[Joint House and Senate Hearing, 112 Congress]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 112-138

                 SPEND LESS, OWE LESS, GROW THE ECONOMY

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

                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                             JUNE 21, 2011

                               __________

          Printed for the use of the Joint Economic Committee











                                _____

                  U.S. GOVERNMENT PRINTING OFFICE
67-929                    WASHINGTON : 2011
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing 
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC 
area (202) 512-1800 Fax: (202) 512-2104  Mail: Stop IDCC, Washington, DC 
20402-0001








                        JOINT ECONOMIC COMMITTEE

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

SENATE                               HOUSE OF REPRESENTATIVES
Robert P. Casey, Jr., Pennsylvania,  Kevin Brady, Texas, Vice Chairman
    Chairman                         Michael C. Burgess, M.D., Texas
Jeff Bingaman, New Mexico            John Campbell, California
Amy Klobuchar, Minnesota             Sean P. Duffy, Wisconsin
Jim Webb, Virginia                   Justin Amash, Michigan
Mark R. Warner, Virginia             Mick Mulvaney, South Carolina
Bernard Sanders, Vermont             Maurice D. Hinchey, New York
Jim DeMint, South Carolina           Carolyn B. Maloney, New York
Daniel Coats, Indiana                Loretta Sanchez, California
Mike Lee, Utah                       Elijah E. Cummings, Maryland
Pat Toomey, Pennsylvania

                 William E. Hansen, Executive Director
              Robert P. O'Quinn, Republican Staff Director













                            C O N T E N T S

                              ----------                              

                      Opening Statement of Members

Hon. Kevin Brady, Vice Chairman, a U.S. Representative from Texas     1
Hon. Robert P. Casey, Jr., Chairman, a U.S. Senator from 
  Pennsylvania...................................................    12

                               Witnesses

Hon. John B. Taylor, Ph.D., George P. Shultz Senior Fellow in 
  Economics, The Hoover Institution, and the Mary and Robert 
  Raymond Professor of Economics, Stanford University, Stanford, 
  CA.............................................................     5
Dr. Simon Johnson, Ronald A. Kurtz Professor of Entrepreneurship, 
  MIT Sloan School of Management and Senior Fellow, Peterson 
  Institute for International Economics, Cambridge, MA and 
  Washington, DC.................................................     6
Dr. Kevin A. Hassett, Senior Fellow and Director of Economic 
  Policy Studies, American Enterprise Institute for Public Policy 
  Research, Washington, DC.......................................     8
Dr. Chad Stone, Chief Economist, Center for Budget and Policy 
  Priorities, Washington, DC.....................................    10

                       Submissions for the Record

Prepared statement of Representative Kevin Brady.................    34
    Charts submitted by Representative Kevin Brady...............    40
    Study titled ``Maximizing America's Prosperity''.............    53
Prepared statement of Dr. John B. Taylor.........................    68
Prepared statement of Dr. Simon Johnson..........................    74
Prepared statement of Dr. Kevin A. Hassett.......................    80
Prepared statement of Dr. Chad Stone.............................    87

 
                         SPEND LESS, OWE LESS,
                            GROW THE ECONOMY

                              ----------                              


                         TUESDAY, JUNE 21, 2011

             Congress of the United States,
                          Joint Economic Committee,
                                                    Washington, DC.
    The committee met, persuant to call, at 2:00 p.m. in Room 
1100, Longworth House Office Building, the Honorable Kevin 
Brady, Vice Chairman, presiding.
    Senators present: Casey and Lee.
    Representatives present: Brady, Mulvaney, and Sanchez.
    Staff present: Gail Cohen, Colleen Healy, Jesse Hervitz, 
Jessica Knowles, Will Hansen, Ted Boll, Jayne McCullough, and 
Robert O'Quinn.

 OPENING STATEMENT OF HON. KEVIN BRADY, VICE CHAIRMAN, A U.S. 
                   REPRESENTATIVE FROM TEXAS

    Vice Chairman Brady. Good afternoon. On behalf of Chairman 
Casey and myself, I want to welcome everyone to this hearing 
entitled ``Spend Less, Owe Less, Grow the Economy.'' I want to 
welcome our witnesses as well, and members of the Joint 
Economic Committee.
    Chairman Casey and I have agreed to share the task of 
organizing hearings for the Joint Economic Committee during the 
112th Congress. Pursuant to our agreement, I convened this 
hearing because the once-vigorous American economy is 
languishing.
    A recent op-ed by Harvard University Professor Martin 
Feldstein entitled ``The Economy is Worse Than You Think,'' 
laments that final sales grew at an anemic annual rate 0.6 
percent during the first quarter of 2011. The month of May 
witnessed the unemployment rate rising above 9 percent again, 
and a collapse of payroll employment gains. Feldstein offers us 
another wakeup call.
    President Obama's economic policies have failed to launch a 
vigorous expansion. Instead, his policies have increased the 
cost of doing business, heightened uncertainty, and deterred 
job-creating investment. Moreover, his policies have burdened 
our children with enormous Federal debt that continues to grow 
as a share of the economy.
    One of our witnesses, Stanford University Professor John 
Taylor, published a graph that depicts President Obama's last 
two spending proposals, his budget in February and his informal 
framework in April, and compares them with the House budget 
resolution. From this graph, it is clear that President Obama 
and congressional Democrats want to make Federal spending a 
permanently larger share of our economy, whereas congressional 
Republicans want merely to return Federal spending to its pre-
recession share of our economy.
    Returning Federal spending to a pre-recession share of the 
economy is normal and prudent. Nevertheless, President Obama 
and some in Washington have embraced the radical, historically 
unprecedented expansion of the size and scope of the Federal 
Government.
    Let me be clear. Excessive Federal spending is our disease. 
Large Federal budget deficits and accumulating Federal debt are 
symptoms of this disease. If you cure our spending disease, the 
symptoms will vanish. If you treat the symptoms, you may 
temporarily alleviate some of the pain, but over time our 
economy will continue to weaken, our international 
competitiveness will erode, and our children will become the 
first generation in American history that is poorer than the 
previous generation.
    In response to these grave fiscal challenges, the House of 
Representatives passed a responsible budget resolution that 
would bring Federal spending in line with revenue over time. 
Unfortunately, the Senate has failed to even consider, let 
alone pass, a budget resolution.
    Congressional Republicans want to cure our spending disease 
in part by reforming entitlement programs to make them 
sustainably solvent for future generations. In contrast, 
President Obama and others have reverted to the discredited 
notion that entitlement programs can largely continue as they 
are without reforms if we only tax the rich enough.
    Congressional Republicans are demanding that any debt 
ceiling legislation must contain substantial spending 
reductions and new fiscal guardrails to ensure these reductions 
actually take place. In response, President Obama and Democrats 
in Congress have launched all-out political attacks asserting 
cuts in Federal spending would push the economy back into 
recession and destroy social programs. These false attacks must 
cease if Americans are to come together to reduce Federal 
spending and grow our economy.
    On March 15 of this year, I released a JEC staff commentary 
entitled ``Spend Less, Owe Less, Grow the Economy.'' This study 
examined other developed countries, our international 
competitors, that had large, persistent government budget 
deficits and a high level of government debt.
    The study found:
    Countries that adopted fiscal consolidation plans to reduce 
their government budget deficits and stabilize the level of 
government debt that were based predominantly or entirely on 
government spending reductions were successful in achieving 
their goals, while countries that included significant tax 
increases in their fiscal consolidation plans failed to achieve 
their goals.
    Fiscal consolidation plans based predominantly or entirely 
on government spending reductions not only increased economic 
growth over the long term, but also provided significant short-
term boosts in many cases.
    Today, we are releasing other JEC Republican staff 
commentary entitled ``Maximizing America's Prosperity.'' This 
study examined what fiscal guardrails would keep Congress on 
track to reduce Federal spending relative to the size of our 
economy.
    This study found several things:
    A balanced budget amendment to the U.S. Constitution would 
not counteract the bias toward higher Federal spending unless 
it contains explicit spending limitations.
    The Federal Government needs a statutory spending cap with 
a credible enforcement mechanism, regardless of whether a 
constitutional balanced budget amendment is ratified.
    The item reduction veto has reduced the growth of State 
spending by strengthening the role of the Governor relative to 
the legislature in making spending decisions. Enhanced 
rescission authority would also help to control the growth of 
spending at the Federal level.
    Sunset provisions, which have been effective in eliminating 
inefficient and unnecessary programs and agencies in U.S. 
States, would be helpful at the Federal level.
    So long as the President and congressional Democrats 
continue to behave in politically expedient but fiscally 
irresponsible ways, American families and businesses will look 
to the future with trepidation.
    Those are the concerns and the issues and the reasons we 
meet today. I look forward to hearing the testimony of our 
witnesses.
    Senator Casey will be here at about a quarter after to give 
an opening statement, and we will recognize him when he enters.
    [The prepared statement of Representative Kevin Brady 
appears in the Submissions for the Record on page 34.]
    [Charts submitted by Representative Kevin Brady appear in 
the Submissions for the Record on page 40.]
    [Study titled ``Maximizing America's Prosperity'' appears 
in the Submissions for the Record on page 53.]
    Vice Chairman Brady. At this point, I would like to 
introduce our witnesses, and on behalf of the Committee, thank 
you all for being here.
    We welcome the Honorable John B. Taylor, George P. Shultz, 
Senior Fellow in Economics at the Hoover Institution, and the 
Mary and Robert Raymond Professor of Economics at Stanford 
University. He also has taught economics at Princeton, Yale and 
Columbia Universities. Dr. Taylor has received the Bradley 
Prize for his intellectual achievements and the Alexandria 
Hamilton award for his overall leadership in international 
finance at the U.S. Treasury.
    Dr. Taylor is a renowned expert on monetary policy and the 
creator of the Taylor rule for determining what the target rate 
for Federal funds should be for price stability. He served as 
the Under Secretary of the Treasury for International Affairs 
during the first term of President George W. Bush. Previously, 
he served as a member of the President's Council of Economic 
Advisers during the Ford and the George H.W. Bush 
administrations. He has also served on the Congressional Budget 
Office's Economic Advisory Panel.
    Dr. Taylor has a long list of academic publications to his 
name, and a recent book entitled ``Getting Off Track: How 
Government Actions and Interventions caused prolonged and 
worsened the Financial Crisis.'' He is a frequent contributor 
to the editorial pages of the Wall Street Journal and other 
widely read publications on the state of the economy. He earned 
his Ph.D. in economics at Stanford University. Welcome, Dr. 
Taylor.
    Dr. Simon Johnson is a Ronald A. Kurtz Professor of 
Entrepreneurship at the Sloan School of Management at the 
Massachusetts Institute of Technology. He is a Senior Fellow at 
the Peterson Institute for International Economics and a member 
of the Congressional Budget Office's Economic Advisory Panel.
    Dr. Johnson previously held the position of Economic 
Counselor at the International Monetary Fund and was the 
director of its research department. He is a codirector of the 
National Bureau of Economic Research Africa Project and works 
with nonprofits and think tanks around the world.
    Dr. Johnson is a coauthor of the 2010 book ``13 Bankers: 
The Wall Street Takeover and the Next Financial Meltdown.'' He 
is a regular Bloomberg columnist and frequently publishes 
economic opinion pieces in major national and international 
news publications such as The Washington Post, the Wall Street 
Journal, and the Financial Times. He is cofounder of the blog, 
The Baseline Scenario. He earned his Ph.D. in economics at MIT. 
Welcome, Dr. Johnson.
    Kevin A. Hassett is a Senior Fellow and the Director of 
Economic Policy Studies at the American Enterprise Institute 
for Public Policy Research. Before joining AEI, he was a senior 
economist at the Board of Governors of the Federal Reserve 
system and an associate professor of economics and finance at 
the Graduate School of Business, Colombia University.
    Dr. Hassett was a policy consultant of the Treasury 
Department during the George H.W. Bush and Clinton 
administrations. He served as an economic adviser to the George 
W. Bush 2004 Presidential Campaign and as Senator John McCain's 
chief economic adviser during the 2000 Presidential primary. He 
also served as senior economic adviser to the McCain 2008 
Presidential Campaign. He is a columnist for National Review. 
Dr. Hassett earned his Ph.D. in economics at the University of 
Pennsylvania. Dr. Hassett, welcome.
    And our fourth panelist today, Chad Stone, is the chief 
economist at the Center for Budget and Policy Priorities where 
he specializes in the economic analysis of budget and policy 
issues. Dr. Stone was the acting executive director of the 
Joint Economic Committee here in 2007, and before that staff 
director and chief economist for the Democratic staff of the 
committee from 2002 to 2006. He held the position of chief 
economist for the Senate Budget Committee in 2001 and 2002. 
Previously, he served on the President's Council of Economic 
Advisers as senior economist and chief economist from 1996 to 
2001. His other congressional experience includes serving as 
chief economist to the House Science Committee.
    Dr. Stone has also worked for the Federal Trade Commission, 
the Federal Communications Commission, and in the Office of 
Management and Budget. He has been a senior researcher at the 
Urban Institute and taught for several years at Swarthmore 
College. Dr. Stone coauthored the book entitled ``Economic 
Policy in the Reagan Years.'' He earned his Ph.D. in economics 
at Yale University.
    Dr. Stone, welcome today.
    Dr. Taylor, we will begin with you.

