result, the interest rate at which GSEs 
borrow is just a little bit above the Treasury rate.
    I would think that until such time as there is a change in 
the views of the financial market about this implicit 
government guarantee that that interest that GSEs pay will 
continue to be pretty close to the Treasury rate.
    Mr. Garrett. Interesting. Thank you.
    Chairman Spratt. Ms. Schwartz.
    Ms. Schwartz. Thank you, Mr. Chairman, and appreciate the 
opportunity to follow-up.
    Some of my colleagues on both sides of the aisle have 
talked about the concern about household debt and the 
relationship to the housing market. And I think that for many 
Americans, they sort of do not necessarily see the cumulative 
effect of each household increasingly borrowing to meet basic 
obligations. I mean, sort of meeting the pattern that the 
federal government is doing the same thing. You know, we are 
borrowing to meet basic obligations.
    What is happening, and I wanted you to comment? You talked 
a bit about both risky behavior and maybe some of the subprime 
market. But even more middle class folks are now using the one 
big asset they have, maybe the only real long-term asset they 
have, their home, to borrow against in order to continue 
spending.
    Now, some of them may be outside of their control a little 
bit in terms of meeting basic obligations, healthcare costs, 
obviously other kinds of costs that they have.
    But could you speak really a little bit more specifically 
about how you see either the risky behavior on the part of 
lenders or maybe the risky behavior on the part of borrowers, 
and this is really every-day Americans who are trying to meet 
their obligations, who have stopped saving and are not only 
using all their dollars that they have to meet obligations, but 
are now refinancing their homes, they are consolidating credit 
card debt and other kinds of debt, maybe even educational debt, 
to borrow against, as I say, that one asset, which is seeing an 
increase?
    Now, of course, the bubble is over in housing. We may not 
actually see the house even be worth it in the future. So they 
are borrowing against their only asset.
    And to what point does that put that family at greater risk 
long term in not planning for a downturn personally, but also 
the effect it has more broadly on the economy not being able to 
access that capital that used to be put into savings 
potentially, either for themselves or so it would be available 
in the marketplace?
    Mr. Bernanke. Congresswoman, that is a very interesting 
question. With respect to an individual family, it would depend 
a lot on their individual financial circumstances. There are 
people who have owned their homes for a long time and they have 
quite a bit of equity in the home. And in that case, it 
probably makes sense to consolidate debt and to pay for college 
and so on from home equity. It is an important part of wealth.
    There are others who have very little equity share and they 
are putting themselves in a situation where they are not able 
to refinance and they could end up losing their home. So it 
depends very much on the individual circumstance.
    I think, you know, it is good that markets have become more 
sophisticated and more flexible so that people do have the 
flexibility to use money from their home under, you know, 
appropriate circumstances. But it does probably contribute to a 
lower saving rate, at least over short periods of time.
    The increases in people's wealth associated with higher 
house prices or higher stock prices are not counted as part of 
the national saving rate or individual household saving. So 
when you do have a run-up in house prices, for example, and 
people let their houses do their saving for them, then that is 
one reason why the current saving out of current income is low, 
and that has the consequence that we talked about before, that 
we have to then borrow for new investment. We have to borrow 
from abroad or pay higher interest rates.
    So my expectation, I mean, one effect potentially of the 
flattening out of prices in the housing market may be if people 
are therefore less able to use extracted equity, they may 
actually begin to save more out of current income. And that is 
one reason to think that saving out of current income may rise 
a bit over the next couple of years.
    Ms. Schwartz. Is there more that we could do, either we, 
you or we could do in helping to have most Americans understand 
that in a way?
    Now, some of what you are suggesting might just be market-
driven people understand they cannot borrow against their 
house, but we are doing the same thing. We are sort of by 
example, federal government is borrowing to meet obligations.
    We are suggesting and there is a lot of market out there 
that is suggesting consolidate your debt. Again, that may be a 
good thing. But over time, individual families are not 
protecting themselves and there will be a consequence to them.
    And could you be more specific in the few seconds left 
about what else we could be doing either by example or to 
educate the American family about how that may not be the best 
even if the market is telling them they can do it?
    Mr. Bernanke. Well, there is one important difference 
between the hypothetical family than the U.S. government. The 
hypothetical family is borrowing against an actual asset that 
they have. I mean, household wealth is still rising on net, net 
of debt. So it is not that the households are drawing down 
their debt in that sense.
    Ms. Schwartz. But it is a point well taken. The government 
is actually borrowing against----
    Mr. Bernanke. We are borrowing against future taxes 
essentially.
    Ms. Schwartz. And we are borrowing mostly from foreign 
governments at this point.
    Mr. Bernanke. Well, not directly, but indirectly, yes. On 
the individual family, I am again a strong advocate 
particularly for lower-income families, helping them through 
counseling, training, financial literacy, and so on, to 
understand better, you know, the complexities of finance, 
personal finance, so that they can live better lives in terms 
of saving and acquiring assets.
    Ms. Schwartz. And then we should learn by example from 
them.
    Mr. Bernanke. Yes, ma'am.
    Ms. Schwartz. Thank you.
    Chairman Spratt. Mr. Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman. And thank you for 
holding this hearing which I believe is probably one of the 
most important hearings we may have this year.
    Chairman Bernanke, welcome. It is good to see you again.
    If I could have chart number two pulled up please.
    Mr. Hensarling. Chairman, on page two of your testimony, 
you used the phrase that we are experiencing what seems likely 
to be the calm before the storm. You allude to the growth in 
the three major entitlement programs and relate that to a 
percentage of GDP.
    As I understand it, you were referring to CBO analysis and 
in that analysis, I believe you show that in 2006, Social 
Security, Medicare, and Medicaid totaled about 40 percent of 
federal expenditures or eight and a half percent of GDP, soon 
to increase to ten and three-quarters of GDP by 2017.
    And eye-balling spending under CBO analysis over the long 
term, it appears that the budget will grow from roughly 20 
percent of GDP if we do not reform current spending trends to 
roughly 30 percent by 2037 and approaching 40 percent, almost 
double, in about 40 years. I do not know if that is one or two 
generations.
    My first question is, and I believe your numbers are based 
on CBO analysis, to the extent that you have looked at other 
analyses from OMB, from GAO, from Treasury, everybody who is in 
charge in the federal government of looking at long-term 
spending trends, is this an accurate analysis? Is there any 
significant disagreement of thought on these long-term spending 
trends?
    Mr. Bernanke. There is always some uncertainty because of 
just the difficulties of projecting far into the future. We are 
quite confident about the demographics. We know how that is 
going.
    One issue which creates some uncertainty is how quickly 
medical costs are going to rise. The standard assumption, which 
is in the CBO analysis that I presented and is also in the 
Medicare Trustee's analysis, is that costs per beneficiary are 
going to grow at one percent faster than incomes, which 
creates, you know, higher and higher cost and is a big part of 
this.
    Now, you could think of that as being pessimistic or 
optimistic. It is actually optimistic in the sense that 
historically, the last 25 years, the so-called excess cost 
growth has been about two and a half percent, much higher. So 
we are going to have to get some efficiencies in terms of our 
medical sector just to get down to that one percent cost 
growth.
    Mr. Hensarling. Using the CBO analysis on page five of your 
testimony, you have a footnote here. Assuming that we were 
agreed that we wish to balance the budget and it had to be done 
in one fell swoop, you allude to an analysis that if we took 
half the burden from tax increases and half from spending 
reductions that we would be looking at an 80 percent decrease, 
I believe, in discretionary spending relative to the baseline 
and an increase in nonpayroll taxes of 35 percent.
    So would that seem to suggest that if we follow that model 
in one generation----
    Mr. Bernanke. He actually did it.
