[Senate Hearing 112-387]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 112-387

 
PERSPECTIVES ON THE ECONOMIC IMPLICATIONS OF THE FEDERAL BUDGET DEFICIT

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

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                            ECONOMIC POLICY

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                                   ON

   EXAMINING THE ECONOMIC IMPLICATIONS OF THE FEDERAL BUDGET DEFICIT

                               __________

                            OCTOBER 5, 2011

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                     Riker Vermilye, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

                    Subcommittee on Economic Policy

                     JON TESTER, Montana, Chairman

           DAVID VITTER, Louisiana, Ranking Republican Member

MARK R. WARNER, Virginia             ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina            MIKE JOHANNS, Nebraska
TIM JOHNSON, South Dakota

             Alison O'Donnell, Subcommittee Staff Director

         Travis Johnson, Republican Subcommittee Staff Director

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                       WEDNESDAY, OCTOBER 5, 2011

                                                                   Page

Opening statement of Chairman Tester.............................     1

                               WITNESSES

Maya MacGuineas, President, Center for a Responsible Federal 
  Budget.........................................................     3
    Prepared statement...........................................    33
Roger C. Altman, Chairman, Evercore Partners.....................     6
    Prepared statement...........................................    62
Douglas Holtz-Eakin, President, American Action Forum............     7
    Prepared statement...........................................    66
William Johnstone, President and Chief Executive Officer, 
  Davidson
  Companies
    Prepared statement...........................................    72

              Additional Material Supplied for the Record

Statement submitted by Robert L. Reynolds, President and Chief 
  Executive Officer, Putnam Investments, and President of the 
  Putnam Funds...................................................    74

                                 (iii)


PERSPECTIVES ON THE ECONOMIC IMPLICATIONS OF THE FEDERAL BUDGET DEFICIT

                              ----------                              


                       WEDNESDAY, OCTOBER 5, 2011

                                       U.S. Senate,
                           Subcommittee on Economic Policy,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 10:04 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Jon Tester, Chairman of the 
Subcommittee, presiding.

            OPENING STATEMENT OF CHAIRMAN JON TESTER

    Chairman Tester. I want to call this hearing on the 
Economic Policy Subcommittee titled ``Perspectives on the 
Economic Implications of the Federal Budget Deficit'' to order.
    We have got an esteemed panel of witnesses this morning, 
and I look forward to hearing their perspectives on the short- 
and long-term impacts of our Federal budget deficit. I am eager 
to hear about the impacts that our deficit has on economic 
growth, activities in capital markets, and investments.
    One of the most important issues facing the Congress and 
facing our economy is the size and the scope of our deficit. It 
is a huge challenge and one that cannot be addressed by 
tinkering around the edges.
    It is a tough challenge given how important it is to get 
our economy back on track right now. There is an urgency to 
addressing both the debt and the economy, and that is a 
difficult needle to thread.
    I strongly supported the recommendations of the President's 
Commission on Fiscal Responsibility and Reform, and I 
appreciate all the good work and leadership that Senator 
Simpson and Erskine Bowles and many of my colleagues have shown 
in working with that Commission. Their work generated 
thoughtful bipartisan conversations in the Senate about how to 
address our deficit.
    The bipartisan Gang of Six used this work to develop a 
framework to cut our deficit and cut spending. But, 
unfortunately, what most Americans saw this summer were not 
careful deliberations or solutions about how to address our 
deficit in a balanced and long-term way. What most folks saw 
was Washington at its worst: too much politics and very little 
in the way of responsible decision making; too many lines in 
the sand, not enough solutions.
    Now, that is too bad because I do not think that accurately 
reflects the willingness of many Members of the Senate on both 
sides of the aisle and Members of this Committee to roll up 
their sleeves and make some difficult decisions necessary to 
address the deficit. A balanced, long-term approach to deficit 
reduction that keeps everything on the table is the only way 
that we are going to be able to address the deficit. That 
includes spending cuts, including defense, and tax and 
entitlement reform. And only those plans that are balanced and 
broad in size and scope have generated bipartisan support.
    I am optimistic about the prospects for the Joint Select 
Committee and their ability to go beyond the $1.2 trillion 
minimum in deficit reduction required by the Budget Control 
Act. But this is not nearly enough to make a dent in our long-
term debt. We can and should overachieve here. Failure to reach 
our target will lock us into mandatory indiscriminate cuts and 
will limit our options in the future, which will ultimately be 
devastating for this country.
    But we can only overachieve if everything remains on the 
table. I do not think we can get there, at least where we need 
to get, without spending, taxes, and entitlements all being a 
part of the equation. And we need to make some tough decisions 
now so that we can take steps to address the economy so that we 
can continue to make the investment in things like 
infrastructure and education and research and development that 
are critical to economic growth and our ability to compete in 
this global economy.
    There is a lot of uncertainty out there--corporate cash 
sitting on the sidelines, long-term investments that are not 
being made, and skilled people who are not being hired. And the 
longer that we kick the can down the road, the worse the 
situation is going to get. If we do not cut the debt in the 
short term, we will not provide any certainty for folks to move 
our economy forward.
    At the same time, if we fail to create jobs quickly, the 
economy will not recover, and the deficit reduction that we 
need will not materialize. When it comes to growing our economy 
and cutting the debt, we cannot fail. It will not be easy. 
Every decision is going to be difficult, and it is going to be 
painful.
    Today I hope we can examine the short- and long-term 
economic implications of the Federal deficits as well as the 
deficit reduction plans and their impacts on our economic 
growth, the appropriate dollar level of deficit reduction 
necessary to ensure long-term sustainability, and how we get a 
handle on the budget deficit right now while still continuing 
to grow the economy.
    I look forward to hearing from all of our witnesses this 
morning. I want to thank them for being here. Unfortunately, 
Senator Vitter is going to be joining us just a little bit late 
this morning, so I want to turn to Senator Hagan to see if she 
has any comments she would like to make.
    Senator Hagan. Mr. Chairman, I appreciate you holding this 
session today, and I am looking forward to the witnesses' 
testimony.
    Thank you.
    Chairman Tester. Thank you, Senator Hagan.
    I want to welcome the witnesses, as I said earlier, a very 
distinguished panel. I want to thank them for their work that 
they have done in preparation for this Committee and their 
willingness to testify here this morning.
    First we have Maya MacGuineas, who is the president of the 
Center for a Responsible Federal Budget and the director of the 
fiscal policy program at the New America Foundation. There she 
has focused on bringing accountability to the budget process. 
Ms. MacGuineas has also served as policy adviser to the 
Brookings Institution and has also worked on Wall Street. With 
that, I want to welcome Ms. MacGuineas.
    Then we have the Honorable Roger Altman. Mr. Altman is the 
founder and chairman of Evercore Partners, an independent 
investment banking advisory firm, and has a distinguished 
career in Washington and in investment banking. Mr. Altman has 
served two tours of duty at the Treasury Department, serving 
most recently as Deputy Secretary of the Treasury during the 
Clinton administration.
    And last but not least, Dr. Holtz-Eakin serves as president 
of the American Action Forum and has a long career as an 
academic and policy adviser, serving as Director of the 
Congressional Budget Office and as Chief Economist of the 
President's Council of Economic Advisers. In addition to his 
roles in Government, Mr. Holtz-Eakin has also served in a 
variety of roles at Washington-based think tanks as an 
economist and a professor.
    I want to thank you all.
    Unfortunately, our final witness, Mr. Bill Johnstone, is 
not going to be able to join us today. We will put his written 
testimony into the record.
    With that, Ms. MacGuineas, please get us started. Just so 
you know, you have got 5 minutes. Your entire statement will be 
in the record, and if you could be as concise as possible, that 
will give us more time for questions. Thank you.

     STATEMENT OF MAYA MACGUINEAS, PRESIDENT, CENTER FOR A 
                   RESPONSIBLE FEDERAL BUDGET

    Ms. MacGuineas. Thank you. I will. Thank you to the 
Chairman and thank you to Senator Hagan, and it is a privilege 
to talk on this important topic and to speak as well with Roger 
Altman and Douglas Holtz-Eakin.
    The country is now facing two major economic problems: 
first, our debt as a share of the economy is higher than it has 
ever been in the postwar period, and we are on track to 
continue adding to the debt indefinitely. In all likelihood, 
the debt is already a drag on economic growth. At the same 
time, we face serious economic challenges where the recovery 
has not taken off as well as we would have hoped, high levels 
of unemployment persist, and we have a number of structural 
economic problems from a skills shortage to underinvestment in 
critical areas and an abysmal Tax Code that is anticompetitive, 
too complicated, misallocates resources, and is harmful to 
economic growth.
    So large deficits and debt have a number of negative 
economic effects. They harm the economy by diverting capital 
away from productive private investments. They drive up 
borrowing costs for families and businesses. That rates are 
currently so low is merely a reflection of the terrible 
situations around the world, and so as some of my colleagues 
say, being the best-looking horse in the glue factory is not a 
reason for relief, right? We have to make changes because of 
the economic problems that we currently face from our debt 
levels.
    From a budgetary perspective, the high levels of debt lead 
to higher interest payments. That squeezes out other more 
important Government spending, and it leads to future tax 
increases. It also leaves us quite vulnerable to increases in 
interest rates, and CBO recently found that a 1-percent 
increase would lead to an addition of $1.3 trillion in interest 
payments over the decade.
    High levels of debt lead to a loss of fiscal flexibility 
and the ability to respond to future crises. From an 
intergenerational perspective, of course, what it is is it is a 
result of us wanting to spend more, and we are unwilling to pay 
the bills. So we pass them along to the future generation, and 
that inequity is made worse by the fact that so much of what we 
are spending is consumption oriented. It is not even on the 
important investments that would help grow the economy and grow 
the future standard of living.
    The uncertainty that comes for businesses and households 
from the high levels of debt is problematic because we know 
changes will have to be made, but we do not know what they will 
be. And that means that businesses, like you mentioned, are 
keeping cash on their balance sheets. They are not investing 
and creating jobs in a way that would be more beneficial for 
the economy in the short, medium, and long term.
    And, finally, ultimately the unsustainable levels of debt 
can and will lead to a fiscal crisis if we do not make changes. 
And so something that was once unimaginable in this country is 
now a real possibility.
    So we know what we need to do. We need to put in place a 
comprehensive, multiyear plan that would stabilize the debt at 
manageable levels and put it on a downward path so it is 
declining as a share of GDP. We should aim to bring the debt 
down to around 60 or 65 percent of GDP over the decade, still 
significantly higher than the historical averages of below 40 
percent, but something that would be more manageable. And all 
areas of the budget have to be on the table.
    So looking forward, our fiscal problems are driven by 
health care costs and the aging of the population. But given 
the commitment to phasing in changes gradually so people would 
have time to adjust, there is just no way to fix this problem 
without looking at all areas of the budget. And so rather than 
focusing on unrealistic promises about what we will not do, we 
should focus on how to reform the Tax Code in a way that raises 
revenues and grows the economy and focus on reforming 
entitlements in ways that protect those who depend on the 
programs the most.
    So the debt threat is extremely serious, but I think it is 
also an opportunity to restructure the budget and tax system 
for the 21st century. By shifting our budget away from one that 
is directed toward consumption toward one that is directed 
toward investment, we can lay a new foundation for growth. And 
in order to be competitive down the road, we are going to have 
to focus on many of the areas that have not been invested in 
sufficiently while also reforming the Tax Code, all to be 
conducive with economic growth.
    So debt reduction is not at odds with the growth strategy. 
In fact, I think it is the center of it. Putting in place a 
credible multiyear plan will have a number of immediate 
economic benefits.
    First, it does reduce the pressure on interest rates, gives 
the Fed more room to maneuver, and it increases output over the 
decade. And if it is large enough, it eliminates the risk of a 
fiscal crisis.
    Second, it frees up enough fiscal space up front to allow 
for more stimulus if that is determined to be the right course 
of action and for more space for the recovery to take hold.
    Third, a multiyear plan will provide businesses and 
households more confidence and stability, allowing them to 
spend and invest in ways that will help the recovery and grow 
the economy.
    Fourth, the added pressures on spending will hopefully lead 
to better oversight and more efficient allocation of resources.
    Finally, a comprehensive plan, if it is large enough, will 
necessarily include tax reform and entitlement reform. And on 
the tax side, we should look to the Bowles-Simpson type of 
structure which broadens the base by reducing tax expenditures, 
lowers marginal rates, and raises revenues to help close the 
fiscal gap.
    On the spending side, again, entitlement reform is the 
center of all of this, and it allows us to free up resources to 
both close the fiscal gap and direct more on public 
investments.
    So, quickly, regarding the Super Committee, as it stands 
now, the new Joint Select Committee is tasked with saving $1.5 
trillion, and this would be a tremendous accomplishment. 
However, unfortunately, it would not be sufficient to stabilize 
the debt. So, instead, the Super Committee should really 
consider going big, which would put in place a plan that is 
large enough to stabilize the debt and put it on a downward 
trajectory. And it should also think about how to go long, how 
to address the long-term drivers of the debt, and how to do it 
in ways that are smart so that they are conducive with economic 
growth--again, focusing on protecting public investments, 
reforming the Tax Code.
    So just today JPMorgan released study talking about 10 
reasons that markets are going to look at the effects of the 
Super Committee and its effects on growth, so we brought that 
study here for everybody to look at. Just to touch on a couple 
of the important key points it makes, the markets are looking 
for a downward debt trajectory, and that means the Super 
Committee is going to have to come up with something that is 
big enough to get that on track. They are worried that it is 
already harming growth.
    We have been warned over and over again--and markets are 
aware of this--of the political polarization that is currently 
sort of dominating politics. There are concerns that global 
credit markets will turn, and this can happen on a dime, 
driving up interest rates here and harming the economy. And, 
finally, we could, in fact, lose our place as the reserve 
currency and all the advantages that that has with it. The 
ability to make changes on those terms is so much easier than 
it will be if some kind of crisis forces those changes.
    So what we want to do is put in place a multiyear, credible 
plan that puts us on a glide path to stabilize the debt. To be 
credible, we should put that plan in quickly. It needs to be 
bipartisan, and it needs to come with triggers and caps both on 
spending and tax expenditures to keep the plan on track. And if 
we do that, I think the benefit of a large enough fiscal plan 
is that it both helps us with our debt challenges and our 
important economic growth challenges that we are currently 
facing.
    Thanks for the opportunity to come today.
    Chairman Tester. Well, thank you, Maya. There will be 
questions as we move forward.
    Next we will go to Roger Altman. Roger.