   STATEMENT OF HON. JOHN B. TAYLOR, Ph.D., GEORGE P. SHULTZ 
  SENIOR FELLOW IN ECONOMICS, THE HOOVER INSTITUTION, AND THE 
   MARY AND ROBERT RAYMOND PROFESSOR OF ECONOMICS, STANFORD 
                    UNIVERSITY, STANFORD, CA

    Dr. Taylor. Thank you very much for inviting me to testify. 
I appreciate the opportunity. I am going to refer to three 
charts during my opening statement.
    Two years ago this month, the recession officially ended 
and the recovery officially began. However, it has been a very 
weak recovery by any historical comparison, and that is why the 
unemployment rate is still over 9 percent. I think if you in 
particular compare this recovery to the last deep recession we 
had in 1981 and 1982--and I show that in my first chart--it is 
quite striking.
    Economic growth in the 2 years, seven quarters we have 
observed so far since the recovery began, has only been 2.8 
percent average, and you can see in the bar charts, that is the 
blue line, quarter by quarter.
    In contrast, during the recovery from the 1981-1982 
recession, economic growth averaged 7 percent, so more than 
twice as high during that same corresponding period of time. 
Those are the red bars.
    You can see how much of a difference there is. So this is a 
weak recovery by any definition.
    I think the reasons for this in my view are policy--fiscal 
policy, monetary policy, and regulatory policy. Since the focus 
of this hearing is on fiscal policy, I will just mention the 
$862 billion stimulus package did not stimulate the economy. 
The increase in spending, Federal spending as a share of GDP 
from 19.7 percent in 2007 to over 24 percent now, did not 
stimulate the economy. Things like Cash for Clunkers, if 
anything, moved spending a few months further.
    Instead what these policies did, along with taking our eye 
off the basic ball of controlling spending, was to raise U.S. 
debt levels to very high and they will continue to go high in 
the future. I think these high debt levels raise a great deal 
of uncertainty. There is even concern of a another crisis, but 
there are certainly concerns about higher inflation, higher 
interest rates down the road.
    So I think the solution to this slow recovery, this weak 
recovery, nearly nonexistent recovery, is to what I call 
restore sound fiscal policy. I think it will bring attention 
and allow more private sector growth, and that is where the 
jobs will come from.
    My second chart shows the quite striking correlation 
between private investment in the United States as a share of 
GDP and the unemployment rate. As you can see, when private 
investment goes up as a share of GDP, the unemployment rate 
comes down. Right now we have low levels of investment and high 
unemployment.
    In contrast, if you look at the next chart, the third 
chart, you see that changes in government purchases, another 
component of GDP, have no such relationship. If anything, it 
goes the other way. But I would say it is not existent, and so 
you should not be worried, in my view, about a credible plan to 
reduce government spending.
    That brings me to the last part of my opening remarks: How 
do we restore sound fiscal policy?
    I think it is very important to have a strategy to do that, 
a strategy that is credible and understandable to the American 
public. I would say it should have four parts:
    First, a game changer which demonstrates a different 
attitude about spending, bringing spending down starting in the 
2012 budget. That establishes credibility which is so important 
for the effectiveness of a program like this.
    Number two, outline a path for spending.
    Number three, as much as possible, legislate what is 
required to get that path accomplished. Don't simply rely on 
promises in the future. That doesn't restore credibility.
    Number four, as you referred to, Mr. Chairman, some kind of 
caps on spending that correspond to the path of spending 
reductions.
    My next chart, basically you mentioned in your opening, 
just represents what I think this amounts to. It shows you the 
share of spending by the Federal Government as a share of GDP, 
and you can see that has gone up so rapidly in the last few 
years. The first budget the President submitted didn't really 
deal with that. That is the top line.
    The next line slightly below that is the CBO baseline. And 
the line at the lower part is the House budget resolution which 
does bring spending down as a share of GDP to levels that are 
consistent without increasing taxes.
    So in my view, it is pretty clear that the credible 
strategy is the one closer to the bottom. The policy that 
doesn't deal with the problem is the one at the top. Right now 
people are looking to negotiate, I believe, something in 
between. And if we do negotiate something in between, that will 
be an important step of progress, but really not enough if it 
doesn't go all of the way.
    Thank you very much.
    [The prepared statement of Dr. John B. Taylor appears in 
the Submissions for the Record on page 68.]
    Vice Chairman Brady. Thank you, Dr. Taylor.
    Dr. Johnson.

 STATEMENT OF DR. SIMON JOHNSON, RONALD A. KURTZ PROFESSOR OF 
  ENTREPRENEURSHIP, MIT SLOAN SCHOOL OF MANAGEMENT AND SENIOR 
    FELLOW, PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS, 
               CAMBRIDGE, MA, AND WASHINGTON, DC

    Dr. Johnson. Thank you very much.
    I would like to make three points, if I may.
    First, I fully support the goal of what I expect of 
everyone in the room, and that is we would like to bring the 
debt-GDP under control in the United States. The trajectory 
that we face going forward, if you look out, the IMF forecast 
horizon of 2016 or look at the CBO's longer-term projections to 
2030 or 2050, the numbers in the baselines are not encouraging 
and we need to have medium-term fiscal consolidation, meaning 
that debt-to-GDP-level should come under control and be brought 
down.
    The second point directly to the topic of the hearing is 
whether we could experience at this point in the U.S. cycle 
what is sometimes called an expansionary fiscal contraction, 
meaning that if we were to cut spending, for example, 
immediately, this would stimulate the economy and actually help 
with growth directly. This is a policy, for example, that the 
government of the United Kingdom is attempting to pursue at 
this moment.
    Now, expansionary fiscal contractions, from experience 
around the world, and this has been studied very carefully by 
the International Monetary Fund recently, such fiscal 
contractions under some circumstances by expansionary, but I do 
not think that we currently have those circumstances in the 
United States for three reasons:
    The first is fiscal contractions can help with the private 
sector economy if they restore confidence, if there is either a 
high perceived risk of sovereign default or some other concerns 
weighing on either consumer confidence or or firm's confidence. 
But I don't see evidence of that right now in the United 
States. Long-term interest rates remain low.
    There certainly are plenty of problems with debt overhang 
from the credit boom, and those are difficult problems, and I 
think that is the main reason we are growing slowly in this 
case, but they are not going to be immediately and directly 
addressed by cutting spending, unfortunately.
    The second thing that can happen, and this is very much I 
think the likely scenario in the United Kingdom, you can 
combine a restrictive fiscal policy with a more expansionary 
monetary policy. I would fully expect if the U.K. economy slips 
back towards recession, which is a real possibility, although 
the latest data are inconclusive on this, I would expect that 
the Bank of England would cut interest rates and otherwise 
increase its so-called quantitative easing policies.
    Now, in the case of the United States, I doubt very much 
the Federal Reserve would feel it had the space to do that. 
Short-term interest rates are very low, it has already 
intervened a great deal through quantitative easing at the long 
end of the term structure. I also don't think it would be a 
particularly good idea for the Federal Reserve to continue its 
innovations in that direction. So monetary policy would not be 
able to offset fiscal policy.
    The third way in which fiscal contractions can sometimes be 
expansionary is if they contribute to depreciation of the 
exchange rate. So if the value of the dollar were to fall, that 
would help our exports and help us compete against imports. 
Again, I think that may well turn out to be a factor in what we 
will see in the United Kingdom over the next 1 to 2 years. But 
in the United States, given the nature of the dollar as reserve 
currency, given the way that the world economy is developing, 
and particularly the problems in the euro zone--which are very 
severe, intending to push holders of reserve assets actually 
towards dollars, not away from dollars--it is again very 
unlikely that the dollar would depreciate, whether or not we 
have contractionary fiscal policy.
    So taking all of that together and comparing that with the 
cross-country evidence, I do not consider us to have 
circumstances that would allow fiscal contraction, for example, 
in the form of spending cuts. I do not think that would help 
stimulate the economy.
    The third point I would make, in conclusion, is that we 
should not lose track of how we got to these problems with 
debt. As you said, Mr. Chairman, to some extent these are 
longer-term problems, and I completely agree that we must deal 
with those issues over an appropriate time horizon. But at the 
same time, debt-GDP went up very sharply, as shown in Professor 
Taylor's pictures, for example, because we had a major 
financial crisis. Big risks were allowed to build up within the 
financial sector.
    And coming from a meeting this morning at the FDIC, its new 
Systemic Resolution Advisory Committee, which is a public 
hearing, and I have to say the tenor of that conversation was 
not particularly encouraging. There are very big risks around 
the financial sector that pose fiscal risks and threaten if 
there is another crisis or when there is another crisis, to 
further push up government debt relative to GDP. I hope we 
don't lose track of the fiscal damage brought by past and 
potential future financial crises in our budget discussions 
today.
    Thank you.
    [The prepared statement of Dr. Simon Johnson appears in the 
Submissions for the Record on page 74.]
    Vice Chairman Brady. Dr. Johnson, thank you very much.
    Dr. Hassett.

