[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
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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
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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