    Mr. Hensarling [continuing]. For all intents and purposes, 
we would have to increase taxes, nonpayroll taxes 35 percent 
just to have a federal government that consists of little 
besides Medicare, Medicaid, and Social Security? There may be 
no border patrol. There may be no U.S. Marines. There may be no 
Department of Education.
    Mr. Bernanke. Congressman, if I may, the simple arithmetic, 
in 2030, according to projections, the entitlement programs by 
themselves will be about 15 percent of GDP and interest on the 
national debt will be about four percent of GDP. So you add 
those things together, you are already above the 18 and a half 
percent of GDP which we are currently receiving in revenues.
    So if you wanted to balance the budget in that case without 
either changing entitlements or raising taxes, as you point 
out, you would have to eliminate the Defense Department and 
everything else that the government does.
    Mr. Hensarling. My time is about to run out. I would like 
to try to slip in one more question. Alluding to this chart up 
here, the debate in Congress today tends to be between that 
blue line and red line debating the wisdom of previous tax 
relief over the last few years.
    Again, this is a CBO analysis. But to some extent, does 
that tend to suggest that we are debating how to mop up six 
inches of water in the stateroom of the Captain of the Titanic 
when we should be focused upon the gaping hole in the hull of 
the ship?
    Mr. Bernanke. I do not want to downplay the importance of 
near-term decisions that you are going to make both in terms of 
spending decisions and how to structure the tax code, how high 
taxes should be. Those are important decisions that are going 
to affect how our economy performs. And they are going to 
affect the near-term deficits as well.
    But I think what that picture tells you is that, you know, 
you should probably think hard about going to the heart of the 
problem, and the heart of the problem is are the entitlement 
programs and those--you are not going to solve this problem by 
small budget cuts or small tax changes. You do have to think 
about these large obligations and, you know, how you want to 
deal with them.
    Mr. Hensarling. Thank you.
    Chairman Spratt. Ms. Kaptur.
    Ms. Kaptur. Thank you, Mr. Chairman, very much.
    Welcome, Chairman Dr. Bernanke. Glad to have you here.
    Mr. Bernanke. Thank you.
    Ms. Kaptur. The first two items I want to mention would 
just be a reporting back from your staff to the Committee. I 
would like your staff to provide a complete list to us of which 
Wall Street firms are earning fees off the sale of the array of 
U.S. debt securities, to provide a list of which firms from 
2000 to the present, and the amount that each has been paid 
annually by U.S. taxpayers for conducting those transactions. 
That is the first request.
    Number two, based on your testimony, in order to help to 
create a savings consciousness in our country, particularly 
among the young, I would invite your cooperation and 
suggestions on how to create and promote a public debt postal 
savings stamp program to sell the debt to our own citizens, 
including our youth in small denominations, as the Japanese 
have done through their postal savings stamp system and 
Franklin Roosevelt created in this country during the 1930s. I 
would value your suggestions there.
    I wanted to make a comment and then ask two questions. The 
basic theme that runs through my comment is that our capital 
markets have to be held accountable in solving some of the 
problems that we face in this nation and that our economy is in 
unchartered waters.
    As you say, we have very high debt levels. Our public debt, 
according to your testimony, amounts to 37 percent of one 
year's GDP. And if you add to that the fact that the trade 
deficit knocks off an additional point off that GDP, that is 
well over half of the growth that does not benefit economic 
investment in this country.
    Our middle class is shrinking. I used to say that these 
conditions were resulting in the middle class running hard to 
stay in place. I now say the middle class is running harder but 
falling behind as reflected in their rising debt levels and net 
negative savings.
    Factory workers in my district are working six days a week, 
ten hours a day, week after week, month after month, and we 
still see the hemorrhage of jobs. They are being told the 
reason for their predicament is that they are in a knowledge 
economy and they are falling behind because they are not smart 
enough or that the problem in your testimony is, well, the fact 
is we got too many people getting older. I beg to disagree.
    I think what is happening is that capital investors have 
figured out how to make egregious profits by outsourcing jobs 
to very undemocratic places and then reimporting those goods 
here because our trade policy is snuffing out jobs and we have 
a tax policy that rewards it.
    And we do not have a redistributed income policy that helps 
our people to keep up in view of what is going on. ExxonMobile, 
I guess, is my key example of where we are out of whack, out of 
sync.
    So my two questions are, what do you think might happen to 
the market for U.S. debt securities if a foreign buyer like 
China or Japan were to sell off a significant portion of their 
holdings of U.S. debt securities?
    And, number two, nearly 95 percent of recent issues of U.S. 
debt instruments have been purchased by foreign buyers. Why are 
they the purchasers rather than American investors?
    Mr. Bernanke. Well, on the first question, I should first 
point out that it is not in the interest of China or Japan to 
dump treasuries on the market. They themselves would suffer 
capital losses from doing that.
    I do think if there were--and I should be very clear, I 
have no information or expectation this is going to happen--but 
if there were significant sales by foreign central banks, for 
example, that there would be some short-run effect on the 
market in terms of the currency and interest rates probably.
    I think the longer-term effect would be somewhat less 
because the market would adjust. It is a liquid market. And the 
holdings of, say, China of U.S. debt securities, including both 
public and nonpublic, is only about five percent of the total 
credit market outstanding.
    So obviously we are watching that very carefully. I do not 
see that as a major threat to our financial system or our 
economy.
    I am sorry. The second question was?
    Ms. Kaptur. The second question is nearly 95 percent of 
recent issues of U.S. debt instruments have been purchased by 
foreign buyers. Why are they the purchasers rather than 
American investors?
    Mr. Bernanke. Well, a couple of reasons. One, as we talked 
about before, is that Americans are not saving that much, and 
you have to save in order to buy assets. And so that is part of 
the problem.
    The other is interestingly that Americans seem to have a 
stronger preference for equities and riskier investments than 
particularly foreign central banks. So at the time foreigners 
have been acquiring fixed income instruments like Treasury debt 
or GSE debt, a lot of American investors have been purchasing 
either domestic or foreign equity which pays a higher return, 
but is also riskier.
    So there is a bit of diversification going on in both 
directions for investors. But, again, the low rate of saving is 
also a contributor to that.
    Ms. Kaptur. Doctor, could I just ask you on the first two 
requests I had for data on providing a list of those brokerage 
firms, can you provide that to the record?
    Mr. Bernanke. I am not certain that we can, but we will do 
our best.
    [The information requested follows:]

          Board of Governors of the Federal Reserve System,
                                    Washington, DC, March 30, 2007.
Hon. Marcy Kaptur,
House of Representatives, Washington, DC.
    Dear Congresswoman: I am responding to a question that you posed 
during my testimony before the House Budget Committee on February 28. 
You asked for information regarding the fees paid to Wall Street firms 
for underwriting Treasury debt.
    On further consideration following the hearing, it seemed to me 
that your question could be based on a misunderstanding of the 
Treasury's approach to issuing debt. Treasury debt is not issued 
through a process in which the underwriting firms earn specified fees 
for assisting with Treasury's debt placement. Rather, the Treasury 
issues marketable debt through a public auction process in which the 
highest bidders are awarded the securities being issued. (Some small 
investors also bid to receive securities at the interest rate set by 
the auction.) Such auctions are open not only to the twenty-one primary 
dealers firm but to all potential buyers, including other dealers, 
banks and other depository institutions, insurance companies, pension 
funds, mutual and hedge funds, and foreign investors. These auctions, 
like virtually all aspects of the Treasury securities markets, are 
highly competitive and transparent. The auction process helps ensure 
that the Treasury issues debt at the lowest possible cost to the 
taxpayer over time.
    I hope this information is helpful. Please let me know if I can be 
of further assistance.
            Sincerely,
                                           Ben S. Bernanke,
                                                          Chairman.