 STATEMENT OF DR. KEVIN A. HASSETT, SENIOR FELLOW AND DIRECTOR 
 OF ECONOMIC POLICY STUDIES, AMERICAN ENTERPRISE INSTITUTE FOR 
             PUBLIC POLICY RESEARCH, WASHINGTON, DC

    Dr. Hassett. Thank you, Vice Chairman Brady.
    Over the past several decades, many developed countries 
have undertaken fiscal adjustments in an attempt to reduce high 
debt levels. These countries' restructurings had varying 
degrees of success and failure, both in reducing debt and in 
stimulating growth. The economics literature is focused on 
answering two main questions in this area: What aspects of 
fiscal consolidations produce lasting reductions in debt; and 
what aspects encourage macroeconomic expansion?
    The answer to the first question is clear. Based on a 
review of the economics literature and an analysis of 21 OECD 
countries, two of my colleagues and I recently found that 
cutting expenditures is more likely to produce a lasting 
reduction in debt than increasing revenues. It is also typical 
that the more aggressively a country cuts expenditures, the 
more likely it is to successfully reduce debt in the long term.
    Averaging across a range of methodologies, the typical 
unsuccessful fiscal consolidation consisted of 53 percent tax 
increases and 47 percent spending cuts. The typical successful 
consolidation consisted of 85 percent spending cuts. In 
particular, cuts to social transfers and the government wage 
bill are more likely to reduce debt and deficits than cuts to 
other expenditures.
    There is more debate over the second question: What aspects 
of fiscal consolidation encourage macroeconomic expansion? The 
essence of the debate hinges on the balance between two 
economic effects of fiscal consolidation, the expectational 
effect and the Keynesian effect. The expectational effect is 
the positive effect on consumption and investment that occurs 
when policy is put on a sustainable path. These likely surge 
after a consolidation because of expectations of lower future 
tax liabilities. In other words, an immediate consolidation 
will alleviate the hoarding that accompanies fears of a larger 
and largely tax-driven consolidation in the future.
    Expenditure-based consolidations would provide stronger 
expectational effects because there is a better chance they are 
successful at reducing debt and because higher near-term taxes 
are hardly designed to ignite optimism in investors and 
consumers. The Keynesian effect reduces aggregate demand, and, 
therefore, GDP growth when government spending declines.
    The controversy is over whether the expectational effects 
of fiscal consolidation can completely outweigh the Keynesian 
effects in order to create short-term growth. There is less 
controversy around the view that the long-term benefits of 
fiscal consolidation are substantial.
    Two schools of thought have emerged in the debate. Harvard 
economist Alberto Alesina and his various coauthors argue that 
consolidation, especially expenditure cuts, can lead to a burst 
of growth starting immediately. A team of IMF economists, 
however, identified possible methodological flaws in Alesina's 
studies and claim that the typical fiscal consolidation would 
be contractionary.
    It is beyond the scope of this testimony to resolve the 
dispute between the two corners of the literature. A fiscal 
consolidation optimist would believe that the Alesina work is 
correct, and then would expect a large fiscal consolidation 
would lead to near-term growth. But a pessimist would point to 
the alternative work at the IMF and argue that the growth 
effects are more uncertain. But it is important to note that, 
even in this case, the IMF study points to positive growth 
effects if the fiscal consolidation is correctly designed. That 
is, both sides of the literature find that reducing 
expenditures will provide a better growth outcome than 
increasing revenues.
    Although the IMF finds that a tax-based consolidation would 
reduce GDP by around 1.6 percentage points 3 years following 
implementation, they find that the negative effects of a 
spending-based consolidation would be small and statistically 
insignificant. That is, even in the most pessimistic corner of 
the fiscal consolidation literature, there is little to 
dissuade us from pursuing a consolidation today.
    Moreover, they find that spending-based consolidations that 
are focused primarily on transfer cuts could produce positive 
near-term growth effects, although we should add that those are 
statistically insignificant.
    The latter point is especially interesting. Since the 
authors studied near-term cuts and entitlements, one might 
expect that these would have a relatively large short-run 
negative effect on consumption behavior. The fact that 
expectational effects dominate, even when entitlements are cut 
immediately, suggests that out-of-control entitlement spending 
has a profoundly negative impact on forward-looking sentiment 
and business and consumer confidence.
    This result also suggests a policy opportunity. Given the 
massive imbalances that exist today, it is likely that 
consumers have very little faith that current programs will 
remain in place throughout the course of their lifetimes. 
Accordingly, cuts to entitlements that phase in gradually over 
time will likely have little impact on their perceived lifetime 
wealth as the benefit cuts are effectively already factored 
into consumers' expectations. If consumers don't expect 
promised benefits to be paid, government can reduce promised 
benefits without causing today's consumption to go down, which 
means, of course, that the expectational effects of a fiscal 
consolidation could easily be expected to dominate and produce 
significant near-term growth if there are few immediate cuts to 
benefits but significant longer-term cuts. If, in addition, the 
fiscal consolidation were paired with a tax reform that 
broadened the tax base and reduced marginal tax rates, then a 
significant growth spurt would be the natural expectation to 
draw from the economic literature.
    Thank you.
    [The prepared statement of Dr. Kevin A. Hassett appears in 
the Submissions for the Record on page 80.]
    Vice Chairman Brady. Dr. Hassett, thank you.
    We have been joined by Chairman Casey today. With his 
permission, we will finish Dr. Stone's testimony, and then he 
will be recognized for his full opening statement.
    Dr. Stone.

STATEMENT OF DR. CHAD STONE, CHIEF ECONOMIST, CENTER FOR BUDGET 
             AND POLICY PRIORITIES, WASHINGTON, DC

    Dr. Stone. Thank you. Chairman Casey, Vice Chairman Brady, 
and other members of the committee, thank you for inviting me 
to testify before a committee where I have a strong personal 
connection, as my biography showed. I have a longer written 
testimony for the record which I will summarize here.
    U.S. policymakers must make smart choices about taxes, 
spending, and deficits to craft the right set of policies to 
help the economy emerge from its current deep slump and achieve 
sustainable economic growth with high employment and broadly 
shared prosperity.
    Making smart choices requires differentiating between: one, 
the longer-term policies needed to produce sustainable growth 
at high levels of employment; and, two, the short-term policies 
needed to restore high levels of employment in the wake of a 
deep recession. In particular, policies aimed at reducing the 
budget deficit are a key ingredient of longer-term policy but 
are likely to be counterproductive in the short run if 
implemented too precipitously.
    This is the mainstream economic position as enunciated, for 
example, by Federal Reserve Chairman Ben Bernanke. In the quote 
in my statement, he observes that fiscal sustainability is a 
long-run concept, and achieving it requires a credible, 
practical, and enforceable long-run plan.
    In current circumstances, he says, an advantage of taking a 
longer-term perspective is that policymakers can avoid a sudden 
fiscal contraction that might put the still-fragile recovery at 
risk. At the same time, there are advantages to acting now to 
put in place a credible plan for reducing future deficits. The 
Congressional Budget Office has made similar points, and we at 
the Center on Budget and Policy Priorities believe this is the 
right framework for thinking about deficit reduction and 
economic growth.
    I recognize that one of the purposes of this hearing is to 
highlight a different point of view from what I regard as this 
mainstream economic consensus, but for the reasons that I will 
lay out, I think that some of the arguments that are produced 
to support that alternative view are unpersuasive.
    The premise is that we are suffering from an unwarranted 
explosion of government spending that has produced an immediate 
debt crisis; that immediate sharp reductions in government 
spending are necessary and could even make the economy grow 
faster in the short term; and that deficit reduction is more 
likely to be successful if it is composed largely of spending 
cuts. I have questions about all three of those premises.
    First, policies enacted since the 2008 election are not the 
main drivers of deficits and debt. The U.S. fiscal imbalance 
problem is a long-term problem that has little to do with the 
short-term imbalances that have emerged as a result of the 
financial crisis and the great recession. The main driver over 
the long term is unsustainable growth in health care costs 
throughout the U.S. health care system in the public and 
private sectors alike.
    As the charts in my testimony show, increases in the 
deficit due to policies enacted over the past few years are 
temporary, and only their relatively modest associated interest 
costs add to the longer-term deficits. The reason government 
spending remains higher over the next decade than it was before 
the crisis is primarily longstanding trends in health costs and 
large interest costs on debt associated with deficit-financed 
tax cuts from an earlier era, deficit-financed wars, and 
deficits arising as a result of the economic downturn itself.
    CBO estimates that discretionary spending as a share of GDP 
in the President's budget would be 2.1 percentage points lower 
in 2021 than it was in 2008 and that net interest costs, for 
the reasons I talked about largely, would be 2.1 percentage 
points higher.
    Second, large intermediate cuts in government spending will 
hurt the still-fragile economic recovery. We have heard some 
discussion about the international evidence, and both the IMF 
and recently the Congressional Research Service in a new report 
have looked at this evidence, and we at the Center on Budget 
have also looked at it, and were surprised to see the extent to 
which, when you look into the data, the examples tend not to 
conform to conditions that we have in the United States.
    The best circumstances for reducing deficits are if you are 
experiencing a debt crisis and interest rates are high, 
monetary policy has the ability to react, and as Simon Johnson 
said, if the exchange rate can react. That is not the situation 
in the United States. And I should say most importantly, when 
you have the degree of economic slack that the United States 
has, deficit reduction efforts that are short and sharp are 
unlikely to be successful.
    Third, on the question of the composition of deficit 
reduction, international evidence has little to say about how 
much of U.S. deficit reduction should be spending cuts and how 
much should be revenue increases, because it is focused on the 
short term. It does not deal with the kind of long-term deficit 
reduction that we need.
    It also does not come to grips with the fact that the 
United States is unique in the extent to which it relies on the 
Tax Code to do what other countries do directly through 
government spending. I'm referring to the trillion dollars a 
year of so-called tax expenditures, which are a prime place to 
go to find worthwhile budget savings, but it is not clear 
whether they should be regarded as spending or as revenues.
    And, finally, it ignores lessons from the successful 
longer-term deficit reduction efforts such as the United States 
pursued in the 1990s when revenue measures were a significant 
component of the 1990 budget agreement and the Deficit 
Reduction Act of 1993, which were followed by the longest 
economic expansion in our history and a balanced budget by the 
end of the decade. Thank you.
    [The prepared statement of Dr. Chad Stone appears in the 
Submissions for the Record on page 87.]
    Vice Chairman Brady. Thank you, Dr. Stone.
    Chairman Casey, thank you for joining us. You are 
recognized for your full opening statement.