   STATEMENT OF ROGER C. ALTMAN, CHAIRMAN, EVERCORE PARTNERS

    Mr. Altman. Thank you, Senator Tester, and thanks to the 
Members of this Committee for inviting me here today.
    There are really two main points I want to make. One is 
that this is a moment of extraordinary economic and financial 
fragility. I think sometimes folks in Washington underestimate 
the degree of fragility that we are seeing right now. And, 
therefore, point two, the budget decisions which Members of 
this Committee, the full Congress, and the President will make 
over the short to medium term, especially through the Super 
Committee, will have a big impact on that fragility, either a 
positive impact in the sense of reassurance or, I fear, a 
negative impact if there is a failure at a time like this. And 
so my main message today is please keep in mind how fragile 
this environment is and how important those decisions are going 
to be from the point of view of that fragility. Now, let me 
just flesh that out a little bit.
    From an economic point of view, I think it is pretty clear 
that the U.S. economy is on the edge of renewed recession. We 
might skate by with a little tiny bit of growth, or we might 
fall back into negative growth. And we are right on the edge of 
that. If you just look at the first half growth rate this year, 
it was eight-tenths of 1 percent. If you look at the forecasts 
for the rest of this year, and especially for next year--I have 
a lot of respect for the Goldman Sachs Economic Department. 
They just lowered their growth rate next to 0.5 percent. All 
these forecasts are coming down. We now see forecasts over the 
last 48 hours that Europe is likely to definitely fall into 
recession. And so we are in a real danger zone.
    Then in terms of financial markets, it would be hard to put 
them or see them on more of a razor's edge. If you look at the 
yields, they are sending a profoundly negative signal. So the 
yield on 10-year Treasurys is roughly 1.8 percent. That is the 
lowest yield recorded since the Federal Reserve began 
publishing market data in 1953.
    Now, yes, there are safe haven factors and, yes, of course, 
the Federal Reserve has got monetary policy on maximum ease. 
But that does not primarily explain it. That signal essentially 
says that the market is anticipating negligible demand for 
capital and negligible inflation. And those are hallmarks of 
recession. And then from an equity market point of view, we 
have seen the equity markets in this country decline 17 percent 
over the past 5 weeks. And it would just be difficult, as I 
said, to see a more delicate risky situation, and many of the 
elements of fear that we all saw in late 2008 and early 2009 
unfortunately have reappeared. I do not want to say that we are 
back exactly to that point. We are not. But the fear factor, 
which was not around a couple of months ago, has crept back in, 
and this is a really worrisome and, as I say, fragile moment.
    Now, turning to the deficit issues themselves, there is 
going to be tremendous attention, of course, on the Super 
Committee, and there are three possible outcomes there.
    The first outcome, of course, is that the Committee fails 
to agree, does not submit recommendations to Congress, the 
trigger is pulled. Yes, there would be $1.2 trillion of 10-year 
deficit reduction that would result through the sequester, but 
the signal of failure at a moment of this fragility I think 
would be a very negative signal and really unhelpful from the 
point of view of just plain the economy and obviously the very 
difficult jobs picture that we are seeing and the possibility 
that the next move on unemployment rate up is up and not down. 
And most people think that is more likely than not that the 
rate goes higher than 9.1 rather than back down, and I do not 
know what it will be in the next couple of days but in general.
    The second possible outcome, of course, is that the 
Committee does agree, sends its recommendations to Congress, 
which indeed passes them into law. That would be a very good 
thing.
    And the third and best outcome is the one that Maya talked 
about, which is that actually the Committee decides to solve 
this problem once and for all. We need about $3 trillion of 
additional deficit reduction beyond the $1.2 to $1.5 that the 
Super Committee will look at or is looking at. It would be a 
good idea if that was done on a balanced basis, but it would be 
a really good idea if the Committee actually did go big and did 
go long, as Maya said. And, by the way, that would send a very 
positive signal to consumers, to businesses, and to financial 
markets.
    I also want to say that it makes sense that there be a 
growth and jobs initiative over the short term just for the 
reasons of the fragility and the economic weakness that I 
talked about. The President, of course, has put forth a $447 
billion program. I think myself it is a sound program. We all 
know the core of it is the payroll tax cut on an extended and 
deeper basis for employees and a payroll tax cut for small 
businesses at the employer level. But there are many variations 
on the theme of growth and jobs agenda. I think the important 
thing is that we actually take a step in that direction, 
obviously a temporary step, one that by its nature ends within 
a year, but trying to provide an insurance policy of sorts to 
this economy would be a sensible thing to do.
    So please keep in mind how fragile and difficult this 
environment is and how relevant the budget decisions that you 
will be making over the short term are to either keeping us 
afloat or, unfortunately, putting us below water.
    Thank you.
    Chairman Tester. Thank you, Roger. I appreciate your 
testimony.
    Dr. Holtz-Eakin.