    Ms. Kaptur. And the fees that are being paid. Who would 
have that if the Federal Reserve----
    Mr. Bernanke. We deal directly with so-called primary 
dealers who are brokers who deal in the Treasury securities and 
will have some information. We collect some information about 
their operations and their income and so on. And we will check 
to see what we have and we will be in touch with your staff.
    Ms. Kaptur. Thank you.
    I mean, you would expect to see Cantor Fitzgerald on that 
list; would you not? You would expect to see Goldman Sachs on 
that list; would you not?
    Mr. Bernanke. Yes.
    Ms. Kaptur. All right. We would be very interested in the 
fees.
    And then secondly, on the question on the postal saving 
stamp program, could you perhaps provide a framework in which 
to suggest how that might be reinstituted in this country?
    Mr. Bernanke. Well, I am eager, as I said before, to try 
and promote saving behavior among young people, and there are 
many ways to do that. Making saving more accessible, making 
acquisition of assets more accessible would be one step in that 
direction. And, you know, I think it is worth looking at.
    Ms. Kaptur. Thank you.
    Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Campbell.
    Mr. Campbell. Thank you, Mr. Chairman.
    Thank you, Dr. Bernanke.
    I have a couple of economic questions, then one relative to 
the savings. First on the economic question, as you stated, 
spending currently is 20.3 percent of GDP which is roughly 
equivalent to the average since 1960.
    If as part of curing this long-term problem that government 
spending as a percent of GDP went up, what impact would that 
have on economic growth?
    Mr. Bernanke. If government spending as a share of GDP went 
up primarily in order to finance transfer payments, that is 
entitlement programs, and taxes would have to go up a 
comparable amount in order to have long-term budget balance, 
then depending on the nature of the taxes, presumably it would 
tend to create a dead-weight burden. It would tend to slow 
economic growth.
    Mr. Campbell. You have eloquently pointed out the problem 
of our snowball of accumulating spending and debt. If, big if, 
political if, we were to arrest that and basically balance the 
budget going forward, does carrying the existing national debt 
that we have, if we were to carry that over time, how big a 
drag is that on the economy and how big a problem is that, if 
we were not adding to it?
    Mr. Bernanke. If we were not adding to it, I think it would 
be a good stable situation. The 37 percent ratio of debt 
outstanding to GDP is actually lower than most other countries. 
Japan has a ratio of over 100 percent, for example.
    So if we were staying at this point, it would be fine. The 
problem is that prospectively with the entitlements coming down 
the road, we are looking to go well over 100 percent in the 
next 25 years.
    Mr. Campbell. Right. But carrying that forward is not the 
great economic disaster if it is does not continue?
    Mr. Bernanke. No. No. I would say that the current level of 
debt, if there were no entitlement problem, which is an 
enormous if, would be not necessarily a problem. But it is the 
prospective increases that are a concern.
    Mr. Campbell. So putting those two questions together, if 
we were able to balance the budget, arrest the increase in 
debt, and keep the government spending and revenues at roughly 
the same kind of level that they are at today and have been 
historically, that would be a pretty good economic situation in 
terms of the government's contribution?
    Mr. Bernanke. Given what we are seeing in terms of the 
potential liabilities for entitlements, it would be an enormous 
improvement over the current situation.
    Mr. Campbell. The last question I have is relative to the 
savings and net worth. Now, I am from California. And as you 
mentioned, net worths are rising. Savings have not been.
    It seems to me that people are consciously making the 
decision to put their net worth increase in places other than 
traditional savings as measured by the Fed or whomever, whether 
that be in the value of their house, equity in their house, or 
some other nonfinancial asset or whether that be in some 
retirement thing or stocks or some other financial asset.
    And I would suggest that people are making those decisions 
because they believe that financially it is smarter to put 
their net worth in those sorts of assets rather than in 
traditional savings.
    So my question to you is, why is the savings rate a problem 
if you agree, and maybe you do not, that that increase in net 
worth is not going into savings because people are making a 
rational economic decision which improves their financial 
stability or certainly they believe improves their net worth 
over time?
    Mr. Bernanke. To a large extent, it is a rational decision. 
If your stocks and your home value are going up a lot, then 
there is less need from your personal family perspective to 
save out of your current income.
    I would just add parenthetically that what some people do 
is take money out of their home, for example, in order to 
invest it in other assets so as to diversify to some extent 
their overall portfolio.
    From the national perspective, though, the problem is that 
increases in the value of homes, for example, do not constitute 
funds that are available to make new investments, for example, 
in capital equipment and so on.
    And so in order to maintain our investment rate which 
includes construction of new homes as well as business capital 
investment, we have been forced to go abroad to the tune of 
about six, seven percent of GDP to finance that out of current 
flows of savings.
    So from the individual family perspective, it is not 
irrational. I would----
    Mr. Campbell. Well, if I can then insert my last question 
before my time runs out, then are we not seeing here a 
disconnect between an individual family perspective making 
something that is perhaps best for them but may not be best 
from a national perspective and, if so, what could we do to 
align those two?
    Mr. Bernanke. Well, I would note first of all that the 
family with lots of equity that is making rational financial 
decisions, that is one group of people. That is not everybody. 
There are obviously some people who would be well served to 
increase their saving, increase their assets, be better off 
financially.
    And the second comment I would make is that, apropos to the 
subject of this hearing, that a big negative influence on the 
national saving rate is budget deficits at the federal, state, 
and local level. And one very direct way to begin to increase 
national saving and in particular to create more resources 
available for current investment, current home construction is 
for the budget deficits to be reduced or for surpluses to 
increase.
    Mr. Campbell. Thank you, Dr. Bernanke.
    And thank you, Mr. Chairman.
    Mr. Becerra.
    Mr. Doggett.
    Mr. Doggett. Thank you. Thank you for being with us.
    In your recent address in Omaha, you endorsed boosting 
national investment in education and training and cited 
specifically the work of the Federal Reserve Bank of 
Minneapolis and its findings of the higher returns from pre-
kindergarten programs and other early childhood efforts and how 
that can help us achieve lower rates of social problems like 
teenage pregnancy and welfare dependency.
    Why do you recommend investing in pre-k and does it appear 
to be one of the public policies with the best return?
    Mr. Bernanke. Well, I was referring to some very active 
research that has been done at the Federal Reserve Bank of 
Minneapolis and some policy work that is being done in 
Minnesota as well. And I was citing the research by Jim 
Heckman, who is a Nobel Prize winner, and others that this is a 
high return activity from a social perspective and from an 
individual perspective as well.
    So I do think it is definitely a direction that might well 
we pay attention from the Congress.
    Mr. Doggett. Thank you.
    I am trying to balance this hearing and one that is 
happening at the same time in Ways and Means concerning climate 
change. And as you are well aware, an increasing number of 
responsible businesses are urging that we address the troubling 
increase in global temperatures, and fewer and fewer fit within 
that shrinking breed of climate change deniers.
    Do you believe that the dynamic economy that you have 
described can absorb the cost of reasonable measures to address 
global warming and perhaps even expand clean energy and energy 
efficiency as a growth industry for our country?
    Mr. Bernanke. Well, let me say first obviously that I am 
not a scientist and I do not have an independent opinion about 
the magnitude of the problem, and I think very importantly I do 
not have an independent opinion about how severe or how large 
the effort would have to be if we were try to reduce emissions 
to levels of 20 years ago. I would imagine it would be a fairly 
significant cost associated with doing that.
    So I hope that the scientists and the economists will get 
together and try and think together about, first of all, you 
know, how much effort is needed, how fast in terms of what 
makes sense for both the climate and for the economy.
    And secondly, I think very importantly that, to the extent 
we agree, that we need to do something that we try to do it in 
ways that will minimize the impact on the economy. One way to 
do that, which is consistent with what you were saying, is 
government support for basic technology. I think that there are 
incentives for firms to develop applied technology. But at the 
basic research level, the government can provide some help, 
some resources.