  OPENING STATEMENT OF HON. ROBERT P. CASEY, JR., CHAIRMAN, A 
                 U.S. SENATOR FROM PENNSYLVANIA

    Chairman Casey. I have to apologize first for being late, 
but I appreciate the testimony of our witnesses, Dr. Taylor, 
Dr. Johnson, Dr. Hassett, and Dr. Stone. I know there are 
others who will be asking questions and maybe making 
statements. I will be brief.
    I wanted, first of all, to make the following assertion. I 
don't think there is any disagreement on this committee, and 
actually throughout most of the country, about the need to 
reduce the deficit and have a strategy to do that. I think it 
is shared in a bipartisan manner, and we are all of one mind to 
do that.
    The questions that we are trying to resolve here are the 
timing of that and what policies yield the best results. On 
these questions, I think there is honest disagreement, but also 
significant disagreement. We are having a robust debate about 
it, as we speak, and throughout the next couple of weeks and 
months. Today's hearing is part of that debate. It is important 
that we have this debate at this time.
    We have a lot of able economists across the country and 
several here today who offer their perspective. I want to 
provide a little bit of context in terms of some of the 
assertions that have been made today and will be made today.
    One assertion is that government borrowing is interfering 
with private investment. That is one assertion.
    The second is that deficit reduction can promote economic 
growth in the short run.
    And third, that deficit reduction is best achieved through 
spending cuts rather than revenue increases.
    I think a number of us would have significant disagreement 
with one or more of those, or at least with part of those 
assertions. But I think, at the same time, we can all come 
together and agree that we have to have more spending cuts and 
deficit reduction, but we also have to be mostly concerned, I 
believe, about job creation.
    My main concern with any strategy that might be discussed 
today or that we would enact into law is that we don't take a 
step that would derail the recovery in what we do in the next 
couple of weeks and months. If we do that, if we take steps 
that will derail the recovery, it will worsen the long-term 
budget outlook, and it will reduce revenues and increase 
government spending on automatic stabilizers like unemployment 
insurance.
    The U.S. economy is recovering, and we have recorded now 
seven consecutive quarters of growth, but the rate of growth 
that we have achieved so far has been modest. In the first 
quarter of 2011, GDP grew at less than 2 percent annual rate. 
The reality is that there are still major economic challenges 
in front of us. Fourteen million Americans are unemployed. 
Housing prices continue to decline. Consumers have been hit 
hard by rising gas prices, and businesses are waiting for 
demand to return before expanding their operations and hiring 
more workers. Small businesses, of course, are struggling as 
well, and the biggest challenge we face, I believe, is job 
creation, or at a minimum, increasing the pace at which jobs 
are created. So getting people back to work has to be our 
number-one priority.
    We cut this year's budget substantially by tens of billions 
of dollars, but there is more to do. There is waste and 
inefficiency that we must cut. Rooting out that waste and 
inefficiency is a prime way to reduce Federal spending in the 
short run.
    I was the Auditor General of Pennsylvania for 8 years and 
State Treasurer for 2. And in that decade, I spent a lot of 
those days, and my team did, locating and eliminating waste and 
fraud, so I know something about it. But I also believe making 
deep, indiscriminate cuts immediately--immediately--to proven 
strategies that we know will help our economy grow and create 
jobs could, in the end, be self-defeating. So I think that the 
question of timing is critically important.
    Let me wrap up just with a reference to someone who has 
spent a lot of time analyzing these problems for many years, 
chairman of the Federal Reserve, Ben Bernanke. He said 
recently, ``If the Nation is to have a healthy economic future, 
policymakers urgently need to put the Federal Government's 
finances on a sustainable trajectory. But, on the other hand, a 
sharp fiscal consolidation focused on the very near term could 
be self-defeating if it were to undercut the still fragile 
recovery.'' He goes on from there.
    Chairman Bernanke has laid out the challenge that we must 
confront. We must have a credible plan to put our fiscal house 
in order, for sure, reducing the deficit in the medium and long 
term. A strong economy is critical to sustainable deficit 
reduction. We cannot reduce the deficit if we are not growing 
and creating jobs, and getting people back to work is the key 
to that.
    I am grateful for the opportunity today to be part of this 
hearing. I am grateful to Chairman Brady for getting us here.
    Vice Chairman Brady. Chairman, thank you very much.
    I appreciate the testimony of all four witnesses today.
    I recently held a round of town hall meetings with job 
creators, small- and medium-sized businesses, and asked for 
their input on how we jump-start this economy. And I dutifully 
set aside my debt crisis PowerPoint to focus on job creation, 
going through a list of ideas that had come from Washington, 
DC. They said, ``Put away that PowerPoint, go back to the debt 
crisis,'' one, because in their view until we tackle the debt 
and deficits, they were not going to make the decisions to 
create jobs, at least in our 11 counties in Texas.
    So I want to ask Dr. Taylor and Dr. Hassett--Dr. Taylor, a 
separate question. You talked about a game changer to restore 
credibility in our financial order. But we are oftentimes told 
that we can't do that; that introducing a fiscal consolidation 
program would mimic that of the Great Depression where spending 
reductions, they claim, created the recession of 1937 and 1938, 
and they use that analogy to apply to today.
    What is your assessment of that analogy; and is it 
important for us to engage in a serious fiscal consolidation 
program now in order to spur the economy?
    Dr. Taylor. I think it is essential to engage in a 
consolidation program now, and it will spur the economy. Again, 
since this recovery began, and it is, quite frankly, hardly a 
recovery, growth has been only 2.8 percent. So the low growth 
now, it is consistent with this pattern from the last 2 years 
since the recovery began.
    As I said before, if you compare that with the last time we 
had a big recession, the growth is less than half as much. It 
was 7 percent at that point. When I look at it, I think that 
negative difference, that low growth we have now, is because of 
all of this fiscal activism. If you look carefully at the data, 
that increased spending that we have had--and it is huge over 
the last 2, 3 years--has not really stimulated--this is the 
weakest recovery we have had by comparison. So there is no 
evidence that it has.
    So I think if you start undoing that, and after all, what 
is so draconian about bringing spending back to where it was in 
2007? Why should that be so hard as a share of GDP? So when we 
use the words ``draconian'' or ``deep,'' think about, for 
example, the 2011 budget--which you agreed to recently--that 
did reduce spending in terms of budget authority from what was 
originally asked for, but the outlays are only down by less 
than a billion. Less than $1 billion in 2011 compared to 2010.
    So the focus should be on how do you get a game changer, 
get enough spending down so it is credible. The problem isn't 
trying to find ways to spend more, the problem is trying to 
find ways to spend less. So the more that you can go in that 
direction, the more you will demonstrate to the country that we 
can get our house in order and that will definitely be 
beneficial to people who are worried about the debt, who are 
worried by inflation and are worried about higher interest 
rates down the road.
    So I think I would emphasize so much just taking the 
efforts now to get started, because if you don't, if it is just 
promises for the future, promises for the next 10 years, it 
will not be viewed as credible and it won't work.
    Vice Chairman Brady. Thank you, Dr. Taylor.
    Dr. Hassett, in your study, what types of cuts do 
governments undertake that bolster the economy in the short 
term, that restore confidence for those making private business 
investment, and also for consumers? What worked?
    Dr. Hassett. The two biggest components of successful 
consolidations were entitlement reductions and reductions in 
the government payroll. I think that both of those show a kind 
of credible commitment to getting the fiscal house in order.
    You both know, Mr. Vice Chairman and Mr. Chairman, how 
difficult such moves would be politically and would require 
broad bipartisan consensus. And to show that we can accomplish 
that would really create kind of a celebration in financial 
markets because people would think, oh, finally, the U.S. has 
solved this big problem.
    I would point, Mr. Vice Chairman, also to the beginning of 
my testimony, and highlight the urgency of action. I think in a 
traditional recession that lasts 11 months or so, and then has 
a recovery, pre-1990s, that grows 5 or 6 or 7 percent in the 
year that we get out, that we launch out of the recession, then 
if you have a really well-timed Keynesian stimulus, that you 
might take a percent or 2 out of growth out of the recovery 
year and move it into the recession year, and if you are 
growing 5, 6, 7 percent, then that kind of a trade could be 
something that everyone on this committee would want to 
consider.
    The difference this time is that we know from the work of 
Carmen Reinhart and Ken Rogoff and also Vincent Reinhart that 
the recovery from a financial crisis is a long slog. It lasts 
maybe a decade. So if we take a Keynesian approach, what is 
going to happen is the hangover from the Keynesian spending is 
going to be present in the slow-growth period, and maybe even--
even if you are a Keynesian optimist about the effects of 
government on growth--pushes down toward a recession. And then 
we might have to have that argument that we need another 
stimulus because we don't want to have a recession this time.
    I would urge members to consider leaving the Keynesian 
roller coaster and thinking about policies that can put us on a 
sustainable growth path without a hangover.
    Vice Chairman Brady. Thank you.
    Chairman Casey.
    Chairman Casey. Dr. Stone, I wanted to ask you a question 
that relates to part of this debate. As you can tell from my 
statement, I want us to focus more on job creation.
    Tell me what your sense is in terms of what is the optimal, 
or even if you have by way of a list, the optimal way to create 
jobs in the near term, meaning the next year or two, in terms 
of either a strategy that the Federal Government employs or 
just by way of tax policy?
    We had, as you know, a tax bill at the end of last year, 
elements of which both parties really disliked and other 
elements which they embraced. But both sides were willing to 
look past their disagreement or their objection to parts of the 
bill in order to keep tax rates where they were and to add 
features like a payroll tax cut which put a thousand bucks in 
the pocket of the average American family. But when you think 
about either government action or a strategy that has been 
tried, or maybe has not been tried, in addition to tax policy, 
what do you think the best approach is to job creation and how 
would you itemize those, if you can?
    Dr. Stone. Let me begin by endorsing the idea that, on the 
budget, a game changer would be really good; and my vision of a 
game changer is bipartisan, a bipartisan agreement that 
recognizes the reality that tax measures, starting with going 
after the tax expenditures perhaps, and spending cuts need to 
be part of a sustainable, believable, credible budget effort.
    So there is no disagreement on the panel about the 
importance of putting in place a plan to get our fiscal house 
in order and that that matters. And it needs to be credible.
    The issue is if you do it too fast, does that harm the 
recovery.
    My first answer to your question is the Hippocratic oath: 
First, do no harm. Don't try to do too much too fast on the 
deficit reduction effort while the economy is still struggling 
to recover. That doesn't mean that you can't put a plan in 
place that is serious and begins to take effect a couple of 
years down the road.
    The most recent economic news has been pretty 
disappointing; and, therefore, I think we should be considering 