 STATEMENT OF DOUGLAS HOLTZ-EAKIN, PRESIDENT, AMERICAN ACTION 
                             FORUM

    Mr. Holtz-Eakin. Thank you, Chairman Tester and Senators 
Hagan and Bennet, for the opportunity to be here today. 
Obviously the outlook for the Federal debt is dangerous, and I 
have laid out some scenarios in my written testimony, and I 
think Maya and Roger have been very clear about this so I will 
not belabor that point. It is imperative that we address this 
problem.
    It is also imperative that we address the growth problem, 
and to the extent that there is a playbook that is available 
from looking at other countries' experience with the dual 
problems of slow growth and large debt, we have some lessons, 
and those lessons are that: you should cut spending, but not 
all spending is created equal; you should focus on cutting 
Government employment--not a big deal in the United States, we 
do not have massive amounts of people on Government payrolls--
and transfer programs; and you should preserve spending on the 
core functions of Government: national defense, infrastructure, 
basic research, education. And so cutting spending and doing it 
right is element number one; number two, keep taxes low and 
reform them to be pro-growth, and what is heartening about that 
is that is my reading of essentially what the Bowles-Simpson 
Commission said. They said this is a national moment of truth, 
we have to do something. Our problem is spending, and it is all 
spending, so each side of the aisle needs to understand that 
some of the things they love dearly are subject to some cuts. 
And if you are going to look at revenues, you have to do tax 
reform, and I thought that was a tremendous message to come out 
of the Committee.
    Going forward, it is clear that we have to address first 
and foremost the entitlement programs. These are the core of 
our social safety net, and they are actually badly broken. 
Social Security is running red ink right now. That red ink will 
increase in the years to come. And absent changes, every 
retiree will face a 23-percent across-the-board cut in 2037 or 
so. It is not a good service to have a core part of the 
retirement system falling apart before our eyes and not fixing 
it. Medicare right now has a gap between payroll taxes in and 
premiums paid and spending going out of $280 billion a year. It 
is an enormous fiscal cancer, and going forward it will only 
get worse.
    Medicaid is essentially all deficit financed at the moment, 
and it is not an outstanding program. Medicaid beneficiaries 
regularly have difficulty finding primary care physicians. They 
are more likely to get ordinary care in emergency room 
settings.
    I think as a matter of good social policy, these programs 
deserve to be reformed. As a matter of budget policy, it is 
imperative that they be reformed. As a matter of avoiding what 
has been called by Erskine Bowles ``the most predictable crisis 
in history,'' we should do it and do it quickly. And so that 
should be the focus of attention.
    I know there are concerns about cutting spending. I want to 
say a couple things about them.
    Number one, everyone should think of reforms that cut 
spending as reductions in future taxes. If you spend the money, 
you are going to have to pay for it one way or another. And so 
every time we take a dramatic step to control those outlays, we 
are actually controlling the future tax burden. That will 
improve the business climate immediately, and it will be 
something that I think will serve this country well over the 
long term.
    The second is I am concerned that fears about cutting 
spending harming the economic recovery are being used as an 
excuse to stall efforts to fix our budget problems. You know, I 
would just say this lovingly. I have watched Congress a long 
time as the CBO Director. I have never seen the Congress cut 
enough to endanger any recovery. And that is a problem I want 
to have, and I will be happy to weigh in when I see it 
happening.
    Much has been said about the budget ceiling debate and the 
efforts that came out of that, but if you would think about it, 
that is a promise, honest, really, that a future Congress in 
2018 will spend a lot less than it might otherwise have. But we 
have not actually cut anything yet, and so I would like to be 
surprised at the aggressiveness of the cutting to come out of 
this Congress because we need to get this done.
    The next thing I would say is that it is not just cutting. 
Especially in light of the Joint Select Committee, ``cutting'' 
is the wrong word. If we simply starve money out of Medicare or 
starve money out of Social Security without reforming those 
programs, we will not have solved the basic architectural 
problems that led us to where we are. And so think about this 
as an opportunity for reform. That means lower future taxes, 
and I think we can do it without impeding the recovery. Indeed, 
I believe it will help.
    And move fast. I think, you know, the evidence is in that 
we are in the danger zone already. The probability of crisis is 
high. Maya stole my line about being the best-looking horse in 
the glue factory, but I will find another one.
    And remember that we also have the other characteristics of 
countries to get in trouble. We have an enormous reliance on 
short-term borrowing. We have a lot of not well understood and 
not easy to value liabilities that pop up in State and local 
pensions and still out of the housing sector, and those are 
exactly the kinds of characteristics of countries that think, 
``We are fine,'' but then end up having a quick reversal in 
financial markets. So I do not think we should do that.
    And the last thing is there is a lesson about the fragility 
and the fear that came out of the debt ceiling debate. My view 
is the debt ceiling debate had a lot of politics as usual, for 
better or for worse. I mean, these are difficult things to do. 
Raising the debt ceiling is not a happy moment for any 
Congress. The difference this time was that something actually 
had to get done. Underneath the debt ceiling debate was a real 
debt problem, and the sooner we fix the debt problem, the 
sooner we undertake the steps necessary, the less the kind of 
political bickering that comes over raising the debt ceiling 
will actually scare financial markets, because we will have 
solved the problem and moved it back to just dealing with the 
Nation's mechanics of finance.
    I thank you for the opportunity to be here and look forward 
to your questions.
    Chairman Tester. I thank you all for your testimony, and we 
will start out. We have been joined by Senator Johanns and 
Senator Bennet before that. I will start, and I think 7-minute 
rounds if that is OK with the Members of the Committee.
    I just want to go back briefly and this is a question of 
all of you about the balanced approach to addressing our 
deficit. We have two realities out there. We have got the 
political reality and we have got economic realities, and 
sometimes they seem to clash. They should not but sometimes 
they do.
    So, given these realities, what is the appropriate dollar 
amount or range that we should be looking for? I know some of 
you talked about big ones but I mean a bigger one which by the 
way I agree with. But if we are going to change the trajectory 
of our deficit, what would you say is the number that we need 
to be looking at to come out of the Super Committee at a 
minimum?
    Ms. MacGuineas. Well, of course, whenever you are talking 
about saving numbers there is always plenty of room for 
gimmickry because of baselines, because the question is always 
saving compared to what.
    But so, I think the most useful number basically to look at 
where you are going to have your debt by the end of the decade 
and whether it is going to be moving up or down as a share of 
the economy.
    So, you basically want to have the debt in the range of 60 
to 65 percent of GDP after a 10-year period and moving down. 
Compared to a realistic baseline which assumes things like 
ongoing patches of the AMT, SGR, extension of part but not all 
of the tax cuts that were in place or revenue levels at that 
level that you compare to, I think the best thing to shoot for 
is about $4 trillion in savings. $3 to 5 trillion might be an 
appropriate range. We have already put 1 trillion of savings in 
place because of the caps we have already accomplished.
    Now, we have recently held a forum where a number of voices 
from all sides of the political aisle and all different 
backgrounds came forth and sort of made a call for go big, and 
there were some people who said we should be thinking about two 
to three times as much as that so 10 trillion.
    That to me would be great in terms of how much debt we are 
going to be adding over the next decade but it is unachievable. 
And I think it is really important that we put down a marker 
that is achievable but pushes us to get enough done that we can 
reassure credit markets, rating agencies, businesses.
    And so my best estimate will be if you can do 3 trillion on 
top of what we have already done that would really get us in 
the range where we bought ourselves some time.
    Chairman Tester. Roger.
    Mr. Altman. I agree with the numbers Maya just used and 
they are in my own testimony. But to complement what she just 
said and echoing what I tried to say myself earlier, I think it 
is really important that the Congress and the President show 
that they can make steady progress on this problem and that, to 
some degree, the fact of progress and that it is on a 
sufficient trajectory so that we are meaningfully eating into 
this deficit overhang and debt overhang is more important than 
the precise amount, particularly in the context of the 
fragility that I talked about.
    So, as Maya said, there was a trillion or 917 billion 
agreed in the context of the debt limit process. There is 
another at least 1.2 trillion as we all know in terms of the 
sequester amount or the trigger that would occur underneath the 
Super Committee. So, you have 2 trillion, assuming that the 
Congress ultimately sticks with it in future years.
    And that is a good start. It is not enough because then 
there would be at least another 2 trillion needed. But the fact 
of progress, in my judgment, is more important than the precise 
amount because the need now is to reassure consumers, 
households, let alone businesses and the financial markets, 
that our country can actually, seriously address this.
    And I think at the moment I think most of the Members of 
this Committee would agree, there is great doubt about that 
coming out of the difficult process to put it charitably that 
we saw on the debt limit.
    Chairman Tester. Dr. Holtz-Eakin.
    Mr. Holtz-Eakin. I will not agree with the numbers but I 
really want to echo Roger's point about extending the 
confidence of markets and the United State's ability to handle 
its affairs.
    So, I think quality over numerical targets is an 
imperative. The best example of that is Social Security reform. 
If we were to do any of the bipartisan Social Security reforms 
that have been proposed over the past couple of years, we would 
solve what I think is a very important part or social safety 
net.
    We would send the signal to world capital markets that we 
can touch what has traditionally been the third rail of U.S. 
politics in a sensible way.
    We would do very little actually over the next 10 years in 
terms of deficit reduction. It is a relatively modest impact 
because we do not hit any current retirees and those near 
retirement in most of those reforms.
    I still think that would be an enormously beneficial step. 
It would also allay a lot of the fears that some people have 
about cutting spending as we struggle through this recovery 
because all of those impacts are in the future.
    So, that I view as a very high quality reform, and the more 
we do of things like that I think the more confidence we will 
instill in capital markets and we will actually address our 
long-term debt problems and that is the kind of progress I 
think we would benefit the most from.
    Chairman Tester. OK. Just kind of a follow-up, and we will 
start with you, Roger, because this is for all of you.
    Is it possible to hit the kind of targets that you guys are 
talking about the 3 to 5 trillion which is pretty much what I 
heard without including everything that is out there, without 
including the entitlements that Dr. Eakin talked about, without 
including reductions in defense spending, without including tax 
reform, you know, all of them?
    Mr. Altman. Mr. Chairman, the short answer is no. It is 
theoretically possible, of course, to try to solve this 
problem, for example, entirely on the spending side. But for 
example, the impact on national security and defense spending 
particularly probably would be unacceptable.
    It is possible, of course, to imagine gigantic revenue 
increases but those would likely have a negative economic 
effect and worsen some of the problems we have discussed here 
before.
    So, the most sensible approach and really the only one in 
practice that would work is a balanced one, balanced in the 
sense that entitlements, of course, are center stage, revenues 
play a role, and the like.
    So, I think the answer to your question, sir, is no, it is 
not possible to do it except with all in.
    Chairman Tester. Doctor.
    Mr. Holtz-Eakin. The short answer is I concur, I mean, that 
you really have to look at everything, and we have big problems 
everywhere you look.
    Chairman Tester. Maya.
    Ms. MacGuineas. Sure, you can do it all on the spending 
side but there is not a single person who would actually be 
willing to when you went through the exercise of what it would 
take.
    And one of the reasons is a very sensible one, that the 
core of any reform plan is going to have to be reforming 
entitlements but those are things that we are going to do 
gradually and we are not going to suddenly raise the retirement 
age starting tomorrow. We are going to phase it in at a very 
slow pace so that people have time to plan and adjust. The same 
with the scaling back of benefits which I presume would be 
targeted more at people who do not need them in order to 
protect them for people who do.
    So, when you are talking about changes that you phase-in 
gradually that makes it basically impossible to do this without 
looking at all areas of the budget.
    I also think from a political perspective everybody needs 
to be in on feeling like this is shared in a way that is fair, 
and one of the things that Erskine Bowles and Al Simpson found 
when they did their commission was that the bigger they went 
the more people bought in and the more support they got because 
everybody felt like they were part of the overall package and 
it became big enough to actually create a win.
    So, when we talk about whether the Super Committee should 
go big or small, one of the benefits other than being 
economically beneficial in solving the problem is that 
politically the rewarded is you solve the problem rather than 
the headlines the next day after you have gone through all this 
hard work of saving a trillion and a half being, well, there is 
still so much more to do. So, there is political upside in 
putting everything on the table and building a big enough 
package.
    Chairman Tester. Absolutely,
    Ranking Member Vitter.
    Senator Vitter. Thank you, Mr. Chairman, and thanks to all 
of our witnesses. I would like to ask each of you what would 
you rate as the chances of further formal downgrades of U.S. 
credit if, A, the Super Committee is not successful and the 
sequestration happens or, B, it is successful only to its 
minimum dollar figure mandate level?
    Mr. Holtz-Eakin. In, A, I think the probability of 
downgrade is one. If we continue to fail, we will convince 
capital markets that we are not going to address
    Senator Vitter. It would be 100 percent.
    Mr. Holtz-Eakin. Yes, 100 percent.
    The second one is harder because how it hits the spending 
limit matters. And as I said before, if we were, for example, 
to do a Social Security reform which would be budgetarily 
modest but have enormous confidence effects I think, you know, 
we can avoid things like that.
    Mr. Altman. Senator, I have a slightly different view. I do 
not think the chances of a downgrade in the event that the 
Super Committee fails to agree or that the Congress does not 
pass its recommendation is 100 percent because after all there 
will be at least 1.2 trillion of deficit reduction then 
triggered over 10 years, again provided the Congress ultimately 
sticks with that.
    So, I think the chances of downgrade under that scenario 
from another agency, remember there are several agencies and 
only one of them so far, Standard and Poor's, has acted on the 
negative side, are probably 50-50 because even if the Super 
Committee fails, we will have set in motion over the past few 
months 2 trillion of deficit reduction against a problem that 
is $3 to 5 trillion in size, probably closer to the high end.
    But I think the psychology again of the Super Committee 
failing is the problem. In other words, the signal that just 
like the debt limit process showed us not in the most favorable 
light a failure of the Super Committee would send a negative 
psychological signal.
    And what often happens, and I will stop on this note, what 
happens is rating agencies follow markets not so much as lead 
them, and if the market sentiment in general is very negative 
and the sense in the markets, and this time you might see it 
expressed more in the equity markets than the bond markets, the 
sense is the reaction to the failure of the Super Committee is 
very negative at a time when, as I said before, everything is 
so fragile.
    That would be then pressure in effect on one of those 
agencies or more than one to take a negative step. So, I think 
it is only 50-50 but I think the problem is the psychology 
rather than the substance.
    Ms. MacGuineas. I would say that the hard truth is that S&P 
was probably correct for downgrading us when they did in that 
we had not set ourselves on a course to do what we all know 
needs to be done and I think now there is another kind of 
moment of truth which is what will come out of the Super 
Committee.
    If they fail completely, I think it is likely that we will 
have a downgrade pretty quickly. If they come up with what 
their mandate charges, the 1.2, I think Doug has made the 
really important point that it kind of depends what the make up 
of that is.
    So, keep in mind the economy is going to be worse than most 
of the projections have been assuming. We have already seen 
that just a 1-percentage increase in interest rates would add 
1.3 trillion to the deficits from increased interest payments 
alone over the next decade.
    So, saving 1.2 in and of itself is not going to be much of 
a debt in the challenges that we have. The only way that I 
think that would be reassuring is if what makes that up are the 
critical problems driving the debt.
    So, if that 1.2 trillion, if the Super Committee 
accomplished just the minimum it is supposed to focused on 
health care or accomplished making Social Security solvent for 
the long run or made real progress on tax reform and improving 
tax expenditures, that could be reassuring.
    But if it focuses just on the low hanging fruit, and we 
need to reform agriculture subsidies and public pensions and 
all those things but that is not a package that would reassure 
credit markets or rating agencies on its own.
    So, if we go big, I think we will not be downgrade because 
we will have put the debt on a stabilized path. If we go 
medium, I think it depends on what is in that package.