    And secondly, if, and, again, I am making no judgments 
about whether this should be done or not, if Congress were to 
decide to go forward with some kind of program, trying to use 
some mechanism like a cap and trade or market-based system that 
equalizes the cost of any given amount of carbon reduction 
across firms, across industries could allow a given amount of 
carbon reduction at lower cost. And obviously we should always 
be looking for ways to reduce the cost of achieving any 
particular environmental objective.
    Mr. Doggett. So a reasonable cap and trade system that 
tries to rely on the marketplace to address these issues is one 
approach that you think we should consider?
    Mr. Bernanke. I think relative, for example, to an approach 
that prescribes how much each particular company, each industry 
has to do that this would provide, again if Congress decides to 
go in this direction, it would allow a given amount of emission 
reduction to take place at lower overall cost to the economy.
    Mr. Doggett. One last one. Some of the questions I have 
heard here this morning seem to suggest that we do not need to 
worry about revenues or tax shelters or tax savings or whether 
corporations are paying their fair share, that all we need to 
be concerned about is that grandma's Social Security check is 
too big.
    And without minimizing our need to focus on entitlements 
and 2030, you are certainly not saying that as we look over the 
next few years of the budget we are developing that we do not 
need to consider both the revenue side as well as the 
expenditure side?
    Mr. Bernanke. No. It is the Congress' responsibility to 
look at all the options, and I am not going to take one side or 
the other, but I think that you should definitely consider all 
options and try to balance the costs and benefits of both sets 
of approaches.
    Mr. Doggett. Thank you for your testimony and your 
important service.
    Chairman Spratt. Mr. Smith from Nebraska.
    Mr. Tiberi.
    Mr. Tiberi. Thank you, Mr. Chairman.
    Chairman, can you tell us a little bit about your thoughts 
on, when we have seen the economic growth over the past several 
years higher than most economists have projected, when you look 
at that, what are your thoughts in terms of behavior? And you 
have talked about behavior with respect to our tax policy. What 
are your thoughts on how the cut in the capital gains tax and 
dividends have impacted that growth?
    Mr. Bernanke. It is frankly hard to assess the effects of 
one specific tax over a short period of time. From a longer-
term perspective and looking strictly at the efficiency side of 
it, public finance economists generally, I would say, support 
keeping taxes on capital low because of the implications for 
saving and investments and other effects that might have.
    But as always, you know, the Congress has to balance that 
against the revenue and progressivity aspects of the tax code 
as well.
    Mr. Tiberi. But a general belief would be that keeping 
taxes on capital gains and dividends would encourage more 
savings and investment.
    Mr. Bernanke. That would be, I think, the view of most 
public finance economists, yes.
    Mr. Tiberi. Thank you.
    Again, thinking about economic growth, we have seen 
probably or I have seen, let me say, over the last year a bit 
of a backlash with respect to America's trade policy, with 
statements made by some that America's trade policy, 
international trade policy has been negative to economic growth 
in America.
    Can you share your thoughts on how international trade 
impacts our economic growth?
    Mr. Bernanke. I think that trade is very positive for 
growth. If you look around the world, countries that are open 
and actively trading show higher growth rates than those that 
are less open. So I think that for the economy as a whole, 
trade provides very substantial benefits.
    Like new technologies, it also creates a certain amount of 
disruption and that is the kind of concern that would be useful 
to address in order to preserve the political support for open 
trade and capital flows, which I do believe are very beneficial 
to our economy both in the short run and the long run.
    Mr. Tiberi. So in the long run, and I do not want to put 
words in your mouth, you believe that a trade policy which 
encourages fair trade between the United States and other 
countries abroad can be helpful to a broadening middle class?
    Mr. Bernanke. I do believe that it will provide broad 
benefits for the economy. Again, one of the problems here is 
that, like many things, that the benefits of trade are 
sometimes widely spread and, therefore, not quite so evident as 
the obvious costs of a shutdown of a mill or a factory.
    And so we have to weigh those costs and benefits and in 
particular to again provide political support for continued 
integration with the world economy, continued openness. I do 
think we have to, you know, not ignore the dislocations that 
take place in particular communities, particular industries.
    Mr. Tiberi. One final question, Mr. Chairman. Following up 
on Mr. Campbell's point about the savings rate, it appears to 
me that a family that rather than puts money in a savings 
account but quickly pays off their 30-year mortgage and has 
equity in a home, the current formula is not showing that 
positive benefit from that family's perspective of paying off a 
home. Yet, if they had not paid off the home and put that money 
in a savings account, it would have shown a different picture.
    What can we do to paint a more accurate picture of 
America's savings?
    Mr. Bernanke. Well, actually, the increase in the value of 
the home due to a rising real estate market, for example, would 
show up in the Federal Reserve's measures of household wealth. 
So we do capture it in wealth measures as opposed to savings 
measures.
    The example you gave of paying down the mortgage, if I put 
something aside from my paycheck in order to pay down the 
mortgage, that, in fact, gets captured as saving because that 
is part of current income which is not being consumed. It is 
being used to pay down debt. That would be part of saving.
    Mr. Tiberi. Thank you.
    Thank you, Mr. Chairman.
    Chairman Spratt. Ms. Hooley.
    Ms. Hooley. Thank you, Mr. Chair, for being here today.
    I just want to follow-up on a couple of questions. One was 
we were talking about capital gains tax cuts, whether that is 
increased savings or not.
    Do we have any proof that that is increased savings? Do we 
know that that has had an impact on savings?
    Mr. Bernanke. Well, as I said, it is difficult to assess 
the effects of one small part of the tax package over a short 
period of time. Economists have looked at this and their 
concern is that when you tax capital income at a too high a 
rate that that will have effects over a long period of time 
because they really distort the decision about how much to 
consume today and how much to save, say, for retirement.
    So there is sort of a theoretical case for this. But, 
frankly, you know, for a specific tax cut over a short period 
of time, it is hard to make an absolutely convincing empirical 
case.
    Ms. Hooley. You said in a recent speech that the income of 
the top 90th percentile has grown over the last 27 years by 34 
percent whereas if you are at the 10th percentile, it has grown 
four percent.
    How do we close that gap?
    Mr. Bernanke. I think there are a few things that could be 
done, but I think by far the most important is to create a 
broader base of skills and knowledge and education.
    There was earlier discussion about manufacturing. So it is 
true that as manufacturing industries have become much more 
productive that the number of assembly line workers has 
dropped. So that type of reasonably well-paying job for 
relatively low educated people is no longer available.
    At the same time, though, the demand for high skilled 
workers in manufacturing who have not necessarily college 
degrees but who know how to operate complex equipment and so on 
has been soaring. In fact, manufacturers cannot find enough 
people with the kinds of skills they need.
    So, again, I am not an education expert and I am afraid I 
cannot give you a long list of detailed recommendations, but I 
think broadly speaking what the issue is is helping those who 
have been left behind to acquire the skills they need to earn 
good wages in what is becoming a more and more technologically 
sophisticated economy.
    Ms. Hooley. Well, as I see our economy changing, I see the 
need for more training and retraining of our workers as time 
goes on. And, yet, I look at the budget that was given to us 
and it has billion dollar cuts in employment and training 
programs. And I think that is where we make a mistake when we 
do not put money into that retraining program. I think our 
economy is better off when we do that.
    Would you agree with that?
    Mr. Bernanke. One of the tough challenges with both 
education and training programs is being effective and doing a 
good job. And so if the budget involves a reallocation from 
some types of training activities to others, for example, I 
think it would be very important not just to look at the total 
dollar number but to see are we using programs that are known 
to work and that are effective because the total dollar input 
is not as important as what is the output on the other side in 
terms of skills acquired.