whether we want to allow the payroll tax holiday to continue. 
And also, the unemployment rate is still extremely high, and 
unemployment insurance is one of the most effective measures of 
injecting demand into an economy that is suffering from 
inadequate demand. And yet the unemployment insurance benefits 
are scheduled to expire at the end of the year.
    So I think those are two things that are already in place; 
probably it is worthwhile extending them into next year.
    This is particularly true because the Fed is--it is not out 
of ammunition, but the ammunition that it would have to use to 
provide further demand stimulus to the economy would be very 
unusual measures that we don't have a lot of experience with.
    So I think don't cut too fast, put a credible deficit 
reduction plan in place, and consider extending the payroll tax 
and the unemployment insurance.
    Chairman Casey. Just very quickly, and I don't know if 
others have an opinion on this, but we had at least three 
really good private sector job growth months in a row, above 
200; one was 230, 222, and a third that was maybe higher than 
that. But 225 or above for 3 straight months. And May came 
along, and every number is off. The net, the overall job 
growth, the private sector number was a lot lower. Anyone have 
a sense of why that happened in that particular month, A; and, 
B, do you think it will prevail or do you think we can get back 
in June, July and August where we were in January to April?
    Dr. Johnson. I think the important point that Dr. Hassett 
made is that this is a fairly standard recovery from a serious 
financial crisis. That is why it is so different, the 
employment pattern is so shockingly different than what we have 
seen in all postwar recessions in the United States, including 
the one in the 1980s that Dr. Taylor was emphasizing. This is 
what happens when you take on a massive amount of debt, 
particularly in the housing sector, you will have some sort of 
stop-start on the job side. And, personally, I don't think that 
you should be throwing more Keynesian roller-coaster type 
stimulus at it. I don't think that works.
    But I would emphasize that most of the increase in the 
debt-to-GDP that we have experienced in the short term is due 
to the automatic stabilizers. You have to let the automatic 
stabilizers work. Our automatic stabilizers, by the way, are 
relatively weak compared to almost every other industrialized 
country. That is a main reason why it made sense to supplement 
them at the beginning or the deepest part of the recession. But 
that is done now. That is history.
    I agree completely with Dr. Stone; you don't want to derail 
the recovery now by overreacting. Sure, we want debt-to-GDP to 
come down, but it will come down as the economy recovers. If 
you try and cut spending too much, too soon, that will have 
counterproductive effects. Unless you think ownership policy 
can respond with a massive expansion, but I haven't heard 
anybody on the panel yet make a convincing case for that. And I 
don't think Mr. Bernanke also would be inclined to make that 
case.
    Dr. Hassett. I just wanted to add that we did a recent 
calculation comparing the U.S. recovery in this financial 
crisis to the past financial crises that were studied by Carmen 
Reinhart and Ken Rogoff, and asked ourselves, if we have the 
typical experience of a country after a financial crisis, what 
will the unemployment rate in the U.S. be in 2018? And the 
answer is about 8 percent.
    So we are in a base case that it is a really tough slog and 
a real painful challenge for America's workers. And if we don't 
get serious about doing something that is not going to jack up 
growth for one year, but really fix the problem--and I think 
that we need both a fiscal consolidation and a fundamental tax 
reform--then we are looking at a base case that is really 
terrible. And I think that is probably something that we all 
agree with on the panel.
    Chairman Casey. Thank you.
    Vice Chairman Brady. Senator Lee.
    Senator Lee. Thanks to all of you for coming. I wanted to 
start with Dr. Taylor.
    What do you think would be the impact of a tax rate 
increase on our economy at a time like this one?
    Dr. Taylor. I think it would be very harmful to have a tax 
rate increase. In fact, I think Senator Casey asked about 
explanations for the sort of little pick-up in job creation. It 
occurred around the time of December when the deal was made to 
postpone the tax increases. I think that was quite significant. 
I wish it was permanently postponed. But there were tax 
increases on the books, and they had been postponed. I think 
that is positive. It gives you some sense of what you can get 
from agreeing not to increase tax rates. I think it would be 
very harmful to the economy.
    Senator Lee. What if we limited the tax increases to the 
wealthy? Couldn't we forestall the problem by doing that?
    Dr. Taylor. It is a very important step. Tax reform is also 
important, and I am glad to hear there is more interest in that 
on Capitol Hill at this point. But to me, the first step is 
don't increase taxes. Leave those tax rates alone.
    Senator Lee. Even in the higher income brackets?
    Dr. Taylor. Across the board. There is no reason to 
increase those tax rates. There is this phrase that people 
sometimes use, ``It is a spending problem, not a tax problem.'' 
That is the truth, actually. If you look at the numbers 
carefully, it is hard to convey that to people without looking 
at the numbers; but when you look at the numbers, that is 
really what it is. And you don't want to risk the 
disincentives. There are enough disincentives now for firms to 
invest, with the regulations and the fear of the debt problems, 
and, for that matter, I think monetary policy. There are lots 
of reasons that investment is not as strong as it should be or 
could be. Of course, housing is part of that. Unless we get 
investment moving, unless firms start investing and expanding, 
unemployment is going to stay high. So I think that would drive 
that private investment, whether it is equipment, structures, 
and you will see jobs being created.
    Senator Lee. And that investment, you would argue, is less 
likely to occur when those would-be investors have the promise, 
the assurance, that they will be able to keep less of that 
money?
    Dr. Taylor. Right. You tax something more, you are going to 
get less of it. These days there is a fear of increasing taxes 
quite a bit because of the budget. I think if that could be 
clarified, that is part of the idea of being credible, 
predictable, is to recognize that the best way to do this is by 
not trying to raise tax rates. Quite frankly, I don't see there 
is much interest in doing that in the country anyway.
    Senator Lee. Would it be fair to conclude that a supposed 
tax rate that affects only the rich is in fact a misnomer 
because it would end up impacting perhaps most acutely, most 
severely, those most-vulnerable people, those people who most 
desperately need jobs would be less likely to find them as a 
result of diminution of investment leading to less employment?
    Dr. Taylor. Yes. If you reduce the incentives for firms to 
invest and expand, you are going to reduce the incentives for 
them to create the jobs, and that is where the jobs come from. 
The jobs are not coming from more government purchases, or even 
less government purchases. That will detract from the jobs. It 
is that private sector investment. That is what the data show. 
And to the extent you can encourage that by not raising the tax 
rates on those firms, there are a lot of small business firms, 
larger small business firms, to be sure, it is going to be 
counterproductive and we will have this high unemployment 
rate--which is a tragedy--for quite awhile.
    Senator Lee. We hear a lot about the debt limit and about 
how the failure to raise the debt limit could result in this or 
that economic catastrophe. Is there not also an economic 
catastrophe that could and would await us if we were to raise 
the debt limit reflexibly, as it has been raised many times in 
the past, without any significant strings attached, without 
attaching it to significant, binding spending caps?
    Dr. Taylor. I think tying the spending reductions to the 
debt limit increase is very important. I wrote in the Wall 
Street Journal about that a couple weeks ago. I think the 
position that has been taken there has been very productive. It 
has actually driven, I think, the talks in a good direction. So 
a clean, so-called clean debt limit increase, without spending, 
would damage credibility, especially at this point because we 
have had such a surge in spending. So I have argued strongly 
for tying these together. And I can see why they would just 
like to have a clean debt limit increase, but I think 
especially at this point in time it would be a mistake. 
Moreover, I think from what I hear about these budget 
negotiations we stand a good chance of tying those together, as 
the Speaker originally suggested.
    Senator Lee. Thank you.
    Vice Chairman Brady. Thank you, Senator. Congresswoman 
Sanchez is recognized.
    Representative Sanchez. Thank you, Mr. Chairman. And thank 
you, gentlemen, for being before us. Oh, gosh. I always am 
amazed at the difference of opinions that we get to whomever we 
speak about the economy. And I am always amazed also when I am 
at events and people come up and think they know all about the 
economy and try to tell us what we should be doing. But what I 
have learned in the 15 years I have been here and in my studies 
when I graduated with an economics degree, and as an MBA, as a 
former investment banker, sometimes you just don't know.
    You know, I would like to say something about the stimulus, 
because I think that it has been maligned a lot here, the 
stimulus package or the Recovery Act. Yes, it was $800 billion, 
but remember that a third of that was tax cuts, it was not 
spending, it was tax cuts. So you can't have it both ways. You 
can't say that the renewal of the tax--of the Bush taxes in 
December were not spending. You just can't say that. You just 
can't say--you can't count spending, a third of the spending 
package that were taxes as spending and not count the Bush 
continuation of tax cuts as not spending either. You can't have 
it both ways. So we either count it one way or we count it the 
other.
    We were told in December that if we passed that package of 
tax cuts it would give stability and businesses would start 
using their $1.4 trillion that they sit on on their balance 
sheet. And you know what, they haven't. It has been a jobless 
recovery. So we hear all of these issues about keep the taxes 
low, don't collect, but the fact of the matter is that Bush's 
own Comptroller has stated that 70 percent of the debt and the 
majority of this debt was accumulated under George Bush, that 
70 percent of that was due to the tax cuts over and over and 
over during that time. And we had a couple of other things, a 
couple wars I didn't vote for, a couple wars I think we should 
be out of, a couple of wars that we keep spending money on more 
and more to the point where it is taking away from investing in 
the future of our military because it is operational, and 
halfway around the world, and it is not money going in our 
pockets, it is money outside of our economy.
    So, you know, I am hearing all sorts of information out 
there, but in the bottom line I think we need a little of both. 
We need to talk about some real spending reforms, and I think 
defense has to be on it. From the looks of the House bill 
passed on defense recently that was increased significantly. 
Everything else took a cut, but defense increased 
significantly. And by the way, it is not going to our people 
working back at home or our defense contractors trying to build 
systems. They are in fact being cannibalized and they are not 
being paid. And they are stopping their production lines, which 
is going to cost us more on the long run to retool and reset 
our military.
    So I want to ask each of you, do you really think that it 
doesn't take a little of both, some spending cut, maybe in a 
moderate way, but with a firm commitment, and some increase in 
taxes to start to get this back? And maybe we will start with 
Dr. Stone and go down the list.
    Dr. Stone. I did say that I think we do need a balance that 
has both. I think that is one of the things that is problematic 
about debating over the debt limit, which really has nothing to 
do with controlling deficits; it may be a way to get people 
talking, but when people are talking they have to be talking 
about something that can really happen, and that would require 
a balance of the two.
    When you ask businesses what is the problem, they don't 