    Senator Vitter. If I could react to some of your answers. I 
agree with your answers. However, I believe if the Super 
Committee hits the minimum target only, they are going to be 
doing that by going after the low hanging fruit, not going 
after any bigger issues.
    If they are going after bigger issues, they can easily go 
well above that number. I do not think that scenario is likely.
    And, Mr. Altman, I just say in terms of sequestration, I 
think the day after the Super Committee fails, there is going 
to be plenty of evidence that that will not hold for any 
significant period of time, to sort of follow up on your 
comment there.
    Second and final question. Give us a ballpark figure in 
your opinion of what fundamental tax reform, broadening the 
base, lowering rates, what revenue it could raise if it is done 
on a revenue neutral basis, in a static model what revenue 
could it produce on a dynamics score?
    Ms. MacGuineas. I would estimate depending on the 
parameters of the tax reform that you would probably be in the 
neighborhood of raising $848 billion from something that is 
revenue neutral on a static basis if you look at the dynamic 
effects, and of course, the form of the corporate reforms would 
be critically important in that as well.
    Mr. Altman. I generally agree with that. I think the 
formula that was used by Bowles-Simpson which is essentially a 
three to one formula in terms of spending versus revenues with 
one of the three being the interest savings is a very good 
framework.
    And obviously under Bowles-Simpson they envisioned about a 
billion dollars of revenue impact.
    So, the figure Maya used or a slightly higher figure would 
be my answer, Senator.
    Senator Vitter. Just to be clear, that model is a little 
different than what I set out. What I set out is revenue 
neutral and a static model. Theirs was not. So, if you are 
talking about something revenue neutral and a static model, 
would you agree with 800 billion?
    Mr. Altman. Yes, sir.
    Mr. Holtz-Eakin. So, I would put it in the range of 700 to 
a trillion over 10 years. The wildcard being how you do the 
international tax reforms. If we were successful in getting the 
corporate rate down to an internationally competitive level and 
moving to a territorial tax system, moving away from worldwide 
taxation, there are many ways to do that.
    But if we do it the way I would prefer and make the U.S. an 
advantageous place to locate future investments, you can get 
much bigger near-term impacts out of international capital 
flows and FDI in the U.S. than you would otherwise. So, you can 
hit all sides of that range depending on how you structure the 
revenue neutral piece of the reform.
    Senator Vitter. Thank you.
    Ms. MacGuineas. I have one quick point which is when we are 
thinking about that and obviously at least the number I put out 
was not precise. It is sort of my best guess.
    But there is also revenue advantages that will come from 
having an overall debt consolidation package. So, you are going 
to have revenue increases from pro-growth tax reform but you 
are also going to have revenue increases from the medium- and 
long-term effects of a debt consolidation package which you 
might want to think about looking at as well.
    Chairman Tester. Senator Bennet.
    Senator Bennet. Thank you, Mr. Chairman, and I want to 
thank you for holding a hearing on this vital topic, and we 
have not spent enough time on this and talking about it, and I 
appreciate your letting me sit in on the Subcommittee.
    Mr. Altman, I share your concern about the fragility of 
this economy. I think it is in much tougher shape than we seem 
to imagine here in Washington. I see it every single day when I 
am home in Colorado. The effects of two decades of declining 
family median income has hit the people in my State very, very 
hard.
    I was struck the other day by a Wall Street Journal piece 
on the front page about Procter and Gamble, the most iconic 
middle class brand I can imagine and how they are adapting 
their business strategy to reflect the decline of the middle 
class by selling to the richest Americans and the poorest 
Americans because that is where the growth is.
    That is what this is really about I think. I mean we talk 
about deficit and debt and all of the rest. The fact is our 
economy is in very, very tough shape and our families are in 
tough shape as result.
    There is $2.3 trillion of cash sitting on the balance 
sheets of America's corporations. It is not being invested in 
the economy to grow jobs. I think a huge part of that is, Mr. 
Chairman, that people do not know what interest rate 
environment they are going to be in because we do not know what 
we were going to do.
    In that spirit, I wanted to ask you about what you think 
the effect of the debt ceiling conversation was on economic 
confidence in the markets in this country, because we went 
through an entire summer of what was in many ways I think a 
disgraceful conversation.
    My sense was that the economy was beginning to move forward 
but, to show you my bias, that conversation or the lack of a 
real conversation has contributed mightily to the lack of 
confidence people have in the economy.
    Can you talk a little more about that?
    Mr. Altman. I think the answer is profoundly negative 
because the signal that was sent to consumers, households, 
businesses was dysfunction. And anytime you are looking at 
economic outlooks, unemployment outlooks, confidence plays an 
important role and we are all seeing surveys which show that 
consumer confidence at 20, 30, 40 year lows.
    Just from my other life, I can tell you that business 
confidence is quite weak, and the debt limit process or lack of 
process played an important role in that.
    I would also like to digress and say in spirit of your 
opening comments, I do not think enough attention is played to 
what the real conditions are in the labor market.
    So, everybody pays attention to the unemployment rate but, 
as Doug points out in his testimony and I point out in mine, 
the labor conditions are actually worse than that. The 
underemployment rate which is probably better measure because 
it captures people who have given up looking for work and it 
captures people who are working part time who would rather work 
full time at 16.2 percent and the labor participation rate 
which is the most basic of all, just the percentage of working 
age adults who have a job is at a 27-year low of 64 percent.
    And then we all saw the poverty data although it seemed to 
come and go with no attention at all but it was pretty 
devastating, 45.3 million Americans in poverty, 15.3 percent of 
the population, the worst figures in about 20 years, obviously 
affected by the economic conditions.
    So, again, this is a moment of great risk. We are really 
close to slipping back into negative territory.
    Senator Bennet. In that spirit, I mean, a fifth of the 
children in this country are living in poverty, a 43 percent 
increase in the poverty rate in the last decade, and an economy 
where the productivity index continues to rise and rise and 
rise.
    We have a very productive economy but we do not have an 
economy that is creating jobs for people in the country.
    In that spirit, I want to ask you, Mr. Holtz-Eakin or any 
of the panelists, that $4 trillion number sounds large over a 
10-year period. But I wonder if you could give us a perspective 
on our run rate about how big that really is, because as 
somebody who has spent time in business and in local government 
and who has had to make tough budget decisions over time, on a 
percentage basis in the face of all the things that we are 
talking about, it is really not that huge a number, is it?
    Mr. Holtz-Eakin. In a $15 trillion economy. So if you did 4 
trillion this year, you would be under 33 percent. If you do it 
over 10 years, 3 to 4 percent. That is where we are.
    The magnitudes, however, can be staggering. If you do the 
arithmetic, we are borrowing $58,000 every second, more than 
the median family income in the United States every second we 
are burning it up. So, there is a real need to change this 
trajectory and do it in a significant way.
    Senator Bennet. My hope, Mr. Chairman, is that we can get 
past what is a political problem in Washington, DC, and create 
a path out of the situation that we are in that is not remotely 
as hard as what people in our States are having to deal with 
every single day.
    So, I thank the panelists for their testimony. I thank you 
for the hearing.
    Chairman Tester. Thank you for your kind words and thanks 
for your questions.
    Senator Johanns.
    Senator Johanns. Thank you, Mr. Chairman, and to all the 
witnesses, thanks for being here.
    All of us over the past years have participated in hearings 
like this. We have sat in each other's offices talking about 
this problem remarkably defining the problems pretty 
straightforward.
    The difficulty is how to go from definition of the problem 
to something that starts putting solutions in place.
    All of you have more Washington experience than I do. But 
it seems like we can all go to the floor no matter which side 
of the aisle we are on, give a great speech about how 
significant the problem is.
    Give us some advice on how best to solve this, and here is 
what I have in mind when I ask that question just to give you a 
fair notion of what I am thinking about.
    You have this deficit group. They came up with a 
recommendation. You have the gang of six, a remarkably similar 
recommendation came out of that effort.
    I think these are two very workable approaches. I am not 
saying I embrace them 100 percent. But they seem to be workable 
and yet they do not seem to be going anywhere at the moment.
    My worry is that we are going to do a trillion two. 
Everybody is going to breathe a sigh of relief. We are going to 
turn the calendar over into a Presidential election cycle. It 
will be much easier not to deal with this than to deal with it, 
and now another year slips by and the problem only gets worse.
    So, you are not going to offend anybody on this panel. Tell 
us what we are doing wrong and how do we overcome that and 
start solving this Nation's problems?
    Roger, can I start with you?
    Mr. Altman. Well, I want to echo in response to that very 
good question, Senator, what Maya said. I think the process 
which the Simpson-Bowles group went through provides a bit of a 
roadmap toward the right outcome here or actually a solution.
    Because it was, because they sought a total solution, 
because it was a very well run and deliberative and careful 
process, and because the ultimate recommendations at least from 
the cochairs were widely seen as fair and relatively 
conservative apropos of this 3 to 1 ratio I mentioned before, 
they achieved at least a modestly bipartisan result.
    We all know the Members of the Committee from both sides 
who voted for the cochairs' recommendations.
    So, I think that is the best guide to how to solve this. As 
Maya said, the greater degree to which you work on a one-step, 
full solution, a full solution, so that we are dealing with 
another 3 to 4 trillion beyond the 917 originally set in motion 
under the debt limit process, I think the better chances of 
success, the higher the chances of success.
    I just cannot think of a better blueprint than the one that 
the Bowles-Simpson group laid out. Is it perfect? No, of 
course, it is not perfect.
    But it had wide appeal and, for example, I happened--my 
private life involves working with the business community and 
there is enormous support for the business community in that 
framework.
    And no one has any problem, I do not mean no human being, 
but by and large, no one has any problem with the ratios they 
used, the size that they wanted to go for, and if you put that 
to a vote at the Business Roundtable or the Business Council or 
any such group it would pass overwhelmingly.
    That does not mean it is the right thing, but just as an 
example.
    Senator Johanns. Maya.
    Ms. MacGuineas. So, I have to say that I know it is pretty 
easy to sit here on the sidelines and say we need to do it. We 
all know what the answer is. You just have to do it.
    And I think looking at what the members of Bowles-Simpson 
did and the gang of six did, it is truly inspiring because we 
have had a decade of nobody confronting the really tough 
choices involved in fixing the fiscal problems.
    And in the past year that has changed. The dynamic has 
changed and people have come out and started talking about 
realistically what is going to be involved, and I think we are 
moving in the right direction.
    I do not think time is on our side but I think we are 
moving in the right direction. And a lot of people sitting in 
this room right now are critical in that, and it really is 
terrific.
    So, it is frustrating because we know what it is going to 
take and we also know that nobody is going to get their first 
choice.
    The past couple of years were for people putting ideas out 
there, and there are a number of ideas now. We, in fact, have 
kind of this comparison table that shows all the different 
policy plans that have been recommended, and all the overlap. 
There is tremendous overlap.
    And it is now the point to say nobody is going to get their 
first choice and it is time to start compromising.
    So, I think the thing you do is you agree on the fiscal 
goal. Let us say that is to save 4 trillion totally, and 
stabilize the debt.
    You run through a couple of scenarios. Let us just look at 
what it takes to do that on the spending side. OK. It turns out 
that realistically that is just not politically acceptable for 
anybody no matter what party.
    Let us look at what it takes to do that primarily on the 
revenue side or even 50-50, and it actually is so harmful for 
growth and is not really practical.
    We know the ratios of Bowles-Simpson are the right place to 
start, and we know that that is terrific. My specific 
recommendations would be take Bowles-Simpson and put in a 
little bit more on health care reform.
    I think if there is one place we need to go is to do more 
on health care. I think that would have helped buy a few more 
people into the entire process of being structurally 
sustainable, and I think you have a great working document to 
start with right there.
    And my final point would be Prospect Theory says that you 
should give bad news all of once. Get it over with. So, if you 
are going to come up with a fiscal package, let us just fix the 
problem. If you are giving good news, do it in lots of little 
bits.
    But this is tough stuff. So, we do not want to have to keep 
coming back and making these hard choices. So, we should go as 
big as we can and use something Bowles-Simpson to get us 
started.
    Mr. Holtz-Eakin. I want to echo the proviso that I am a 
little uncomfortable giving cheap advice from the easy side of 
the table. I have been in the position of doing that for a 
number of years. What you are asking is actually quite hard. 
But, you know, I think both Roger and Maya are right about 
Bowles-Simpson. That is the politically tested architecture 
that was much more successful than anyone really dreamed it 
would be, and it gives you the components on spending and tax 
reform that are going to be elements of success. So on the 
politics, I think that is right.
    On the second piece, which is the substance, how to really 
be successful, I would urge everyone to really change real 
programs, which dominates, in my view, tremendously what we 
have done so far, as it processes, promises on caps in the 
future, sequesters that are more reneged upon than honored in 
the history of budget by the Congress. And so we have really 
got to change the program so that it is far more convincing. 
And in doing that, you know, these tough issues of taxes and 
spending, I think we have to somehow overcome what has been a 
recent--I do not know what the very word is--a recent viewpoint 
where principle compromise is not possible, it is always viewed 
as surrender.
    It is important to recognize that--you may not think it is 
fair to have your program cut, I might not think it is fair to 
have my taxes increased. But both of those are dwarfed by how 
unfair it will be to leave this problem unfixed and ask the 
next generation to do both those things in the presence of a 
broken economy because we did not do our job. You know, that is 
where we are, and somehow we have to rediscover that spirit and 
understand that that is what is at stake.
    Senator Johanns. Thank you, Mr. Chairman.
    Chairman Tester. Thank you for your answer to the question. 
Before we go to Senator Hagan, I would just say, sitting on 
this side of the table, I will tell you that I think there is a 
realization by everybody up here and a whole lot of folks in 
the Senate that tough decisions are going to have to be made, 
or as every one of you pointed out, things are going to get a 
hell of a lot worse.
    Senator Hagan.
    Senator Hagan. Thank you, Mr. Chairman, and once again, 
thank you so much for holding this session, and for our 
witnesses, your testimony is certainly stark, realistic 
opinions and facts, and I am hoping that everybody can listen 
to what you are saying and realize that we do have to take 
action. And I have always said that I have been a strong 
supporter of the Bowles-Simpson report and a strong supporter 
of the Gang of Six, and I am certainly am hoping that the Super 
Committee goes big, goes long, and goes smart.
    Dr. Holtz-Eakin, I have been looking at a number of 
measures that might be used to get the economy growing again, 
and one measure that I know that has bipartisan support is to 
allow companies with earnings trapped abroad to bring that 
money back to the United States at a temporarily reduced tax 
rate. I know you have done a lot of work on this issue. Can you 
talk about some of the economic benefits of what this measure 
might mean?
    Mr. Holtz-Eakin. Well, as you know, I have done some work 
on this, and I think that Roger is right about how fragile the 
economy is. I think we need to do things that boost the near-
term growth rate for sure. I also think we ought to do things 
that are consistent with the long-term path we want to end up 
on. And in my view, we should end up with a territorial tax 
system with zero taxes on repatriations and a much lower rate 
overall. This moves in that direction.
    I think that if you do a fair reading of the research 
literature--and the most important thing about a fair reading 
is you focus not just on the companies that in the past have 
repatriated profits, because the mistake that literature makes 
is if a company brings some money back and repurchases shares, 
they then pretend that money is going into a black hole. It did 
not. It went into the economy, and a correct reading is what is 
the overall impact of bringing those dollars back on the 
economy, not on those companies. I think it would have very 
beneficial impacts. It is the same kind of economic impacts as 
the President's stimulus bill was modeled on. If you use those 
kinds of estimates, you get, you know, $360 billion in 
additional GDP from a sort of stylized repatriation policy.
    So I certainly think it cannot hurt to bring the money here 
instead of leaving it overseas, and it is the kind of thing we 
ought to do and do quickly.
    Senator Hagan. Thank you.
    Mr. Altman. Senator, could I comment for a second on that?
    Senator Hagan. Yes, please.
    Mr. Altman. I would just add two provisos. One is there is 
a pretty good argument for there being some quid pro quo 
associated with repatriation, because we all can look at the 