    Ms. Hooley. I am going to ask you a question that has not 
been asked, and that was if you were in a class of fifth 
graders, how would you explain to them the consequences of our 
national debt and deficit and how that is going to impact their 
lives, and what happens when they do not have a savings? So 
what would you say to that fifth grade class?
    Mr. Bernanke. I would say that our economy needs machines 
and new factories and new buildings and so on in order for us 
to have a strong and growing economy. If the government does 
not cover all those expenses, it has to take out the money that 
would otherwise be used to build those machines, those 
factories, those office buildings, all those things that make 
the economy strong, and give them the opportunities when they 
grow up to have well-paying, productive jobs. That probably 
would not work for a fifth grader, but that is about as close 
as I can get.
    Ms. Hooley. That is okay. Thank you for your time.
    Chairman Spratt. Mr. Alexander.
    Mr. Alexander. Thank you, sir.
    Mr. Chairman, good morning still.
    One of the ladies earlier said something about a stamp 
program under the Roosevelt's Administration to help stimulate 
growth. But is it not true that President Roosevelt used some 
of the Social Security funds to finance the new deal?
    Mr. Bernanke. Well, Social Security was tiny. It was just 
beginning essentially in the 1930s.
    Mr. Alexander. Well, it was tiny, but the pay-outs were 
tiny, but----
    Mr. Bernanke. Well, it is true that the Social Security has 
always been primarily a pay-as-you-go system which means that 
the payroll taxes that are collected have not been invested in 
real capital. They have either gone into holding government 
debt or otherwise been used on benefits.
    Mr. Alexander. Okay. When we are talking about the 
entitlement programs, a lot more money coming out of those 
programs today than it has been in the past and, of course, a 
lot more money going into those programs.
    But on a percentage basis, how much difference is it today 
percentage going in and percentage coming out than it was 20 
years ago?
    Mr. Bernanke. I might not have your question exactly right. 
In terms of the flow of in and out, currently, as you know, the 
Social Security system is running a surplus, even forgetting 
about interest on the trust fund. The total benefits being paid 
are about four and a quarter percent of GDP and the total 
payroll taxes being collected are about five percent of GDP.
    So that is three-quarters of a percent GDP contribution to 
the unified budget deficit not counting the interest being 
earned on the trust fund. So the Social Security fund is still 
in surplus now and is reducing the unified budget deficit.
    Mr. Alexander. Okay. Going back a long way, I think 1965 is 
when President Johnson signed Medicare into law.
    Mr. Bernanke. Right.
    Mr. Alexander. At that time, I could have bought absolutely 
the best car on the lot for $4,000. And today we have a system 
that is spending that much or more for medical devices, 
motorized wheelchairs or whatever, and I am not arguing that 
there is not a need for it, but I am just leading up to a 
question.
    The amount of money that is being spent withdrawing from 
those entitlement programs now, how much of it is a decision by 
bureaucrats versus Congress? I mean, I do not know if it was a 
congressional act that said, okay, we will now start buying 
fancier wheelchairs for people that need it.
    Mr. Bernanke. Well, going back to history, there has been a 
big increase in the size of the entitlements even up to now. 
The total entitlement spending in the mid 1960s was about three 
percent of GDP and now it is greater than eight, eight to nine 
percent of GDP. So there has been a big increase.
    The Congress is ultimately responsible, of course, for the 
spending plans. In some cases, they are put on somewhat 
automatic pilot, which is why they are called mandatory 
programs.
    For example, the formula for calculating initial and 
subsequent Social Security benefits is in the law and then 
whatever wages and prices do, that determines how much the 
benefits actually are.
    And similarly some of the medical expenditure is not 
directly controlled. It is set by the rules that Congress has 
created for defining those benefits. So there is an annual 
appropriation for the total spending on entitlements.
    Mr. Alexander. In other words, you are saying oftentimes 
the spending is not necessarily something advocated by 
Congress, it is just something that Congress did not stop when 
they had an opportunity to?
    Mr. Bernanke. Well, Congress created the structure and the 
rules and that is the consequence of those rules.
    Mr. Alexander. Thank you.
    Chairman Spratt. Thank you, sir.
    Mr. Berry is not here.
    Mr. Moore.
    Mr. Moore. Thank you, Mr. Chairman.
    Chairman Bernanke, thank you for being here today and for 
your service to our country.
    I printed off just before I came over here from the U.S. 
Treasury web site a document that shows major foreign holders 
of Treasury securities of our country, and it shows Japan as of 
December 2006 held $644 billion; China, mainland China, $349 
billion; United Kingdom, $239 billion; and even Mexico had $34 
billion in holdings for a total--I did not read off all the 
countries--but for a total, according to this document, of 
$2,223,000,000,000. Does that sound correct, sir?
    Mr. Bernanke. I think that is the total of international 
reserves. There might be more in private hands.
    Mr. Moore. Okay. But I am talking about----
    Mr. Bernanke. That sounds about right.
    Mr. Moore. Okay. And I heard your answer to Ms. Kaptur's 
question about what if these countries that hold our debt 
decided they did not want to hold it anymore for whatever 
reason, because of our deficits, because of our trade deficits 
or budget deficits or trade deficits, and decided they wanted 
to not hold these anymore.
    And I heard you say I do not think that will happen, and I 
hope you are right. But sometimes we are not right. Sometimes 
we are wrong.
    And if these foreign countries decided for whatever reason 
they did not want to hold our debt in the future, what would be 
the impact? What would you expect to be the impact in this 
country?
    Mr. Bernanke. Well, it would be disruptive in the debt 
markets in the short run. It would cause, for example, an 
increase in interest rates.
    As I said before, I think in the longer term, the effects 
would be somewhat less because besides the Treasury debt, there 
is many other forms of corporate and GSE and other debt that is 
available as part of this broad fixed interest market.
    I think it should be noted that the Federal Reserve could 
be of assistance in that situation. If interest rates went up 
and slowed U.S. economic growth, for example, the Federal 
Reserve could respond by using monetary policy and that would 
have some benefits.
    I want to make a distinction that the foreign central banks 
acquire U.S. assets because we do have very deep and liquid, 
safe financial markets and they find it in their own benefit to 
do so, not because they are doing us any kind of favor.
    Mr. Moore. I understand.
    Mr. Bernanke. And as I said, I think that they will be 
willing to hold that for some time. In the scenarios I have 
described, though, where 20, 25 years from now the debt and the 
deficits are so big as to create a tremendous burden, then the 
willingness of foreigners or even our domestic citizens at that 
point to hold government debt at reasonable interest rates 
would certainly be much affected.
    Mr. Moore. I understand. I just wanted to point out, 
though, that sometimes we are incorrect in our assessments and 
the Administration, in fact, projected that between 2001 and 
2004, there would be a $1.28 trillion surplus which, in fact, 
turned out to be an $850 billion deficit.
    So sometimes with the best intentions in the world and 
trying to be completely straight, we just are in error in our 
assessment; is that not correct?
    Mr. Bernanke. Yes, sir.
    Mr. Moore. Another question then, and I have got just a 
minute and a half left. What would you think, Chairman 
Bernanke, about--well, you said that the Social Security fund 
is still in surplus now, correct?
    Mr. Bernanke. The current flow of payroll taxes collected 
is still higher than the benefits being paid out.
    Mr. Moore. Right. What would you think about establishing a 
true Social Security Trust Fund, one that could not be used for 
any purpose except what it was intended for and that is to pay 
Social Security benefits?
    Mr. Bernanke. So currently we are shooting for a budget 
balance that includes the Social Security system.
    Mr. Moore. Yes, sir.