say--they always say it is taxes, but that stayed constant. 
What has really gone up is they say sales. And so to give 
businesses incentives to add to their capacity when they don't 
have customers in the stores is problematic. I think they need 
the customers in the stores first.
    Dr. Hassett. Yes, Congresswoman, thank you. I in my 
testimony, I say that it should be both. I recommend modeling 
it after the typical successful consolidation which had a 
balance of both.
    Representative Sanchez. Thank you, Doctor.
    Dr. Johnson. I completely agree with you, Congresswoman, 
that military spending needs to be capped over the long run, 
but particularly health care spending as a percentage of GDP, 
if you look out to 2030 or 2050, that is a major problem. I 
would actually go further than Dr. Taylor just now. If you have 
the possibility of putting in place a credible limit on future 
health care spending as a percentage of GDP, by all means tie 
that to the debt cap discussion or implement it in some other 
way. That would have a major effect on fiscal credibility. That 
is mostly about spending, but I would emphasize it is not just 
government spending, not just Federal Government spending, you 
have to look at general government spending and you have to 
look also at private sector spending.
    When I talk to entrepreneurs, which I do a great deal in my 
various jobs, they are worried about health care costs that 
they will face in 5 years, 10 years, and 20 years. That is a 
major burden that we have not yet seriously addressed. So I 
would put that front and center of the long-term fiscal 
consolidation needs.
    Representative Sanchez. Thank you, Doctor.
    Dr. Taylor. May I use a couple of my charts to answer this 
question? I guess not. Okay.
    One of my charts shows that if we brought spending back--
the next to last one, I believe. This is Federal spending as a 
share of GDP, going back a few years, and you can see how it 
grew a lot in 2008, 2009, 2010. It was 19.7 percent of GDP in 
2007. And the House budget resolution, which is the line that 
brings us down, brings it back to about the same level, 19.7 
percent of GDP. So that is roughly what you need, maybe a 
little bit less, depending on what we think is happening with 
taxes for budget balance, because the deficit was like 1 
percent of GDP in 2007 or so. So that is why I think it is a 
spending problem, that is why I say it is that way.
    If you look at the next slide, the next slide, that first 
slide divided everything by GDP because I think that is how 
economists like to think about it. But in fact we are not 
talking about cutting things. This is the total spending 
without just what it is. And you can see where it has been, and 
you could see where it would go with the President's first 
budget, and you could see where it goes with the House budget 
resolution. And they all increase, I mean these are all 
increases. I think you have to put that in perspective as well.
    And then finally your question about the tax part of ARRA 
and the tax part of the 2008 stimulus is a very important 
question. When I look at the impact of the tax rebates or the 
one time payments, they seem to do very little good in terms of 
stimulating consumption. Both in 2008, February 2008, the 
Economic Stimulus Act, and 2009, the ARRA, the tax components 
of those were mainly just to send money to people, tax credits 
from previous earnings and mostly was spent. It did not jump 
start the economy. You can see that in the data.
    When we talk about tax rates increasing, that is a 
different story. That is what is going to happen if you create 
a job or if you expand your business. The money you are going 
to get from doing that or the benefits from that. That is not a 
rebate from the past, which just tends to get wasted 
unfortunately in terms of stimulating the economy. But what is 
so important are these tax rates, and that is why in answer to 
Senator Lee's question I said raising tax rates would be a 
terrible mistake at this point in time.
    Thank you.
    Representative Sanchez. Thank you, gentlemen.
    Vice Chairman Brady. Thank you. Mr. Mulvaney is recognized.
    Representative Mulvaney. Thank you, Mr. Chairman. I will 
continue on what the Congresswoman was talking about and see if 
we can't find some similarities of opinion in what we are 
talking about today. I would like to start with taxes, 
following up with what the Senator said as well. If they would 
bring up slide number 1, please, which is the Federal income 
tax revenue and top income tax rate. This is a graph that shows 
two different things, which essentially, once they get it up, 
what you will see is a red line that shows the Federal revenue 
as a percent of GDP and a blue line that shows the top tax 
rate.
    And as you can see, I think several of you may be familiar 
with this graph. Over the course of the last 60 odd years the 
Federal Government generally has taken out between 15 and 20 
percent of GDP and tax revenues. I think the average over the 
course of the last years 50 years is roughly 18\1/2\ percent, 
but that during that period of time where the government's 
share of the economy was relatively stable, tax rates were all 
over the map. This is the top marginal tax rate.
    What I heard just a moment ago from this panel as we went 
down and talked about the importance of having a mix between 
spending reduction and tax increases I did not hear anybody 
clamoring for dramatic increases in the income tax. What I 
heard Dr. Stone actually mentioning was tax expenditures. Dr. 
Hassett, I have read some of your work. I think you have done 
some work on other fiscal consolidations that focus on tax 
increases on consumption as opposed to productivity.
    So I guess what I am looking for, gentlemen, is some 
consensus here that as we look our hand over and as we look at 
different options that are available to us, is it fair to say 
that increasing the top marginal tax rates is probably the 
least desirable way to go forward? And I will start with Dr. 
Stone.
    Dr. Stone. I mentioned tax expenditures because that is 
something we ought to be able to agree on. Dr. Taylor is 
talking about how government spending has moved to a new higher 
level. I think that if we are realistic about the demographics 
in this country, about rising health care costs, and the 
increased interest that we are now paying because of the debt 
incurred as a result of the recession, we are not going to be 
go back to historic levels of spending as a share of GDP 
without more revenues. And the President's proposals would move 
us back to--would include some increases in tax rates in the 
income tax, that will move us back to the levels that we had in 
the 1990s when we really did not have--when we had our longest 
economic expansion and a balanced budget. So it is not 
prohibitive. Very high marginal tax rates are discouraging, but 
modest increases in tax rates I don't think we need to be so 
afraid of.
    Representative Mulvaney. Thank you, Dr. Stone. I have heard 
this before, so I don't mean to interrupt and I will give 
everybody a chance, but I look at the rates during the late 
1990s when they were increased, and while they did represent a 
slight, they did lead to a slight increase in the government's 
share of GDP, it was not marked at all. In fact, you could 
argue that it was actually the GDP growth that was experienced 
during that time that boosted the government's share of 
revenues. It wasn't the tax increases that actually boosted the 
revenues, it was the larger share of the overall economy.
    Dr. Stone. I don't disagree that the strong economy helped 
and, importantly, those tax rates did not interfere with that 
very strong economy.
    Representative Mulvaney. Thank you. Dr. Hassett.
    Dr. Hassett. I agree with Mr. Mulvaney. I would add it is 
especially urgent, as Mr. Camp who is often in this room knows, 
to address the fact that we are about to have the highest 
corporate tax on earth. And if you are wondering why it is that 
it has been a long time since any of us has driven down the 
road and seen a new plant building growing there on the side of 
the road, it is because they are being located offshore to take 
advantage of much lower tax rates. And so I think that as we 
think about the fiscal consolidation then one of the urgent 
design problems will be finding the space to get to U.S. to at 
least the middle of the OECD in terms of corporate rates if we 
expect growth to renew here.
    Representative Mulvaney. Dr. Johnson.
    Dr. Johnson. I completely agree with the need for tax 
reform. I don't know the details of Dr. Hassett's proposal. We 
may differ on that. But I think shifting away from taxing and 
towards taxing consumption and doing that in a way that protect 
relatively poor people, which certainly can be done, and it is 
done in other industrialized countries, that is a good idea.
    However, with regard to what you do about marginal tax 
rates within the existing code, just two points. First of all, 
I don't think anybody paid the very high rates that we had in 
the 1960s. There were many exemptions, as you know, many ways 
to manage your tax liabilities there. And I don't think anyone 
is proposing to go back to those levels. However, I for one did 
argue against extending the Bush tax cuts in December. In terms 
of the feasible ways, credible measures you can take to bring 
the budget under control, if you have ways to control health 
care spending, if you have ways to end foreign wars, I am 
completely open to that. I think those will be better. But 
given the feasible choices before us, addressing a little bit 
of discretionary domestic spending is not going to make a big 
difference. Addressing or not further extending the Bush tax 
cuts next time they come up in 2012 would make a first order of 
difference. And I think now is the time to start considering 
that.
    Representative Mulvaney. Mr. Chairman, I would ask Dr. 
Taylor be given an opportunity to respond.
    Vice Chairman Brady. Dr. Taylor.
    Dr. Taylor. Your chart is very important to take into 
account when people are thinking about raising marginal tax 
rates, because history showed especially at the top end where 
people can avoid them or take actions not to pay them it 
doesn't raise the revenues people think. But I would also add 
that since spending is an issue here, too, that if you grab 
spending going way out into the future, along with what taxes 
would be even with a marginal tax rate increase, spending just 
dominates. Spending is like this exponential thing that eats 
you alive. And if you try to raise taxes and deal with this it 
may take you up just a little. It is hard to notice in a graph. 
It is hard to notice what it will do. So forget that for a 
while, you know basically that is not the thing to do in a weak 
recovery. Put that off to the side. Look for tax reform, 
broaden the base and reducing marginal rates is always good to 
try to do, but in the meantime it really seems like it is a 
spending problem, as people say.
    Dr. Johnson. Mostly health care spending in the 2050----
    Representative Mulvaney. Thank you.
    Vice Chairman Brady. Thank you, Mr. Mulvaney. Let me ask, 
we hear a theme that spending cuts will endanger this recovery 
however weak it is. But as economists you are aware of a body 
of work of fiscal consolidation looking at our competitors 
around the world who in the last 40 years took on various forms 
of fiscal consolidation, as many of you mentioned. And in 26 
instances they grew their economy in the short term as well. 
They spent less, controlled their fiscal policy, they owed less 
as a nation, reduced their debt, mainly through targeted 
spending cuts and grew the economy in the short term as well. 
Canada is a great example. You know, hobbling along at less 
than 1 percent growth, high debt levels. They went on a 
conscious effort to reduce their spending, lowered their 
country's debt by around 12 percentage points. Their economy 
went to a 3\1/2\ percent average growth rate that lasted for 
more than a decade. Sweden did the same. New Zealand had an 
even more interesting experience along the same way.
    So to this theme that if we control spending it will harm 
this economic recovery, Dr. Taylor, Dr. Hassett, do you believe 
that to be the case? Do you think Congress is capable of such 
severe spending cuts that it will endanger this remarkable 
recovery?
    Dr. Taylor. I don't think so based on the 2011 agreement 
which was good, but budget authority has shifted from plus 39 
to minus 39 in the discretionary accounts, but outlays just 
down by less than a billion. So that is an example I think of 
why it is so hard.
    I would say, quite frankly, I think that the credibility is 