amounts of cash--Senator Tester referred to that--that 
corporations have already here in this country on their balance 
sheets and extrapolate that the likely result of that 
repatriation would not necessarily be any positive impact on, 
for example, hiring or investment, at least over the short 
term, which is when we need it. So there are various ways to 
think of quid pro quos, but if it were left up to me, I would 
want a repatriation plan which was tied to some positive 
economic impact rather than just a blanket one.
    And the second proviso is I am a little concerned that we 
may need repatriation to facilitate tax reform, and we al know 
that tax reform is going to be necessary in the context of 
deficit reduction and, more broadly necessary for 
competitiveness. So I wonder if that should not be an element 
in broad-based tax reform rather than a separate step all unto 
itself.
    Senator Hagan. Well, I think we do need broad-based tax 
reform, but I also think we need to look at what is happening 
right now and what we can do to make an impact. But I do 
appreciate the comments, too, on how we can structure something 
to be sure that it does have more of an economic impact on 
jobs.
    The debt-to-GDP ratio is often cited as a sign of fiscal 
health. I would welcome your comments on what ratio of debt to 
GDP you think would trigger increases in the interest we pay on 
our debt. Anybody on the panel.
    Mr. Holtz-Eakin. I think that it is just not possible to 
draw a statistical line and say on this side credit markets 
will trust you, on that side they will not. It is really about 
their perception of the U.S. future and will we be able to get 
what is clearly an unsustainable trajectory back on track. And 
when the confidence that we can do that goes away, the interest 
rates rise inevitably. That is when you see a rush for the 
exits and real financial market turbulence.
    So we do not know the number, but we do know that if you 
use history as a guide, we are in the danger zone. We already 
debt-to-GDP ratios which historically have been associated with 
slower growth, high probability of sovereign debt crisis, and 
we should not pretend that we have any luxury of additional 
increases. We should go the other direction fast.
    Ms. MacGuineas. So just to jump in on that, I think there 
are two sort of economic effects you want to be aware of. One 
is when your debt level is harming your economic growth, and 
the second is when it is triggering capital markets losing 
faith in you. So by all accounts, the best studies that are out 
there--and there is a new one just presented at Jackson Hole 
this summer--we are already in the danger zone where our total 
debt is already a drag on economic growth, which is one of the 
reasons that a debt consolidation plan would actually be pro-
growth. Sometimes it has an immediate negative effect in the 
very short term, but in the medium and the long term, that 
would help us increase growth.
    In terms of what level we need to be to avoid a fiscal 
crisis or capital markets losing faith in us, exactly what Doug 
said, nobody knows. It is really a psychological exercise. We--
and Doug was on this as well--ran a commission, the Peterson-
Pew Commission on Budget Reform, for the past 2 years, and the 
recommendation we came out with is stabilize the debt at 60 
percent of GDP, at the time we said 2018. That now looks out of 
the range of possibilities, unfortunately. None of the plans in 
place would accomplish that. But we could credibly get to 65 
percent of GDP by the end of the decade, and I think what you 
want to do is push yourself as far as you can get without 
taking a goal that is so high--I mean, we cannot get back to 
historical averages this year, this decade. We cannot balance 
the budget this decade in all likelihood. We would like to, but 
we are too far away.
    So it seems to me that the range of 65 percent of GDP by 
the end of the decade is the right thing to be shooting for and 
that markets as well have kind of glommed onto that number and 
focused on that.
    Senator Hagan. Thank you, Mr. Chairman.
    Chairman Tester. Senator Wicker.
    Senator Wicker. Well, Mr. Chairman, I want to thank you for 
putting together a balanced panel, and I think both the 
testimony today and the questions have been very helpful. So 
thank you.
    Dr. Holtz-Eakin, let me begin with you. What is your 
understanding of the President's proposal with regard to tax 
increases on wealthier Americans? He has famously been 
referring to Warren Buffett and talking about the fact that Mr. 
Buffett's secretary pays a higher percentage in taxes than Mr. 
Buffett does. What is your understanding of exactly what the 
President is proposing and what effect that would have on the 
economy?
    Mr. Holtz-Eakin. I do not know exactly what he is 
proposing. It sounds----
    Senator Wicker. You have been watching him pretty closely, 
haven't you?
    Mr. Holtz-Eakin. I do pay some attention, sir. I do not 
know the specific proposal. It sounds like something we already 
have, which is the alternative minimum tax, to make sure that 
those with high incomes pay a minimal rate. In that case, we 
should fix the alternative minimum tax instead of adding 
another layer of tax.
    It also to my mind sounds like Mr. Buffett, although a 
famously successful financier, is not a very good tax policy 
analyst. The layers of taxes on many of those pieces of income 
start at the corporate level, and they are not reflected in 
that calculation.
    And the last point I would make about this is all of the 
discussion today has focused on in particular Bowles-Simpson, 
but in general the need for tax reform being the route to 
higher revenues. Proposals that raise marginal tax rates go the 
wrong direction from a tax reform proposal. And what we need 
are a broader base, lower rates, better growth policy in our 
Tax Code, and none of these proposals are consistent with them.
    Senator Wicker. Ms. MacGuineas, do you agree with that 
final statement about proposals that raise marginal rates being 
harmful to job creation and economic growth?
    Ms. MacGuineas. I do. I do not think we are at a point 
where the marginal rates are so high that they are incredibly 
negative on the economy, but I think if we tried to solve this 
problem by raising marginal rates, that would be the complete 
wrong approach because we have a tremendous opportunity to 
reform the Tax Code in a way that actually lowers marginal 
rates. That is what happens when you have over $1 trillion a 
year in tax expenditures that probably misallocate capital more 
often than not and greatly complicate the Tax Code. So we have 
a remarkable opportunity to raise any revenues that we want to 
raise as part of a fiscal package while simultaneously lowering 
rates.
    The thing that I do understand is I remember back in 
graduate school studying these tensions, and one of the biggest 
tensions is between economic growth and equity. And I 
understand the frustration that growing income inequality is at 
profoundly disturbing levels right now, and you want to think 
about ways, while we are dealing with fiscal problems, to try 
to get at that. But even if you want to make the Tax Code more 
progressive than it currently is, you can do that as part of 
fundamental tax reform while lowering rates overall as well. 
You can do distributional changes that are pro-growth as part 
of tax reform, and I would say that, if we want to change any 
of the distributional effect, should be how we do it. 
Increasing marginal rates just politically it is not the right 
way to start right now, but more importantly, economically it 
would be much less beneficial than the Bowles-Simpson type of 
approach to reforms.
    Senator Wicker. Mr. Altman, do you want to respond to that?
    Mr. Altman. In effect, I want to add a footnote. I agree 
entirely with the points Maya just made, that the Bowles-
Simpson approach--focusing on tax expenditures, broadening the 
base, lowering rates--is the best approach, and hopefully we 
will undertake serious broad-based tax reform soon. But just 
for the record, if the Bush high-earner tax cuts were to expire 
and we were to return to the Clinton rates, 39.6 on the top 
marginal rate, 20 percent on the capital gains rate and so 
forth, I think we have a lot of evidence during the 1990s that 
that was not damaging to economic growth, damaging to 
investment, damaging to financial markets. And I do not believe 
it would be again damaging.
    Is it the optimal way to go? No. But would it have 
dreadful, terrible, catastrophic effects? I believe the answer 
to that is no.
    Senator Wicker. OK. Back to you, Dr. Holtz-Eakin. Would you 
challenge that last statement of Mr. Altman?
    Mr. Holtz-Eakin. I am sure Roger is doing better empirical 
work than many who defend what went on in the late 1990s, but 
my concern is that you often hear this, ``Well, we raised taxes 
and the economy grew like mad and everything was great.'' 
People forget we also had a tech bubble which, when it burst, 
provided the same level of losses as did the housing bubble 
bursting and caused a recession. That very same tech bubble was 
the source of the revenue surge that ultimately led to budget 
balance and surplus in the United States, and it was also 
fueled by the peace dividend with the decline of the Soviet 
Union.
    I do not think anyone wants to go back to a world that 
relies on being safer in the globe--we are not--and having a 
bubble fuel both the Federal budget and private economic 
growth.
    So I think the tax policy did not make that happen. I think 
other factors made it happen, and to raise taxes back to those 
levels in this environment would be a bad idea.
    Senator Wicker. OK. Dr. Holtz-Eakin, let me begin with you 
on a second thread. This Congress passed and President Obama 
signed a stimulus package of approximately $820 billion early 
in 2009, and let me make my question bipartisan. In early 2008, 
there was a modest $152 billion stimulus bill passed by this 
Democratic Congress and signed by President Bush.
    Did those two economic stimulus packages work? Were any 
part of them a success? Were they helpful in any respect?
    Mr. Holtz-Eakin. I would give----
    Senator Wicker. And let me just do this because I do not 
want to interrupt you. If you had $821 billion to spend in 
early 2009, how could we have better spent it?
    Mr. Holtz-Eakin. So I am not a big fan of the 2008 episode. 
I think the evidence is pretty clear that that temporary 
stimulus, and many others designed that way, are largely 
ineffectual, and that one--there is nothing in the data to 
suggest it worked.
    The 2009 I think you have to evaluate by a different 
standard. There is no President or Congress who would not have 
acted in those circumstances. You had to. And my reading of 
what we did with that is, you know, we threw nearly a $1 
trillion at the economy. That has to have an impact. Assertions 
that there was zero impact from the stimulus just cannot be 
right. The work we have done suggests that--since we will never 
know what would have happened in the absence of it, it is 
always guess work. But the work we have done suggests that 
stopped the fall by about $1 trillion, and that was good. But 
there were not these grand multiplier effects that you hear so 
much about, that basically for every dollar we spent, we got $1 
of GDP, maybe a little more. And that I think reflects the 
design flaws in that bill. The bill had numerous deficiencies. 
We have heard a lot about the shovel-ready things that really 
were going to take a long time. That was predictable. It also 
contained many things which were not about short-term stimulus 
but which were downpayments on a domestic policy agenda by the 
Administration. They should have actually focused on things 
which were genuinely short-term stimulus. And it was 
unrealistic, I think, to scale up some things and expect them 
to work. The best example is we used to have two $20 million 
rural broadband programs in the Federal budget, one in USDA and 
one in the Department of Commerce. That bill had $4 billion for 
rural broadband. There is not any organization in the public or 
private sector that can scale itself that much overnight and 
use the money effectively. It just cannot. And it was destined 
to fail. Worse, once attention got focused on things like that, 
everyone running such programs was afraid they were going to 
end up on ``60 Minutes'' as the poster child for waste, and so 
they started writing grant agreements that were ironclad so 
that they would be safe, and the money never went out.
    And so it really was a flawed effort, and we could have 
done much better with the $800 billion.
    Senator Wicker. Mr. Chairman, it is only you and I left on 
the panel. I have a number of other questions. Perhaps you 
would like to take another round or just tell me how you would 
like to proceed, but I have at least another round.
    Chairman Tester. No, no. We will do another round. I have 
just a couple left, and that would be good.
    You folks have all described the fragility of this economy. 
I am going to start with you, Mr. Altman, given your background 
and your work. If the Super Committee was to come out with $3 
to $5 trillion in reductions, how do you think the capital 
markets would respond? And just as importantly, how quickly 
would they respond?
    Mr. Altman. Overnight, and at least on the equity side and 
globally, very positively. It would be a big surprise. If we 
were getting to the verge of that, presumably we would all see 
that we were getting to the verge of it. But, in general, it 
would be a big surprise. It would be a huge positive surprise, 
and it would have a tonic-like effect. All markets would 
respond very positively. As I said a minute ago, interest rates 
in most sectors of the credit markets are already so low that I 
do not think they could go lower because they are so low for 
some of the wrong reasons. But the overall effect would be big 
and it would be overnight and it would be positive.
    Chairman Tester. And the potential for those interest rates 
to blow up would be minimized, do you think?
    Mr. Altman. Yes, although I do not think we are going to 
see any blowup soon, because as I say in my testimony, right 
now, as is the case so often with financial markets which have, 
by definition, a rather short term point of view, the focus is 
on the European sovereign debt crisis and the risks of 
recession in both Europe and the United States. That focus will 
return to our deficit and debt problem. It is just a matter of 
when. There is no doubt that it will return. And if we have not 
done much to solve it, that will be a bad time. But right now 
that is not what is preoccupying markets because the other two 
issues are so front burner. But I do not think there is a risk 
of blowup over the very short term. But as I said earlier, a 
failure on the part of the Super Committee, cannot agree, 
defaults to the sequester, is going to be taken quite poorly.
    Chairman Tester. Maya, as far as capital markets, do you 
agree?
    Ms. MacGuineas. I agree completely. I think the question is 
what will happen if they come out with something in the medium 
size and whether that will be reassuring or not. But I think we 
know that there would be an immensely positive upside if they 
came out and exceeded expectations; and if they gridlock and 
they cannot get anything done, this is just going to be another 
sort of failure that keeps markets low and uncertainty high and 
is very damaging.
    Chairman Tester. Well, let me touch on that again, and we 
will get to you, Doctor, and you can address any of them you 
want. But if they come out with a medium size, what do you 
think is going to happen to the capital markets?
    Mr. Altman. Maya said earlier it depends on the composition 
of it, and it depends on the precise size. But so that I am not 
wishy-washy, I think if there is a successful outcome in the 
sense that the Super Committee actually reaches agreement and 
the package is bigger than the minimum, the reaction is going 
to be positive, not negative.
    Chairman Tester. Yes, go ahead, Maya.
    Ms. MacGuineas. Just one quick point, which is I do think 
that if they were to come out with the minimum, the 1.2, but 
set in place the next stage so that we can sort of encompass 
all of go big in some stages but it is all one comprehensive 
piece, that would be reassuring. We cannot just say 1.2 and we 
are done, we will until after the election, because that is not 
going to do the trick. But if we keep this momentum building, I 
think that can be positive.
    Chairman Tester. I agree. Doctor.
    Mr. Holtz-Eakin. Just on the mechanics of it, I think a 
numerical success big enough to move the next debt ceiling 
increase past the election would be a very big win for the 
financial markets. And then in terms of looking at the markets 
to monitor the reaction, I just want to say what I think Roger 
said, which is look at the equity markets. I think that is 
going to be the key. We actually want interest rates to go up. 
We do not want them to spike and reflect a crisis, but higher 
interest rates, you know, throw me in that briar patch. That 
would mean we are actually growing. That would mean we are 
actually are looking more normal as an economy.
    Chairman Tester. OK. Taking it down to a small Main Street 
business, working-family perspective, how would they be 
impacted, either by the capital markets or by some sort of big 
agreement overall? What would be the positive impacts? What 
would be the negative impacts? Whoever wants to start can.
    Mr. Altman. Oh, maybe I will start. There should be a 
positive impact on credit availability. Right now a lot of 
lenders see this weakening economic condition, which leads, of 
course, to weaker credits for everybody, and lenders are very, 
very hesitant. We see that everywhere. So I think it would have 
a positive impact on the ability of a small business to borrow, 
at least at the margin.
    I also think it should improve confidence levels at the 
business level and the consumer level. You should see--and this 
will not happen in a tidal wave sense, but you should see some 
improvements in consumer spending, and you should see some 
improvements in business investment and hiring. I do not want 
to imply they will be dramatic overnight, but some of those 
spigots should begin to turn a bit.
    So I think there are benefits and that they will be 
meaningful over the medium term.
    Chairman Tester. OK. Maya or Dr. Holtz-Eakin?
    Ms. MacGuineas. I think certainly there would be more 
stability than there currently is, and I think that would have 
the deepest effect on the business environment where some of 
the uncertainty is really causing businesses--you know, they 
have two problems right now. There is not sufficient demand, 
and there is certainly not enough stability and security for 
them to invest as we need to.
    I think if we were to see a political compromise, we should 
not underestimate the huge increase in confidence that you 
would see in this country to see a functioning political system 
because people, as you all know from going back home, are so 
frustrated with--you know, the solution is in sight, and yet we 
cannot find the political way to get ourselves there.
    Chairman Tester. That is right.
    Ms. MacGuineas. And I think the real advantage--and it is 
similar to your question about stimulus, but in some ways it is 
the counterfactual. What would happen if we do not do it? And 
the real advantage would be some things that families may never 
understand, which is how much better making some of these tough 
choices now, whether it is raising the retirement age gradually 