    Mr. Bernanke. If we were able to shoot for a budget balance 
that did not include the Social Security system and, therefore, 
was essentially buying down Treasury debt with that surplus, 
then clearly that would be putting our long-term fiscal 
situation on a stronger footing.
    Mr. Moore. We talk about a Social Security Trust Fund. In 
fact, in the real sense, the legal sense of the word, there is 
not one because we spend Social Security money for a lot of 
other things, some good things and some things people might 
have questions about, is that not correct, even though we still 
do have as a government the liability and the obligation to 
make good on the Social Security money that was supposed to be 
in that fund; is that not correct?
    Mr. Bernanke. Well, the $2 trillion Social Security Trust 
Fund is an asset of the Social Security system and affects the 
benefits profile, for example, going forward. But the $2 
trillion Social Security Trust Fund is not an asset of the 
government as a whole because every dollar that is owed Social 
Security is a dollar that the government has to raise. So it is 
correct that from the government's perspective or from 
society's perspective, it does not reflect any real assets like 
capital or equipment.
    Mr. Moore. Thank you, sir.
    Chairman Spratt. Mr. McHenry.
    Mr. McHenry. Thank you, Mr. Chairman.
    Great to be with two of my neighbors to the south, Chairman 
Spratt from South Carolina and Chairman Bernanke from South 
Carolina. It is a pleasure to be with you all.
    I wanted to follow-up on Mr. Tiberi's question about 
unlocking the potential of capital and the free movement of 
capital by reducing capital gains tax rates.
    At the time we reduced the capital gains tax rate for 
individuals, we did not reduce the corporate capital gains tax 
rate, which now stands at 35 percent.
    In terms of unlocking the potential of capital to move 
freely and to see its highest and best use, would it be 
appropriate to look at that, reducing the corporate capital 
gains tax rate?
    Mr. Bernanke. Well, specifically one of the advantages of, 
again from specifically an efficiency perspective, of keeping 
the dividend tax rate low is that it allows firms to pay out 
dividends without tax penalty and that money then gets 
recirculated in the capital markets and may find better uses 
than if it is in some sense trapped in the corporation. So that 
is one of the benefits from an efficiency perspective of low 
dividend tax rates.
    Mr. McHenry. But in terms of corporate capital gains.
    Mr. Bernanke. Corporate capital gains are a part of the 
return to savings, return to investment. And for some of the 
reasons I gave earlier, economists tend to argue that moving 
towards taxing consumption and leaving saving to accumulate, 
not distorting saving decisions through taxes on saving 
behavior, leads to higher income in the longer run.
    Mr. McHenry. All right. Chairman, you also spoke about 
whatever the size the government is chosen to be, tax rates 
must ultimately be set at a level sufficient to achieve an 
appropriate balance of spending and revenues in the long run.
    I know you have spoken about this before. But in terms of 
entitlement reform, at what point does our inaction as a 
Congress have a negative effect on the economy, meaning our 
inaction to achieve entitlement reform? At what point does that 
actually become a drag? Is that 2008?
    Mr. Bernanke. I do not think there is a magic point. But 
the further this goes without any action, the bigger the 
current deficits are going to get which is going to draw 
capital out of more productive uses like capital investment or, 
alternatively, increase our obligations to foreigners. And, 
moreover, the further along we get, the harder and more painful 
it is going to be to try and adjust the budget in order to stop 
the accumulation of debt.
    So it is really a two-sided aspect which is that it is true 
that we are not feeling a lot of pain at the moment from 
deficits, which makes it harder, I understand, politically to 
take action, because the benefits and costs of this are further 
down the road.
    On the other hand, as I said, by acting now, we can at 
lower cost and with greater notice, we can make changes to 
programs that will take effect ten, fifteen, twenty, twenty-
five years from now. And in that respect, we can do what we 
need to do or you can do what you need to do without immediate 
impact or without affecting those people who are already 
retired, who are near retirement, and who would perhaps 
justifiably feel that they were not getting what they had been 
promised if you were to affect their benefits.
    Mr. McHenry. I know there are a number of discussions going 
on in the Congress right now about entitlement reform and, in 
essence, creating a commission to look at all the entitlement 
programs, all the mandatory spending programs, to look at ways 
to reform them.
    And I wanted to ask you if you would be willing to comment 
on those ideas for maybe a BRAC like, BRAC style commission to 
review policy prescriptions and have that sent back to the 
Congress for a simple up or down vote.
    Mr. Bernanke. I am reluctant to endorse or comment on 
specific budgetary measures or similar measures as you 
describe. However, I do think that trying to focus Congress on 
the longer term and emphasizing the urgency of beginning to 
take action is highly desirable and whatever methods achieve 
that objective would be very good to undertake.
    Mr. McHenry. Thank you, Chairman.
    Chairman Spratt. Mr. Berry.
    Mr. Berry. Thank you, Mr. Chairman.
    Thank you, Mr. Chairman, for being here.
    The United States Congress almost all the time is in this 
debate about taxes and tax cuts are good and tax increases are 
bad and so on and so forth. And I think we all agree that the 
lower the taxes can be, the better it is.
    Now, you have already said here today, I believe, that they 
need to be the same. Whatever your revenues are, they need to 
be the same as your expenditures.
    Does the impact of a tax cut change if you make that policy 
change and it results in tax reductions, but to offset the loss 
of revenue, you borrow the money?
    Mr. Bernanke. Because taxes and spending have to be 
commensurate in the long run, if you cut taxes and lose revenue 
through that tax cut and you do not make any adjustments on the 
spending side, then that tax cut will essentially have to be 
temporary. It will eventually have to come back up in order to 
finance the spending.
    So in order to get the incentive benefits of a tax cut, you 
also have to look on the spending side and be willing to make 
equal cuts in spending.
    Mr. Berry. We have heard from any number of people that 
sometimes these tax cuts do result in an improved economy and 
sometimes they do not. Would you agree with that?
    Mr. Bernanke. Not all tax cuts are created equal. Some are 
more effective than others. And, again, tax cuts that are 
accompanied by spending restraint would be more effective than 
those which are not.
    Mr. Berry. And we have also heard over and over again, and 
I think it is obviously true, that Medicare and Social Security 
as they are structured today are unsustainable, that we have 
got a train wreck waiting to happen out there. It is not going 
to happen tomorrow, but it is a very serious matter to this 
country.
    Would this nation be better off without those programs?
    Mr. Bernanke. I do not think anyone is seriously advocating 
eliminating those programs. I think the question is trying to 
look at how they work and make some judgments about are there 
ways that the cost can be reduced and, if not, and let me just 
say, if not, then making the tough decisions to raise taxes on 
the other side.
    I mean, the main decision which Congress has to make is how 
big is the government going to be. And all I am saying is the 
laws of arithmetic have to apply. If you just decide to have a 
larger government, which is not illegitimate, you could well 
believe that the social services and the other benefits of 
government spending are worth it, then that is fine, but you 
just have to be willing to accept the higher taxes and the 
implications that might have for economic growth.
    Mr. Berry. But right now we are really not facing up to 
that and we are just kind of whistling past the graveyard.
    Mr. Bernanke. Yes, sir.
    Mr. Berry. And hoping that the tooth fairy comes and bails 
us out of this deal. Is that a correct assessment? I know that 
is mine, not yours, and I would not expect you to assign 
yourself to what I just said.
    Mr. Bernanke. I do not know about the metaphors there, Mr. 
Congressman, but I do think that Congress does, and I realize, 
as I said several times, this is not an easy task by any means, 
but Congress does need to begin to address these long-run 
fiscal imbalances.
    Mr. Berry. Thank you, sir.
    Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Andrews.
    Mr. Andrews. Thank you, Mr. Chairman.
    And thank you, Mr. Chairman, for your very edifying 
testimony. I wish every member would read it. I think it is 
very, very edifying.