very important to make sure it does have positive effects. 
Willy-nilly, unpredictable changes in government policy is not 
good. It makes for more uncertainty. So everything that you can 
do to say that what we are doing is part of this long-term 
path, caps on spending, tying it to debt increases, putting in 
legislation, everything that can make it a credible, believable 
deal will make it more powerful in a positive sense and 
mitigate the negative things that Dr. Stone is referring to. 
The credibility, to be able to plan for the future, to know 
that this is what government is doing, at least it is clearer 
now than it was. They are getting their house in order. That 
will enable businesses to expand. So I put a great deal of 
emphasis on credibility. It is going to be gradual almost for 
sure. That is the nature of the politics. It will be gradual. 
And I think to some extent the statements that it is going to 
hurt the economy if we go too fast, if it is too draconian, I 
don't think that helps the discussion because it puts up this 
thing which is like a straw man. That is not where we are 
going. Look at my charts. The charts don't have draconian--even 
with the most ambitious budget there are not draconian changes 
we are talking about.
    Vice Chairman Brady. Thank you. Dr. Hassett.
    Dr. Hassett. Yeah, Mr. Brady, one way I like to think about 
the potential scale of the near-term effects is that in present 
value maybe we guesstimate all of the things that we are short. 
It's something like $100 trillion if we just tried to in 
present value, you know, let Medicare run the way it is planned 
and so on. If businesses expect to have to pay their normal 
share of tax increases to cover that $100 trillion, then we are 
talking a tax liability in present value that is bigger than 
$10 trillion--bigger than 10 percent of that, which is closing 
in on the market cap for U.S. firms. And so the scale of the 
tax shortfall is humongous, and it is really large relative to 
the scale of U.S. corporations.
    And so maybe they don't think that we are going to cover 
the whole thing with tax increases, but if they think even that 
half of it is going to be covered with tax increases then that 
is a significant liability, implicit liability that is on their 
books. And if you do something to relieve that, then that is 
good news today. You could set off an investment boom today.
    And so I think the scale of the problem is such that this 
expectational effect that I talked about could be really large 
if it was credible, if the spending deal was accompanied by 
maybe some very clever new Gramm-Rudman style rules that made 
believe that the spending cuts are there to stay.
    Vice Chairman Brady. Thank you, Doctor. I would point out 
we often talk about people looking to the Clinton years as the 
golden years of the economy. I would point out that President 
Clinton, working with the Republican Congress from 1993 to 
2000, lowered the spending to GDP ratio from over 21 percent to 
around 18 percent, and the economy grew as we did it. So 
shrinking, spending less, owing less can spur this economy very 
much in the right direction.
    Senator Lee.
    Dr. Stone. Excuse me. May I?
    Vice Chairman Brady. Absolutely.
    Dr. Stone. A couple things. You point out what happened in 
the U.S. in the 1990s, and you mention the Canadian experience. 
I won't ask that the chart be brought up, but I have a chart in 
my testimony that talks about the Canadian experience. And two 
things are notable. One is that Canada is very sensitive to 
U.S. economic conditions. And Canada rode the expansionary boom 
of the 1990s that you talked about. Also Canada started with a 
higher level of spending than we had and came down but not all 
the way to the level of spending as us. And so I would be 
careful about Canada as an independent successful experience.
    One other thing, you talked about the 26 episodes of 
expansionary contractions. Expansion was defined in that study 
by being in the top quarter of the 107 episodes that they 
studied. When you look at examples that were both expansionary 
and successful at bringing down the debt to GDP ratio, there 
are only 9 examples, and three of them are Norway, one is 
Sweden, one is the Netherlands, Scandinavian economies that 
looked quite different from ours.
    Vice Chairman Brady. I would point out, too, if we could 
bring up another chart about Canada. This shows Canada's 
experience, total government spending, where government, as you 
can tell in a very struggling economy, took on a conscious 
effort to reduce their debt, including spending caps on each 
budget area where agencies that were run in effect by members 
of parliament could not increase spending without commensurate 
spending cuts elsewhere to keep it under those caps. They 
lowered their debt and grew the economy in a substantial way. 
It is as a neighbor, I think a very key example of how 
countries can consciously control their spending and grow their 
economy in the short term as well.
    Senator Lee.
    Senator Lee. Several of you have discussed the importance 
of credibility in the eyes of the public as we approach the 
debt limit increase and other decisions that will affect the 
spending of Congress as we move forward.
    Dr. Hassett, a minute ago you referred to Gramm-Rudman, 
Gramm-Rudman-Hollings legislation. I was a big fan of that. I 
was in high school when it passed, and I had great optimism for 
it. I was disappointed when it ceased to do its thing because 
as we found over time Congress has a certain tendency to be a 
walking, breathing, living waiver unto itself. One Congress may 
not bind another Congress. We can't speak now for what 
successive Congresses will do. PAYGO was a great idea, but 
PAYGO has been waived so many times that it doesn't really do a 
whole lot.
    But there is one way that we could bind a future Congress, 
which is by amending the Constitution to cap to a fixed 
percentage of GDP the level of our spending, to require a 
balanced budget and to put certain restrictions on what it 
would take to raise tax rates. What would you think about that, 
Dr. Hassett, in terms of its credibility with the marketplace?
    Dr. Hassett. I would very much support such a cap, a 
constitutional amendment. It could be that it is impossible, 
that it is so hard to change it.
    Senator Lee. Nothing is impossible, Dr. Hassett.
    Dr. Hassett. But a constitutional amendment with a spending 
cap, especially if the spending cap were relative to something 
like potential GDP so that we didn't have a kind of very 
procyclical effect of the budget rule, then I think it would be 
very easy to support.
    Senator Lee. What potential GDP? Do you want to explain 
what you mean?
    Dr. Hassett. So if we are at full employment then it would 
be say how much GDP we could make. And if that is the sort of 
metric that we use to say, well, how big should government be, 
then we won't have a problem that if suddenly GDP collapses 
then we are hitting this cap, then we have to really reduce 
everything government does in the middle of a recession, which 
would make it hard for automatic stabilizers to work.
    Senator Lee. Thank you. Dr. Johnson.
    Dr. Johnson. If you had an amendment that said you must hit 
a number in terms of government spending in terms of actual 
GDP, and sometimes that might work fine, but you could also 
have a calamity, financial crisis, or some other kinds of 
problems. So the GDP falls by 20 percent, this happens in many 
economies around the world. The U.S. fortunately hasn't had 
that experience recently. And then if you had to reduce 
government spending to hit constitutionally the target ratio, 
well, then you would have to do all kinds of things, including 
perhaps raise taxes at the worst possible moment, which would 
be in the economic freefall.
    Then of course, once you start to define it around 
potential GDP, how do you define potential GDP. Who will be the 
arbiter of this? The cross country experience with very tough 
and hard budget rules of this kind is that is only as good, as 
you yourself have said, as the Congress will or the equivalent 
body because you can always find ways to redefine potential as 
circumstances change. So it is a little bit more elusive than 
you might think.
    Senator Lee. Sure. And I understand why the task of 
defining potential GDP would be difficult, and that is one 
reason why basically all balanced budget amendment proposals, 
including that sponsored by all 47 Republicans in the Senate, 
have provisions in them allowing for these restrictions to be 
circumvented. It just requires a higher vote threshold.
    Did have you something to add, Dr. Hassett?
    Dr. Hassett. One thing I wanted to add short of a 
Constitutional amendment is that, as you know, there are a lot 
of States, almost every State has a balanced budget 
requirement, and they also often have things like supermajority 
rules to increase taxes. And mechanically it is often the case 
that a simplemajority could vote to ignore the supermajority 
rule, but it almost never happens. And so I think that, if you 
are thinking about a design short of a constitutional amendment 
that could accomplish your objective, you might try to think 
about whether something like a supermajority rule could create 
a taboo that Senators and Representatives would not want to 
violate.
    Senator Lee. Thank you.
    And I have one final question for Dr. Taylor. Interest 
rates are really low right now. They are substantially below 
the 40-year average, as I understand it, maybe as much as 350 
basis points below the 40-year average. How high do you think 
interest rates could rise, let's say, in the next, I don't 
know, 18 to 24 months once quantitative easing, QE2, comes to 
an end and if other factors change. How much play do you think 
there is in the sort of intermediate term, meaning 18 to 24 
months?
    Dr. Taylor. Well, right now this weak recovery that I 
referred to before is one of the reasons why rates are low, so 
hopefully we will get the recovery moving with some of these 
policies and they will go back to normal levels. And a normal 
level is you could have a real interest rate of 2 percent, and 
if inflation is 2, then that is sort of 4 percent on the short 
end. That is kind of a normal level.
    I think the fear and the concern is that when we might get 
behind the curve on dealing with inflation and that inflation 
would over--you know, go higher, if you like, overshoot any 
reasonable target. And of course that would drive interest 
rates up dramatically. That would be very harmful. So we 
haven't talked about monetary policy, but there is a concern 
with all this overhang of reserves and money whether the Fed 
will be able to pull it back out at a sufficient speed without 
also being disruptive as it pulls it out to prevent inflation 
from picking up down the road.
    We have already had some movements up in inflation. I think 
they will probably come down a little bit, but the real concern 
is they are going to go back up again. That would be the main 
driver of interest rates down the road, and it is a concern to 
me.
    Senator Lee. Thank you very much.
    Vice Chairman Brady. Thank you. Congresswoman Sanchez.
    Representative Sanchez. Thank you, Mr. Chairman. I just 
wanted to read into the record because we were talking about--I 
think it was Dr. Taylor who was saying that is not draconian to 
go back from what we are today back to the 2007 fiscal numbers, 
for example. I had stated that in fact I think we have to have 
some spending cuts, and we have to look at them carefully and 
that in fact we had not cut spending on defense. In fact, my 
Republican colleagues continue to increase.
    I just want to read into the record that in fiscal year 
2007 the total for defense spending was $110 billion as a base 
and $109 billion because we were in the wars we are in, for a 
total a $219 billion. In the fiscal year 2012 bill NDAA, that 
was just approved in the last week or two, the authorized 
amount is $690 billion. So $690 billion is what they have set 
it at from the House, with a Republican controlled House; $219 
billion are your 2007 numbers. Again I think there are a lot of 
places to cut, and I think that would be one of those that 
would show some credibility about how Congress feels about some 
of the spending.
    I would also note for the record that with respect to PAYGO 
because it was brought up by one of my colleagues, I personally 
when I first arrived here at the Congress voted for the PAYGO 
rule almost 14 years ago as a Blue Dog. We were the ones who 
proposed it. We were the ones who helped to get it through. And 
I will remind my colleagues that it was actually when the 
Republicans controlled both the House and the Senate that they 