in the future or scaling back on some benefits or slightly 
higher taxes at some point, is so much better than waiting 
until markets force us to make these changes, where all of 
those tough choices will be there--we will have to do them all, 
and we will have to do them in a much greater scale, and we 
will not be able to protect people from dangerous tax hikes 
that would choke off the economy. And we will not be able to 
protect people from making more changes to the safety net than 
we otherwise would have to.
    So it is doing it now in a thoughtful and gradual way that 
allows us all to protect the most important interests as 
opposed to waiting until we are hit with a crisis, which would 
be the worst across the board.
    Chairman Tester. OK. Dr. Holtz-Eakin.
    Mr. Holtz-Eakin. I think three things.
    First, a crisis averted. It might not be visible, but it is 
the biggest benefit, and emphasis should be placed on that.
    Second is I believe there will be beneficial business 
climate improvements, and that will mean jobs and growth. And 
that is the number one priority. It is going to be especially 
important among young people who have been disproportionately 
hurt by this recession, both in terms of the numbers and 
duration of their unemployment, the wage losses, and I think 
with people dropping out of the labor force, we are running the 
real risk of a cohort having marginal attachment to the labor 
force, and that leads to bad social problems. Main Street is 
not going to like that, so that would be a benefit.
    The last thing is just that the mechanics of a household 
level, there is no real confidence in Social Security. Medicare 
has to be a scary proposition. There is an incentive then to 
save against a future that is really quite uncertain in their 
mind. Settling some of that would mean that they can 
concentrate on fixing household balance sheets, which is 
important, but not more. And they would then live better in the 
moment than they would otherwise, and that I think they would 
see right away.
    Chairman Tester. Good. Senator Wicker.
    Senator Wicker. Thank you.
    Ms. MacGuineas, could you briefly describe the additional 
health care reforms that you would have added to the Bowles-
Simpson report? And would they have attacked the real problem 
with health care costs, namely, that they are rising at 3 to 4 
times the inflation rate?
    Ms. MacGuineas. Right. So as I mentioned before, I think 
probably the part that needs to be strengthened the most in 
Bowles-Simpson is to do more on health care. And a stark 
reality on all this is none of us know how to fix health care. 
This will be--you know, we can fix Social Security. We can do 
it. With health care we are going to have to go back a number 
of times. And so the answer, when it comes to health care, is 
we have to do everything we can possibly do, and I look at that 
as kind of three categories. One, there are the things that 
will save money, and they are not structural, but they will 
save some money. So if that comes from providers or wherever we 
can find that, that is a savings. It does not bend the curve.
    The most important area----
    Senator Wicker. We have hit the providers pretty hard.
    Ms. MacGuineas. We have hit the providers very hard, and 
there is only so much--if there is even anything that you can 
squeeze out of there.
    Senator Wicker. OK.
    Ms. MacGuineas. That is short term, how you save money. 
What is really important is how you slow the growth. I think 
what came out of the Obama and Boehner discussions was 
critically important. Let us talk about raising the retirement 
age because that is one thing that we now have the ability to 
do in Medicare that would save money in ways that created 
better incentives. I think reforming the tax expenditures for 
the health care exclusion, which is part of Bowles-Simpson, but 
looking at that as aggressively as possible, would make a big 
difference.
    I think greater levels of cost sharing is very, very 
important, and I think we have to look at that as aggressively 
as we can while protecting people who cannot afford to pay 
more. And I think malpractice----
    Senator Wicker. You would do that at the higher-income 
level?
    Ms. MacGuineas. I would do that at the higher end, and 
where you had to, at the medium levels. I mean, we have to--we 
cannot perpetuate this notion that health care is something 
that somebody else pays for for you. So bringing people closer 
to the effects and the prices helps us make better choices, 
just like it does in other markets, even though health care is 
not a normal market.
    Then when it comes to the deepest structural reforms, I 
believe health care does need to have a budget that limits its 
growth.
    Senator Wicker. I interrupted you, and you were about to 
say----
    Ms. MacGuineas. I was about to say with medical malpractice 
and tort reform, I think that should be a piece of it. And 
depending on how you do it, it can save more or less money. But 
I think that is something we should look at. Basically every 
idea that is out there--I look at what Coburn and Lieberman 
did, I look at what all other outside groups have recommended, 
and I would do as much as we possibly can.
    And then on structural reforms, I do think thinking about a 
version of premium support, which is the one that Domenici and 
Rivlin recommended, where you look at premium support, but it 
grows at more manageable, I think, levels than the proposal 
that has come out of the House on that, so the growth rate 
would be a little bit higher, and it stays in place--it keeps 
in place traditional Medicare as a parallel program, and you 
control costs of both of those, is a way to get at some of 
these deeper structural reforms we need to make. But we cannot 
have health care be open-ended indefinitely. We are going to 
need to put real budgets on that. There are different 
approaches to that. IPAB is another way to help control costs, 
and those all need to be considered to stay within a health 
care budget.
    Senator Wicker. Let me begin with Mr. Altman, and then the 
other two can respond. Of the target of $1.2 trillion, 
realistically how much of that can be achieved through 
reductions in discretionary spending in the 10-year window?
    Mr. Altman. I think all of it can be achieved through 
discretionary spending, if it has to be. But if I interpret 
your question a little more broadly, that does not send a very 
encouraging signal because you are dealing with such a small 
portion of the total budget, and you are saying we cannot deal 
with entitlements, we cannot deal with revenues, and so we are 
going to do it entirely this way.
    Would $1.2 trillion divided equally between defense and 
nondefense over 10 years be undoable? No, it would not be 
undoable, although I am sure there is a big, huge debate in the 
national security community as to whether that magnitude of 
defense cuts could be managed or not. My very amateurish 
judgment--but I do talk to a few people that know something, 
unlike me, about that--is that it could be. But it is not the 
ideal approach.
    Senator Wicker. Dr. Holtz-Eakin, in answering the question, 
if you could discuss how severely we would have to get into 
those three core functions that you mentioned in your 
presentation of infrastructure, basic research, and national 
defense.
    Mr. Holtz-Eakin. I do not want to say none, but that would 
be my best advice, that, in fact, going with exclusively 
discretionary cuts comes with two very serious handicaps. One 
is that discretionary spending is where we locate those core 
functions--national defense, basic infrastructure, research--
and those are things that we need to both do and do better in 
the United States. And I think it would be a mistake to focus 
the cuts there.
    The second is that you cannot cut discretionary spending 10 
years from now. Discretionary spending is done annually, and it 
is utterly unconvincing, given the budgetary history of the 
United States, to promise to cut discretionary spending 10 
years from now. So I think markets are going to look at that 
and say, ``Yeah, right.'' Real changes to mandatory spending 
programs start now and stick and are far more compelling and 
the place that I think the Committee should be focused.
    Senator Wicker. OK. Let me ask all three of you, and I will 
begin with you, Dr. Holtz-Eakin, and then we will just go down 
the panel, and this will probably end it up, Mr. Chairman, and 
I thank you for your indulgence.
    If we go big and long, is it not true that we can have a 
very positive effect even if we do not reach much over the $1.5 
to $2 trillion amount because we have done long-term structural 
things? And I am asking specifically about the really tough 
political things where the Chairman and I and the President 
would all have to agree to hold hands and jump off the high 
dive together. If we follow the suggestion of gradually raising 
the Medicare age for people who are under the age of 55 
presently to eventually match the--bring the Social Security 
and Medicare ages together, if we redo the CPI to make it more 
accurately reflect the real world for retirees, if we do the 
means testing beginning at the top end for some of these 
entitlement benefits, if we do those sorts of things, we do not 
get as much punch in the 10-year window that we are talking 
about. But is it not a fact that we have really done better by 
future generations than doing some of the low-hanging fruit 
that Ms. MacGuineas talked about in her testimony?
    Mr. Holtz-Eakin. I completely agree. If the gentlemen you 
mentioned could hold hands and address Social Security, 
Medicare, Medicaid, and the Affordable Care Act, make 
fundamental changes to their trajectory over the long term, and 
hit only $1.2 trillion in the first decade, I think that would 
be an enormously beneficial step, and I think everyone would 
recognize it as such.
    Senator Wicker. Mr. Altman.
    Mr. Altman. Well, of course, you cannot jump off the 
Washington Monument now because it is closed, but I agree with 
Doug. If the Super Committee, A, did more than the minimum and, 
B, took on the issue as you are talking about, the reaction and 
some of the benefits I said to Senator Tester in response to 
his question really would be very considerable, very positive 
result.
    Senator Wicker. Ms. MacGuineas.
    Ms. MacGuineas. Absolutely. It is a really important 
question--because if we could focus on something that would say 
raise the retirement age gradually, means-tested entitlements 
in the way that protected people who depend on them but asked 
for people who do less to give more, and I would also add into 
that at least some reform of tax expenditures--because do not 
forget, some of the tax expenditures are growing as quickly. 
They are just like entitlements, and some of the problematic 
ones. Boy, would that be a tremendous package. And the CPI as 
well, of course, which is a technical fix. There is absolutely 
no reason we should not be correcting a CPI which overstates 
inflation.
    But all of those things have the benefit of having the 
savings compound over time so they would not show as huge 
savings in that 10-year window, but the effect they have is so 
important because what it does is it brings that debt level 
down.
    Now, I do think that you want to have some savings in the 
10 years because our debt levels need to be brought lower, but 
more important than that is that they are on that downward 
trajectory.
    The only thing I would recommend is that just as Doug said 
about caps, things can be undone, you want to make sure that 
all those changes are credible and that there is a real 
political commitment to stick to them so that they are 
reassuring enough that those savings which would material more 
in the long run would come along as promised. And I think there 
are budget process maneuvers that could help tie up a deal like 
that. And anything along the lines of what you just put out 
would be immensely reassuring and helpful to the economy.
    Senator Wicker. Well, thank you. I want to thank the 
panelists.
    Let me just observe in closing, Mr. Chairman, almost every 
Senator who came and attended today spoke out in favor of going 
big and going long, and I would add what Senator Hagan said, 
going smart. I immediately embraced the concept of the Group of 
Six. It was an idea that was so trashed at once from both the 
right and the left that it was dead on arrival by sundown of 
that very day.
    I think there is a willingness on this panel and in this 
Senate and both ends of the Capitol to do something tough at 
this moment of divided Government. I serve in a Democratically 
controlled Senate. The House of Representatives is Republican. 
The executive branch is Democratic. And, frankly, the agencies 
and the regulatory bodies are largely Democratic. But this is 
an ideal time--it is actually the perfect time to do big things 
where we all have our fingerprints on them, and we cannot make 
them an election issue afterwards.
    I would just suggest to my Democratic friends and to anyone 
within the sound of my voice that if the President of the 
United States would step forward and give a clear signal to the 
Super Committee that he is willing to be engaged in this, he is 
willing to endorse this, he is willing to say early on that he 
would sign legislation that goes big and goes long, I think we 
could get it done a la Tip O'Neill and Ronald Reagan, and we 
would actually have something that we can tell our 
grandchildren that we did for their future.
    Chairman Tester. Thank you, Senator Wicker, and I do not 
think there is a soul, on this panel at least, that does not 
agree this is the preeminent issue we have got to deal with. So 
we are going to have to get on the same page.
    Instead of talking about the good things that can happen 
with the good, long-term big package, I want to talk about the 
other side of the equation. Let us say that the Super Committee 
cannot come to any sort of real recommendations. Let us say 
that the sequestration is evident that it is going to start and 
with that will be bills brought up to the Senate, at least, and 
probably the House to eliminate programs that will be 
sequestered, for example--well, one of them, military spending 
has already been brought up. We are not going to do that.
    Give me some sort of idea--and I think I know what your 
answer is going to be, but give me some sort of answer on what 
that would do, that not only do we not come to some sort of 
$1.2 trillion discussion, or much bigger than that, but also 
the sequestration that has been mandated by the agreement that 
was done on the debt ceiling, there are inroads into that so 
that that does not even happen. Give me some sort of idea. 
Doug, you can start.
    Mr. Holtz-Eakin. Well, I think, you know, obviously you 
would have severe disappointment in markets. I am firmly 
convinced that you would see more agencies downgrade U.S. 
credit ratings. I think you would see markets steadily 
reevaluating the relative position of the U.S. versus other 
places to park their money. Because it is always relative, we 
can, you know, be the best-looking horse in the glue factory or 
the world's tallest pygmy or a lot of things that we are right 
now, but markets at some point are going to decide someone else 
is just a little bit better, and that would trigger the more 
dramatic reaction.
    You do not want to find out when that happens. We do not 
need that experiment, and we should avoid it.
    Chairman Tester. Thanks. Roger.
    Mr. Altman. Well, Senator, I agree with what Doug said. Let 
me just add one element. Right now there is a widespread 
expectation that the Super Committee is going to fail to agree, 
and that expectation, among other things, is being underscored 
by Members of Congress themselves who often privately rather 
than publicly are themselves saying that.
    So the expectations are awfully low right now, and apart 
from agreeing with everything Doug said, one of the advantages 
of actually achieving an agreement, especially if it were above 
the minimum, it would be such a surprise. You know, it would be 
doubly beneficial because it would be confounding the 
conventional wisdom.
    Chairman Tester. Maya.
    Ms. MacGuineas. It is terribly discouraging because I think 
the trigger is a real problem. Peterson-Pew came out with a 
number of recommendations about how to build a trigger, and 
basically there are two ways you want to do it. You want to 
create a trigger that either is something that if it went into 
place would be a good thing. Like a good trigger would be, 
well, if you do not come up with an option, Bowles-Simpson goes 
into place. Right? You pick a default that is good or that is 
strong enough that it causes people to act but they will not 
bypass it.
    This trigger, so much of it is security. You can already 
see people lining up to be concerned about it. So many things 
are exempt. We recommended that you have broad-based triggered 
both on revenues and on spending so both parties would hate 
them and you not exempt any program so that all people would 
say we do not want this to hit.
    So I am concerned that the design of the trigger is not as 
effective, and the main thing that is going to cause action is 
not just the threat of the sequester, but that it is the right 
thing to do, that there is this huge outcry to do the right 
thing. And you can just see from the comments we have heard 
today on this, the Senators who have been here have just asked 
all the right questions and showed the momentum to do the right 
thing. That is what is going to push it more than the 
sequester, I believe.
    Chairman Tester. I would agree. I want to thank you all 
very much for your testimony. As I said when I met you earlier 
today, I appreciate the work you have done in preparation for 
this Committee, and I appreciate your insights about this whole 
process and how it can work very, very well or how it might 
turn into a train wreck.
    I can tell you from a personal standpoint, one of the 
reasons I wanted to have this hearing, as Senator Bennet said, 
this is a very important issue. But we also need to give the 
Super Committee the knowledge to know that there are a lot of 
people out there that want to see this thing work and work well 
for our country and for our kids. And now is the time to act. 
We cannot continue, we just cannot continue to kick the can 
down the road.
    I remain optimistic. My fellow Senator from Montana, Max 
Baucus, is on that Committee. I hope that he as well as the 
other five Senators can provide solid leadership to bring forth 
comprehensive deficit reduction. I think it is the Senate's--I 
think it would serve the Senate well, and I think there are--I 
mean, as I counted it up here, I think almost everyone one of 
us, if not every one of us, are part of the Gang of 35, if that 
is a gang or group or whatever you want to call them, pretty 
much evenly split, Democrats and Republicans, that want to see 
a big reduction plan.
    As was pointed out, as we look to the future, this is 3 
percent. My God, we ought to be able to do that with our hands 
tied behind our back.
    So just as a formality, this record will remain open for 7 
days for any additional comments and questions that might be 
submitted for the record. I once again want to thank you all. 
You may come from different political persuasions, but I think 
I heard a hell of a lot more agreement than I did disagreement 
today. I very much appreciate that because I agree with what 
you said.
    Thank you all. We are adjourned.
    [Whereupon, at 11:46 a.m., the hearing was adjourned.]
    [Prepared statements and additional material supplied for 
the record follow:]