    You describe our budgetary situation as the calm before the 
storm and I think you very correctly identified the storm as 
being severe consequences for the economy if capital pools are 
drained, if the price of capital rises, if we continue a policy 
of borrowing our way to an illusionary prosperity.
    One of the matrix that you discuss as a way of measuring 
our progress toward avoiding that storm or preparing for that 
storm is the idea of the measurement of the long-term solvency 
of entitlement programs, such as the long horizon present 
values of unfunded liabilities for Social Security and 
Medicare.
    Do you think that there are benchmarks that the markets are 
going to express and manifest as to which benchmarks we have to 
hit on that issue? I will ask you the question another way.
    My understanding is we are adding each year to the present 
value of those unfunded liabilities by failing to take action 
on entitlement reform, and we are also adding to it by failing 
to put away Social Security surpluses which could be saved for 
those forthcoming problems.
    Do you think that the market will manifest a benchmark 
where if the unfunded liability grows too large and the time 
before the storm starts grows too short that the markets will 
begin to punish us with higher long-term interest rates and, if 
so, what would you think those benchmarks are both in terms of 
size of the unfunded liability and distance from the storm?
    Mr. Bernanke. I think it would be hard to give you exact 
numbers. Thus far, the Treasury market has very willingly 
financed the government. Real interest rates are low. They have 
not come up much.
    I would think that concerns would begin to mount if the 
government got to the point where it was coming closer to one 
of these snowball situations where the accumulation of interest 
on the debt was adding to the deficit which was adding to the 
debt.
    If that looked to be something that was inevitable and that 
it was becoming increasingly unlikely that the Congress was 
going to be able to address that, and, again, the closer you 
get to that, the harder it is, then I think capital markets 
would become concerned about it.
    Mr. Andrews. We, as you know, deal in five-year budget 
windows in the resolutions that the Committee addresses.
    Could you give us a perspective as to what the markets 
would regard as a successful five-year project that would 
either reduce the unfunded liabilities or at least let their 
rate of growth slow? Is there a target we should be shooting at 
in the five-year window?
    Mr. Bernanke. Well, as I indicated, you need multiple 
indicators, and I am not sure that the five-year window 
sufficiently captures the long-run imbalances. So it would be 
interesting to look at projections as we saw on the screen a 
while ago of the imbalance at ten, fifteen, twenty years down 
the road and steps that move in the direction of ensuring that 
those imbalances are being closed. And I think just moving in 
the right direction is important.
    Mr. Andrews. Assuming that we were able to enact a budget 
resolution that during the five-year window stop the process of 
using the Social Security surplus and began to bank it or save 
it toward reducing this future unfunded liability by making it 
funded, would you regard that as a positive development?
    Mr. Bernanke. I think it would be extraordinarily difficult 
to move that far on budget surplus in a few years, within five 
years and----
    Mr. Andrews. But if it were, would it be a positive 
development?
    Mr. Bernanke. Well, the Federal Reserve would have to 
offset the short-term spending effects of that with lower 
interest rates. But that would be----
    Mr. Andrews. So you promised us lower interest rates if we 
do that? Is that what I just heard?
    Mr. Bernanke. If you do that, we will do our best. But what 
we would do is we would respond in such a way as to try and 
keep the economy at full employment.
    Mr. Andrews. I understand.
    Mr. Bernanke. But I think if you can demonstrate a plan 
that seems plausible and make a down payment on it, if I may 
say so, that would be certainly the right direction. It would 
be reassuring.
    Mr. Andrews. I think one of the imperative projects of this 
Committee is to define plausibility, and we need your input on 
that and those of other leaders.
    And I thank you very much for your testimony and for 
answering my questions.
    Mr. Bernanke. Thank you.
    Mr. Andrews. Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Etheridge.
    Mr. Etheridge. Thank you, Mr. Chairman.
    Chairman, thank you for being here this morning and thank 
you for your time. This is an important issue and you have got 
a tough job. We appreciate the job you do.
    Let me ask you a question. You touched on this in different 
ways and all of us sort of struggle with our own family incomes 
and what our debt ratio is to our assets, et cetera. But my 
question is, do deficits matter at the federal level?
    Mr. Bernanke. Yes, they matter because they are part of the 
process by which debt builds up, and that debt burden is going 
to affect our children and grandchildren in two different ways.
    First of all, it is going to be actually a debt that they 
have to do something about paying off, number one. But, number 
two, it is going to drain capital from the construction of new 
machines, new factories, and the like, or increase our debt to 
foreigners so that when that time comes to pay off that 
interest, they are going to have a less vibrant economy, you 
know, to earn income from in order to do it.
    So debt does matter because it is the process of 
accumulation of debt which creates the burden for the next 
generation.
    Mr. Etheridge. Thank you. I happen to agree. I just asked 
that question because Vice President Cheney has stated that 
deficits do not matter. And it is obvious they do not with some 
of the spending, but let me move to another question.
    You were quoted earlier saying, and you touched on this a 
little earlier today, and you had said earlier this month 
really that policies that focus on education, job training, and 
skills and that facilitate job search and job mobility seem to 
me to be promising means by moving toward that goal, talking 
about expanding the economy, et cetera, making it bigger, 
making the pie much larger.
    I assume you still stand by that statement.
    Mr. Bernanke. Yes, sir.
    Mr. Etheridge. Thank you.
    I ask that question because, just so you will know, in my 
previous life, I was in business. Prior to that, I was State 
Superintendent of Schools for a few years. And I happen to 
believe that if you are going to make the pie larger as we look 
out with all the challenges or projections, we can change those 
projections by changing output, educational levels and 
productivity of workers and the value added of each worker to 
that, because you have been saying that.
    Mr. Bernanke. It will add to growth and it will also create 
more opportunities for people across the income spectrum.
    Mr. Etheridge. Change those dynamics. And I look at the 
budget that we are dealing with that the Administration sent 
over, and there are a whole lot of gaps as relates to job 
training and education and those investments that I think are 
long-term investments as we look at the out years.
    And I would be interested again in your comments and any 
thoughts you could help us with as we are dealing with that 
because it seems to me that if you really want to change the 
dynamics, it is an investment versus and expenditure, and you 
invest in the future and you spend for today.
    And I think your comments have indicated previously that if 
you invest in education today and monitor it and measure it, 
that will give you a reward down the road if you do it right.
    Mr. Bernanke. If you do it right. I mean, the only caveat I 
would add is that the total budget line is not the only 
indicator of the commitment or the effort. It also has to be in 
programs that have shown to produce a good result.
    Mr. Etheridge. Well, let me just give you a couple examples 
before we get to your comments because I think it is important.
    If we go back to World War II, the GI Bill was an 
investment. And men and women who were coming home and we know 
the results of that.
    In the 1960s with the Sputnik, we got frightened. We put 
the ``National Defense Act'' in place, and the results of that 
was an infusion of capital that excited young men and women 
about a goal of going to the moon and it turned into a 
tremendous economic boom for this country. And we led the world 
in a host of ways.
    We really need, I think, that kind of vision once again for 
our young people to challenge them academically to generate the 
kind of growth in opportunities we need.
    And I think budgets are more than just numbers and figures. 
I think they are moral documents that speak to our visions, our 
hope for the future.
    Mr. Bernanke. I agree that a strong commitment to helping 
young people realize their potential is extremely important. 
There are many ways to address that. People disagree about the 
right way to do it. And I urge Congress to have a healthy 
debate about how best to foster learning, education, and skills 
among our whole population.
    Mr. Etheridge. Thank you. And thank you for your time.
    Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Chairman, if you will indulge, Mr. 
Cooper has a question he would like to ask also, if you have 
the time. Thank you very much.
    Mr. Cooper.
    Mr. Cooper. Thank you again for your testimony.