let the PAYGO rule expire.
    So there can be a lot of talk about what we want to do. We 
actually had it and it was working, but because of the large 
spending that happened when the Republicans controlled both 
houses of the Congress they did not want to abide by PAYGO and 
they let it expire.
    And I would just like to have those comments in the record, 
Mr. Chairman.
    Vice Chairman Brady. Probably no chance I could deny that 
one.
    Mr. Mulvaney.
    Representative Mulvaney. Thank you, Mr. Chairman. And 
gentlemen, the chairman has informed me that I am last, which 
ordinarily is a bad thing, but it is actually good for me in 
this circumstance because he says that I can have more than the 
5 minutes if need be, and it is a tremendous opportunity for me 
to sit here and get you all in one room together. I am a big 
fan of Dr. Hassett and Dr. Taylor's work. I am looking forward 
to reading more about Dr. Stone and Dr. Johnson's work after 
today.
    So let me come at a couple different topics. We have talked 
about Canada, something that I have spent a little bit of time 
looking at.
    Dr. Stone, you mentioned something that I hadn't thought 
about before, which was the fact that may have been along for 
the ride on the economic boom that we had during the 1990s and 
that may have contributed to their success. And I had not 
considered that and will going forward. I would encourage you 
to consider the fact they also dramatically reduced their 
automatic stabilizers, that's one of the things they did. The 
two major reductions they had to their spending was number one 
their health care, but also to their unemployment benefits, 
which I thought was interesting. We have heard a lot of talk 
about leaving the automatic stabilizers in place, but clearly 
if we do look to what Canada did, it is clear that they 
actually reduced their automatic stabilizers.
    As I go out and I drive around and I talk to employers, I 
hear oftentimes they are finding difficulty finding people to 
go to work because of the stabilizers. I have several examples 
of them going back to folks they had laid off during the 
downturn, offering them their jobs back, and then being told 
that they have 8 months worth of benefits left and to please 
call them in 7\1/2\ months.
    Do you gentlemen not think that maybe extending these 
automatic stabilizers--I heard, I think Dr. Johnson mentioned 
that in his testimony--would have a negative impact on job 
growth, that there are jobs out there that are going unfilled 
at this point simply because we are essentially incentivizing 
unemployment. So, Dr. Johnson, I put that to you to begin with.
    Dr. Johnson. No, I don't think we incentivized unemployment 
in this country. Compared with any other industrialized 
country, this is a tough place to be unemployed. You get 
relatively low benefits, you are getting them for a relatively 
short period of time. And I am sure you are right that there 
are employers who have trouble finding the precise workers that 
they want.
    In general the employment picture around the country is 
bleak, and that is actually another very disconcerting parallel 
or comparison with other postwar recessions. There is always--
previously, for example, at the end of the S&L crisis, when 
Texas was in big trouble other parts of the country were 
booming and people were able to move to those booming parts of 
the country. That is not available right now, and we have the 
problems of house mortgages and people being underwater on 
their homes, making it even harder to move.
    But no, I think overall our automatic stabilizers are weak, 
and I think with regard to Canada where I was just a couple of 
weeks ago meeting with finance people, the Department of 
Finance there, and the Treasury and Central Bank, it is true 
that there were some reforms. It is also true they had one of 
the greatest commodity booms of all times in a very commodity 
intensive economy. And their health care system is still far 
more generous to far more people than the U.S. And I am sure 
you were not proposing that we go in the direction of Canadian 
health care.
    Representative Mulvaney. Thank you. Let's talk about jobs 
for a second, gentlemen, because I think it was Dr. Hassett 
mentioned why you don't see the plants built anymore as you 
drive down the road. And certainly I think there is a tax 
component to that. I also think there is a regulatory component 
to that. Unfortunately, I live in a textile area and a lot of 
what we used to do is simply illegal to do now, especially 
dealing with chemicals and dyes and so forth.
    So the regulatory environment certainly I think explains 
why we are not seeing more job growth. But I had a discussion 
the other day with folks in the construction business. That is 
what I used to do. And the analysis that they go through on 
whether or not to build a new plant I think is insightful. Not 
only are they looking at the after tax returns, and so forth, 
there is no question about that, not only are they looking at 
the regulatory environment, but they are also looking at the 
net present value of their particular investment, which means 
that they have to focus relatively sharply on what the discount 
rate is going to be. And I think it was Dr. Johnson who said 
that one of the things they are concerned about is the long-
term implications of what you are doing. And I think you are 
seeing that raise its head in the discount rates. We are 
assuming that inflation is zero, hear what Dr. Taylor says 
about some incipient inflation. They actually think it is 
higher than is reported simply because we took food and energy 
out. But I think businesses look at what we are doing and 
recognize that there is going to be inflation, that businesses 
look at us and say, look, they are either going to have to 
print money in order to get out of this. They are never going 
to be able to agree on tax cuts or increases, they are never 
going to be able to agree on spending cuts, and they are going 
to end up printing money. As a result the discount rates that 
businesses are looking at are dramatically different than we 
think from an academic standpoint.
    Would you agree with me, gentlemen, that by us continuing 
to run up these dramatic deficits we are discouraging 
investment in this country? Is there anybody who disagrees with 
that statement?
    Dr. Johnson. I agree completely, but the CBO forecasters 
are ambiguous, 2030, 2050 we have massive deficits, much higher 
debts, GDP much more than any country will get away with, 
including Japan, is due to uncontrolled health care spending. 
That is the primary driver of Federal Government, general 
government, and also the burden on the private sector, on the 
private business. That is what they are terrified of, with good 
reason. If you can fix that you will be heroes, whatever side 
the political spectrum you come from.
    Dr. Stone. Can I also say about that, long run health care 
costs are the game. If you can control them in the economy, the 
deficit problems are manageable. If you can't, you won't. But 
the other thing that is driving those horrible long-term 
pictures, I guess CBO is going to come out with its long-term 
outlook tomorrow, is there is interest on the debt. So a huge 
amount of what is going on in the outyears is spending on 
interest payments. And if you control the deficits now, whether 
with taxes or with spending, you get rid of an awful lot of the 
spending problem that is due to interest in the outyears.
    Representative Mulvaney. Lastly, at least I am getting 
ready to finish. If you could bring up, please, Dr. Taylor's 
figure number 3 and I can't get--I was trained as a Keynesian 
and I have come to see the light, and I disagree with you 
gentlemen philosophically, but I can't get two highly qualified 
Keynesians in a room and not ask them to explain to me where 
Keynes went on this graph. The top line is the unemployment 
rate, the bottom line is the Federal Government purchases as a 
percentage of GDP. And you can see unambiguously that those two 
lines move together. Government spends less, people go back to 
work. When the government spends less, people go back to work. 
There is another graph, by the way, the committee has come up 
with that shows the correlation between private fixed 
nonresidential investment and private payroll employment. And 
those two numbers are perfectly correlated. See if they can 
bring that up.
    So tell me, gentleman, what I am seeing in the real world, 
and the reason I am no longer a Keynesian is that what I see is 
when the government spends less, business spends more, and when 
business spends more, people go back to work, and the exact 
opposite is true. So tell me why are we still clinging to this 
concept that the government needs to spend more in order to put 
people back to work?
    Dr. Johnson. Look, you have to ask the question of 
causation. I am not by any means an unreconstructed Keynesian. 
As I said, I am not favoring generally fiscal stimulus left, 
right, and center. I am the former chief economist of the 
International Monetary Fund. I am a fiscal conservative by any 
reasonable standard around the world. But what happened in the 
United States in 2007, 2008, the financial system blew itself 
up. We had a huge crisis and we can argue for a long time about 
the consequences, but that is the fact of the matter.
    A massive financial crisis at every country which that 
happens drives up unemployment and causes the economy to 
contract. And it was Dr. Hassett who told you, completely 
accurately, that when you have a calamity and GDP falls, you 
are going to naturally have government spending rise relative 
to GDP. Actually whether or not you have automatic stabilizers 
that is probably what is going to happen. And if you have some 
reasonable automatic stabilizers, that is usually what we have, 
not super strong and they are not zero, then that is the 
consequence certainly of the big change that you are seeing 
here.
    Over longer periods every time I think it absolutely makes 
sense to keep tax burdens down to allow entrepreneurs to make 
good money, to allow them to get a better return on their 
investments, to have less uncertainty about the value of future 
taxes.
    Representative Mulvaney. I don't mean to interrupt you, but 
you may have hit on exactly my point, and the reason I no 
longer am on maybe your side or Dr. Stone's side of the aisle, 
which is that we have been doing this forever. We have been in 
a Keynesian stimulus for the last 25 years. I guess I can agree 
philosophically what you said that if you get into a short term 
you could use a Keynesian stimulus in order to prevent the 
bottom from falling out, but we have been pumping this system 
full of Keynesian cocaine for the last 25 years.
    Dr. Johnson. Well, seeing you brought it up, Congressman, 
let me be honest. Congress, when it was controlled by the 
Democrats and by the Republicans, has leaned away from 
balancing the budget towards big deficits and towards debt. 
That is absolutely true. Sometimes you have been helped by an 
administration and sometimes the administration has tried to 
pull back a little bit, but there is no question that spending 
has tended to outrun revenues in this country for a long time.
    Actually, to be honest, the other point we haven't 
discussed at all today is how we finance these deficits. 
Increasingly we finance them by selling bonds to foreigners. So 
now we run 11 nuclear aircraft carriers around the world. 
Nobody else has a single one. We finance that by selling bonds 
to China. How does that make sense? If you want to make it 
something taboo, I would suggest you make that taboo, financing 
the U.S. military by selling debt to China because that surely 
is not going to prove ultimately sustainable.
    Representative Mulvaney. Thank you, gentlemen. I could do 
this all day, but the tapping sound means that I have run out 
my patience with my chairman. So thank you, gentlemen. It has 
been a privilege.
    Vice Chairman Brady. No, it was a good line of questions. 
You could have done that all day, but I think we all could 
have, the truth of the matter is. Yeah, this is a great 
discussion. We are all looking for a game changer, I think, in 
this country both for the economy and for spending questions. 
How do we do it, how do we do it smartly, and what are the best 
approaches? You all provide us very good ideas and input and 
insight as we go forward with that. Thank you for the testimony 
today. Thank you to our members for being here as well. And 
with that, this hearing is adjourned.
    [Whereupon, at 3:43 p.m., the committee was adjourned.]

                       SUBMISSIONS FOR THE RECORD





                                  