                 PREPARED STATEMENT OF MAYA MACGUINEAS
           President, Center for a Responsible Federal Budget
                            October 5, 2011

    Chairman Tester, Senator Vitter, Members of the Subcommittee, thank 
you for inviting me here today to discuss the economic problems 
presented by our budget deficit.
    I am Maya MacGuineas, president of the bipartisan Committee for a 
Responsible Federal Budget and the director of the Fiscal Policy 
Program at the New America Foundation. I am also a member of the 
Peterson-Pew Commission on Budget Reform, which recently released two 
reports--Red Ink Rising and Getting Back in the Black, which focus on 
the need to adopt multiyear debt targets and automatic triggers to help 
improve the budget process.
    Our debt as a share of the economy is now higher than it has ever 
been in the postwar period, and we are on track to continue adding to 
it indefinitely. In all likelihood, the debt is already a drag on 
economic growth, and without changes, it will at some point result in a 
fiscal crisis.
    At the same time, we face serious economic challenges: a slowing 
economic recovery, unemployment at unacceptably high rates, and a 
number of persistent problems from a skills shortage, underinvestment 
in a number of critical areas, and an abysmal, inefficient, and 
anticompetitive tax code, all of which stand in the way of longer-term 
growth. So we have our work cut out for us.
    The debt owed to the public grew from $9.0 trillion, or 62 percent 
of GDP, at the end of fiscal year 2010 to $10.1 trillion, or 67 percent 
of GDP, at the end of fiscal year 2011. Under the Congressional Budget 
Office's current law baseline, debt is projected to grow to $14.5 
trillion by 2021. Interest payments alone would be over $660 billion in 
2021.
    Yet, these assumptions are likely wildly optimistic. The Committee 
for a Responsible Federal Budget recently updated its ``Realistic 
Baseline'', which includes more realistic assumptions about future tax 
and spending policies than the current law assumptions CBO is directed 
to follow.* Our baseline shows deficits at nearly $1.1 trillion, or 4.5 
percent of GDP, by the end of the 10-year window; public debt growing 
to $19.4 trillion, or 81 percent of GDP; and interest payments reaching 
$815 billion in 2021.
---------------------------------------------------------------------------
     * The CRFB Realistic Baseline assumes the 2001/2003/2010 tax cuts 
are fully extended, the AMT continues to be patched, war costs slowly 
decline, and scheduled reductions to Medicare payments to physicians 
continue to be waived for remainder of the decade. It does not assume 
the $1.2 trillion in savings the Joint Select Committee on Deficit 
Reduction has been charged with.



    Under realistic assumptions, debt will continue to grow over the 
coming 10 years, and then continue to rise to over 100 percent of the 
economy in the late 2020s, to over 200 percent in the 2050s, and 
eventually to nearly 400 percent by 2080. Obviously, we would 
experience a fiscal crisis well before it would ever get to these 
points.
    Large deficits and debt have a number of negative effects.

    They harm the economy by diverting capital from productive 
        investments to finance Government borrowing, which will 
        inevitably push up interest rates and the cost of capital for 
        families and businesses. A number of academic studies find that 
        high debt levels are already likely negatively impacting the 
        U.S economy. \1\
---------------------------------------------------------------------------
     \1\ See, Stephen G. Cecchetti's September 2011 paper: ``The Real 
Effects of Debt''. http://www.kc.frb.org/publicat/sympos/2011/
2011.Cecchetti.paper.pdf, and Carmen Reinhart and Kenneth Rogoff, 
``Growth in a Time of Debt''. http://www.ycsg.yale.edu/center/forms/
growth-debt.pdf

    From a budgetary perspective, high debt levels lead to 
        higher interest payments which squeeze out other Government 
        spending and lead to higher taxes. Higher interest burdens also 
        leave the Government more vulnerable to increases in interest 
        rates. The Congressional Budget Office recently found that if 
        interest rates were one percentage higher each year than 
        currently projected, it would lead to $1.3 trillion in 
        additional interest costs over the next decade. \2\
---------------------------------------------------------------------------
     \2\ See, the Congressional Budget Office's January 2011 ``Budget 
and Economic Outlook''. http://www.cbo.gov/ftpdocs/120xx/doc12039/01-
26_FY2011Outlook.pdf

    High debt levels lead to loss of fiscal flexibility. Though 
        the past recession was quite severe, we escaped a far worse 
        outcome due to our ability to borrow to smooth out some of the 
        economic shocks. With our current higher debt levels, we no 
        longer have as much fiscal space to respond to emergencies, and 
        doing so will be much more difficult and costly in the future 
---------------------------------------------------------------------------
        if the debt trend is not reversed.

    From an intergenerational perspective, excessively high 
        deficits and debt reflect the basic policy of our spending, yet 
        refusing to pay for it, and passing the bills along to future 
        generations, along with a lower standard of living than they 
        would otherwise enjoy. This inequity is exacerbated by the fact 
        that the bulk of our Government spending goes to consumption--
        much of it for the elderly--rather than investments, which 
        would at least have the potential to boost longer-term growth.

    The uncertainty that comes from businesses and households 
        knowing the changes will have to be made, but not knowing what 
        they are, makes planning and investing significantly more 
        difficult than if policy changes were already clearly put in 
        place. The lack of certainty is one of the major factors 
        causing businesses to keep their cash on their balance sheets 
        rather than making productive investments that would help 
        create jobs and grow the economy.

    Finally, ultimately, unsustainable levels of debt will lead 
        to some type of a fiscal crisis. Once unimaginable in the 
        United States, we should no longer see ourselves as immune from 
        such a crisis.