    You say toward the close of your testimony that if early 
and meaningful action is not taken implied by Congress, U.S. 
economy could be seriously weakened and future generations 
bearing must of the cost.
    Our problem here is lighting a fire under some of our 
colleagues to get the tough decisions made. So one of the 
pieces of data that I have been using came from last summer's 
``Wall Street Journal.'' It was on page C6. It was from 
Standard & Poors, a leading credit rating agency.
    And they projected, they did not predict, but they 
projected that the U.S. Treasury bond itself would lose its 
triple A credit rating if current trends continued by the year 
2012.
    Then they went on to project that by the year 2025, the 
U.S. Treasury bond would achieve junk bond status below 
investment grade. And that has been one of the more tangible 
warning signs because most folks kind of heard of S&P and 
think, well, gosh, that is not Democratic, that is not 
Republican, that is credit markets. And everyone has a sense 
that U.S. Treasury bond is the most important, most liquid 
instrument in the world.
    So the prospect that we are literally destroying America's 
credit today by our inaction has helped light a few small 
fires, but still not enough to get folks going. So I 
appreciated your response to Rob Andrews' questions.
    We, if we were to follow the President's budget, would be 
using $1.3 trillion worth of alleged Social Security surpluses 
to mask the true size of the deficit, because when the 
President brags that he is going to achieve a surplus in year 
five that he does not tell you that he would be doing that by 
borrowing that year about 230 or 40 billion dollars from Social 
Security.
    So that really, if you look at all of our programs, 
including Social Security, we are still going to have a deficit 
in year five.
    So how do we get a greater sense of urgency here? You are 
doing all that you can, but what can we be doing to get this 
problem solved early as you suggest?
    Mr. Bernanke. I think you need to consult with your 
colleagues and try to think about a plan. I think one of the--
and, again, I am reluctant to get into congressional process of 
which I am certainly not an expert--but a good bit of the 
budgetary planning is about the relatively short run, and the 
question is whether Congress can define some matrix or 
benchmarks for progress on the long-term imbalance issue. If 
that were possible and if there were some will in Congress to 
try to meet those benchmarks, that would be a step in the right 
direction.
    You are right. That is somewhat difficult because so far, 
the effects of the deficits are not evident to the average 
American. I mean, the average American does not know about the 
current account deficit and those sorts of things.
    But, again, I think it is also an opportunity because we 
have enough lead time that we can make changes in programs that 
will not take effect until people who are now in their thirties 
and forties are approaching retirement and give them plenty of 
time to plan and adjust to those changes.
    Mr. Cooper. I thank you, Mr. Chairman.
    Chairman Spratt. Mr. Becerra.
    Mr. Becerra. Thank you, Mr. Chairman.
    Mr. Chairman, thank you for being patient and wading 
through the different questions that we have all asked you.
    I want to go back to something that I know you have talked 
about quite a bit today and in other days and that is how 
deficits do matter.
    And I think to underscore that, it is important to point 
out that this year, we are paying something close to the size 
of the identified deficit of $240 billion simply in interest 
payments on the national debt, which means we are getting 
nothing out of those $240 billion or so in payments on money we 
owe.
    But I wanted to highlight and talk to you a little bit 
about what I think is not being explored well by all of us in 
government, certainly to the detriment of the American people, 
and that is the fact that while the President identifies our 
budget deficit for 2007 as being $244 billion, if it were not 
for the fact that we are using all the monies that we are 
collecting in the Social Security Trust Fund, all the extra 
dollars that are not being spent today for benefits to the 
Social Security recipients, the actual size of the deficit 
would be closer to $435 billion because there is about $190 
billion in excess money that you today, I today, and every 
American who got up today to go to work is paying in the FICA 
tax for our Social Security and Medicare contributions.
    I think it is unfortunate, and I think the Chairman tried 
to focus on this as well, that the American people do not quite 
understand what is going on and do not quite grasp why deficits 
do matter and what the consequences could be, not so much to us 
today, but to our children in the future.
    And I am wondering if you can just comment a bit. This year 
in 2007, there are about $190 billion in surplus dollars in 
Social Security that you and I and everyone in America who 
works is contributing to the system with the expectation that 
it will be around when we retire. Next year, that amount rises 
to over $200 billion in surplus money. In 2009, it is about 
$218 billion estimated. In 2010, $230 billion. In 2011, $246 
billion. In 2012, $255 billion in surplus monies in Social 
Security.
    Each one of those amounts of surplus in each of those 
years, the President has in his budget that he has presented to 
us consumed every single cent of those monies, over a trillion 
dollars, in something other than Social Security. And you have 
mentioned how we need to have some fiscal discipline, how we 
have to get these deficits down. Is it wise for us--here is the 
question--is it wise for us knowing that we will have this 
liability, whether it is legal or otherwise, to the American 
people who today are contributing in FICA taxes for the Social 
Security benefits in the future, is it wise for us to not do 
more to explain to the American people that the size of the 
deficits are not 244 billion as the President identifies in his 
budget, but really $434 billion because we are masking the size 
of the deficit by using Social Security monies that ultimately, 
I think you and I would agree, we must commit to spend on 
Social Security in the future?
    Mr. Bernanke. Well, first, the unified budget deficit 
concept, which is what you are talking about, has been in use 
for a while. It is not a brand new thing. But you are right. It 
does have the property that essentially the surplus from each 
year is payroll taxes being used for other purposes.
    I do not know how effective it would be, but I think 
probably some Americans do think that Social Security is like a 
401k plan and that their contributions are being invested in 
real assets, which is, of course, not the case except in the 
very narrow sense that the trust fund has these IOUs in it. So 
I do think that would be something worth pointing out.
    And I guess I could go even further and just note, as we 
had discussed earlier, that beyond the on budget deficit, which 
is what you are talking about, there is also the accrual 
deficit which adds to that the accrued obligations to, say, 
federal employee pensions and the like. And beyond that, it is 
the money that we are essentially owing each year as we get 
closer and closer to the demographic crunch.
    So there are multiple measures of this. And I agree that 
the unified budget deficit is in some sense the least revealing 
in terms of long-term obligations.
    Mr. Becerra. And, Mr. Chairman, I would guarantee you that 
most Americans would say to you so you are using those monies 
that we are contributing extra to Social Security to help us 
take care of our troops, to make sure they are well armed, or 
to make sure that Katrina victims are being addressed or taken 
care of in New Orleans. I think they would say fine, that is a 
good investment.
    But I wonder if most Americans would say that helping pay 
for the President's tax cuts which have benefitted very few of 
the majority of Americans who got up to work today because most 
of those tax cuts are directed towards folks who are probably 
in your income bracket and my income bracket and the upper 
echelons of our wealth, if the American public would say, well, 
that is really where I want to see my $190 billion in surplus 
Social Security funds going, recognizing that today we have got 
a budget deficit that is bigger than the whole $190 billion 
that Social Security is contributing to this budget.
    And I think if we did a better job, all of us, in our 
respective roles of educating the public on the money that is 
out there, I think they would guide us in some good decisions 
and these long-term decisions that we have to make to try to 
corral these deficits that are growing very large and the 
entitlement spending that we have to at some point address as 
well.
    So I thank you for being patient and being here and look 
forward to seeing you again at some point in the future.
    Thank you, Mr. Chairman. I yield back.
    Chairman Spratt. Thank you, Mr. Becerra.
    Mr. Chairman, you have been forthcoming as well as 
forebearing and we appreciate the efforts you have made to help 
eliminate the problems that line our path. They are daunting 
challenges, but they definitely need to be addressed. And you 
have helped issue a sobering call to action.
    Thank you very much for your testimony today. We very much 
appreciate it.
    Mr. Bernanke. Thank you, Mr. Chairman.
    [Whereupon, at 12:25 p.m., the Committee was adjourned.]

                                  
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