    The solution to all of the risks of higher debt is a multiyear, 
comprehensive fiscal plan that would stabilize the debt at a manageable 
level and set it on a course to decline as a share of GDP. The sooner 
we enact such a plan, the better.
    We should aim to bring the debt down to around 60 or 65 percent of 
GDP over a decade--still significantly higher than the historic average 
of below 40 percent, but more manageable--and continue to bring it down 
to precrisis levels over the following decade. All areas of the budget 
should be on the table.
    The debt threat is extremely serious, but it is also an opportunity 
to restructure our budget and tax system for the 21st century. By 
shifting our budget from one directed towards consumption to 
investment, we can lay a new foundation for growth. In order to be 
competitive down the road, we must strengthen critical investments in 
human capital, infrastructure, and high value research and development. 
And our tax system needs to be fundamentally reformed to both help grow 
the economy and raise more revenues to help close the fiscal gap.
Debt Reduction as an Engine for Economic Growth
    It is important to recognize that debt reduction is not at odds 
with economic growth strategy, but rather, a central part of one. 
Putting in place a credible multiyear debt stabilization plan 
immediately has a number of economic advantages.
    First, a credible debt reduction package reduces the negative 
consequences of excessively high debt levels, including pressure on 
interest rates and payments. The Congressional Budget Office has 
analyzed the potential impacts of a multitrillion debt reduction plan 
over the course of a decade and has found that while it can dampen 
economic growth in the short-term, the overall size of the economy 
later in the decade and over the long-term can be notably larger. CBO 
estimates that by 2021, real GNP could increase by 0.6 to 1.4 
percentage points from a $2.4 trillion debt reduction plan, compared to 
what otherwise would have occurred, \3\ The International Monetary Fund 
has also found that fiscal consolidation in high-debt countries will be 
beneficial and likely increase output over the long-run. \4\ There is 
also evidence that the announcement itself of a credible, long-term 
debt reduction can have positive economic effects in the short-term 
effects by improving confidence and pushing down long-term interest 
rates. Finally, debt reduction would reduce or eliminate the risk of a 
fiscal crisis.
---------------------------------------------------------------------------
     \3\ See, the Congressional Budget Office's July 16, 2010, report: 
``The Macroeconomic and Budgetary Effects of an Illustrative Policy for 
Reducing the Federal Budget Deficit''. http://www.cbo.gov/ftpdocs/
123xx/doc12310/07-14-DeficitReduction_forweb.pdf
     \4\ See, the October 2010 International Monetary Fund, World 
Economic Outlook, ``Chapter 3: Will It Hurt? Macroeconomic Effects of 
Fiscal Consolidation''. http://www.imf.org/external/pubs/ft/weo/2010/
02/pdf/c3.pdf
---------------------------------------------------------------------------
    Second, a credible, multiyear debt reduction plan can help free up 
enough fiscal space upfront to allow the economic recovery to continue 
to take hold. Rather than implementing immediate spending cuts and tax 
hikes, budgetary changes could be phased in more gradually, putting the 
debt on a glide path to stable and then declining levels. Gradual 
changes would also allow beneficiaries of our entitlement programs and 
taxpayers more time to adjust. But, a plan does need to be credible to 
be effective. Three keys to a credible plan are:

    It must be put in statute, not just promised.

    It must be bipartisan so that there isn't an immediate push 
        by either political party to undo it.

    It must include a well-designed fiscal rule to ensure that 
        savings are realized as promised and that the plan stays on 
        track. Such rules could include spending caps at the levels of 
        an agreed-upon plan, and broad-based automatic triggers that 
        provide savings if policies fall short. The more difficult to 
        override, the better. The Peterson-Pew Commission reports and 
        the Gang of Six plan include a number of budget process reforms 
        that should be integrated into any debt reduction plan to help 
        ensure that stays on track.

    Third, a multiyear plan will provide businesses and households more 
confidence and stability, allowing them to spend, invest and plan in 
ways that will help the economy.
    Fourth, the added pressures on spending will likely lead to better 
oversight of Government programs and reforms or elimination of 
outdated, ineffective, and redundant spending programs. This is also an 
important opportunity to transition the U.S. budget from a consumption-
oriented budget to an investment-oriented one, which will be critical 
to long-term economic growth. In so doing, consumption oriented 
programs would be cut, while spending on many key areas of productive 
public investments would be increased. Our current incremental approach 
to deficit reduction is doing just the opposite of thoughtfully 
reassessing our priorities and their effects on economic growth, and we 
are instead chipping away at the absolute wrong parts of the budget.
    Finally, a comprehensive plan to stabilize the debt, if large 
enough, will by necessity include reforms to entitlement and the tax 
system, which if done prudently, will help grow the economy. Examples 
of such pro-growth structural reforms would include:

    Fundamental tax reform like what the Bowles-Simpson Fiscal 
        Commission proposed, which dramatically reduces tax 
        expenditures, lowers rates--including corporate tax rates, and 
        uses a share of the revenues for deficit reduction.

    Entitlement reform--particularly health and pensions, not 
        only because this is primarily where our fiscal challenges lie, 
        but because fundamental reforms would allow us to more 
        efficiently use our country's resources, and provide better 
        incentives for consumptions, savings, and work.

    While smaller budget deals are less likely to include fundamental 
overhauls of major entitlement programs and the tax code, a larger deal 
would encompass all areas the budget and could reform them in a way to 
create better growth incentives and reduce the deficit simultaneously.
    Our tax code is simply a massive mess. It is littered with over 250 
special credits, deductions, exemptions, and exclusions that cost us 
nearly $1.1 trillion a year. These ``tax expenditures'' are truly just 
spending by another name. By reducing, if not eliminating, many of 
them, we can reduce tax rates to more effectively encourage work and 
investment, while also helping to reduce deficits. Fundamental tax 
reform is critical in turning our fiscal situation around and 
strengthening our economic well-being.
    To be large enough in the medium and long-term, and to reassure 
markets that a plan is serious, entitlement reform and tax reform must 
be at the center of any fiscal turnaround plan.
    While the policy choices involved in tackling our out of control 
debt are not easy, they are far easier than what we will face if we 
continue to delay. One thing should be clear: it is preferable to make 
these difficult budget choices on our own terms then if and when they 
are forced upon us by credit markets.
    As it stands now, the new Joint Select Committee, or Super 
Committee, is tasked with recommending savings of $1.5 trillion over 10 
years. This, however, is unlikely to be sufficient to stabilize the 
debt. Instead, we would urge the Super Committee to ``Go Big'' by 
implementing a larger plan that would be sufficient to stabilize the 
debt at a manageable level and, in so doing, to tackle the most 
problematic areas of the budget, including health and retirement 
entitlements and taxes. Specifically, we urge the Super Committee to:

  1.  Go Big. From a realistic baseline in which current policies are 
        extended, $1.5 trillion is not nearly enough to stabilize the 
        debt. The Super Committee should look at all areas of the 
        budget in order to achieve more savings, with a goal of 
        stabilizing the debt as a share of the economy and then putting 
        it on a downward path.

  2.  Go Long. Any serious fiscal plan must address the long-term 
        drivers of our growing debt. The Super Committee should enact 
        serious reforms to Social Security--which seems to be all but 
        forgotten in this discussion--as well as Medicare, Medicaid, 
        and other Federal health spending.

  3.  Go Smart. Without economic growth, it will be difficult if not 
        impossible to get our fiscal situation under control. The Super 
        Committee should pursue pro-growth tax reform which broadens 
        the base and lowers rates, and should reprioritize spending to 
        better encourage short- and long-term growth.

  4.  Stay Honest. The Super Committee must not rely on budget gimmicks 
        to make it appear that they identified savings to meet their 
        target or that the problem was solved, while failing to fix the 
        problem in reality.

  5.  Make It Stick. Once savings have been identified, the Super 
        Committee should put in place an enforcement regime to ensure 
        savings materialize as promised.

    Thank you to the Committee for all your work on this and the 
opportunity to appear here today, and I look forward to your questions.

APPENDIX 1























APPENDIX 2



















ADDENDUM











                 PREPARED STATEMENT OF ROGER C. ALTMAN
                      Chairman, Evercore Partners
                            October 5, 2011

    Mr. Chairman and Members of the Subcommittee, thank you for 
inviting me to testify before you today on American fiscal policy.
    You are holding this hearing at a time of serious economic and 
financial fragility for the United States. More than 2 years after the 
trough of the Great Recession (June 2009), our recovery has stalled and 
there is a serious threat of slipping back into negative growth. The 
sovereign debt crisis in Europe continues to rage, and that is 
undermining consumer, business and investor confidence. As a result of 
these two factors, severe and alarming strains have reemerged in our 
own financial system and in the global system.
    In other words, this is a dangerous moment from an economic and 
financial perspective. And, the decisions which the President and 
Congress make on fiscal policy over the short and medium term will play 
an important role in diminishing, or in worsening, those financial 
strains and our economic stability itself.

Economic and Financial Conditions Today
    I want to spend a moment walking through this point on fragility.
    First, the U.S. economy is threatened with renewed recession. It 
decelerated to an 0.8 percent growth rate during the first half of this 
year. That was down from 3.9 percent for the first half of 2010, as you 
can see in Table 1. Just a few negative developments, in financial 
markets, employment trends, or in overall confidence levels, could push 
this low growth rate into negative territory.



    In addition, the present growth rate trend is far too slow to 
improve our struggling labor markets, given population growth. This is 
why net monthly job growth for the past three months has averaged only 
35,000 new jobs, with zero jobs added in August.
    The medium term outlook is also not encouraging. The latest IMF 
forecast for the U.S. economy over the second half of this year is a 
similarly meager 1.5 percent. And, the well regarded Goldman Sachs 
economic forecast is just slightly above that.
    As for next year, Goldman Sachs' 2012 growth number is now down to 
0.5 percent. And, in the face of such weakness, the U.S. unemployment 
rate will likely rise. That same forecast envisions an average 2012 
unemployment rate of 9.4 percent. That is discouraging.
    Further, the unemployment rate, while high, probably understates 
the real weakness in labor market conditions. The so-called 
underemployment rate (U-6) reflects those who have given up looking for 
work and those who work part time but would like a full time job. It 
presently stands at 16.2 percent, the highest since 1994. Moreover, the 
labor participation rate, which just measures the percentage of working 
age adults with a job, is 64 percent currently. That is a 27 year low.
    The latest Census Department data on poverty is also important, and 
it received too little attention. 15.3 percent of the American 
population, or 45 million people, now lives below the poverty line. The 
latter is defined as income of $22,000 or less for a family of four, 
excluding in-kind benefits like food stamps. This is the highest 
percentage of Americans in poverty in 28 years.
    My point is that this is a poor overall economic picture. There are 
two main explanations. The aftermath of the credit market collapse of 
2008, the second worst financial crisis in 100 years, is still 
restraining consumers. And likely will do so for another few years. 
Household balance sheets, which were severely overleveraged when the 
bottom fell out (debt at 140 percent of household income) have only 
returned halfway to historically average levels of debt.
    More household deleveraging will occur, driven by the continuing 
weakness in home prices, weak incomes and overall economic insecurity. 
This is why the personal savings rate, at 4.5 percent, is so far above 
the negligible level of 3 years ago. Which, in turn, explains why 
consumer spending, which constitutes approximately 70 percent of U.S. 
GDP, is relatively stagnant.
    The other major factor contributing to economic weakness is credit 
availability and lending volume. Total bank loans to commercial and 
industrial businesses are well below 2008 highs. Present outstandings 
are $1.29 trillion, as compared to the $1.61 trillion high. This 
reflects the bad combination of tighter lending standards and weak loan 
demand. The problem is that such low levels of borrowing are not 
consistent with a durable economic recovery.
    These factors explain why, according to CBO, the country is ``only 
halfway through the cumulative shortfall in output relative to its 
potential level'' which will have resulted from the Great Recession. 
The total of that cumulative shortfall is estimated at $5 trillion.
    Let me also comment on financial market conditions, starting with 
credit markets. Again, two main points. One is that the level of yields 
on U.S. Treasury securities is so low as to be nearly incomprehensible. 
Or the Treasury 10 year, for example, the yield is hovering around 1.80 
percent. That is the lowest recorded level since the Federal Reserve 
System began publishing market data in 1953. And, it is a profoundly 
negative development. For, it signals negligible demand for capital and 
negligible inflation. These are hallmarks of recession.
    Second, the sovereign debt crisis in Europe, and the concomitant 
risk of a banking crisis there, has infected financial markets all 
around the world. Borrowing in public credit markets has recently 
become much more difficult. Stock prices have fallen nearly 20 percent 
since April, and equity financing levels have dropped accordingly. The 
window for initial public offerings, for example, has nearly closed. 
The fear factor which we saw so vividly in late 2008 and early 2009, 
has crept back into these markets. They are on a razor's edge.

Role of the Federal Deficit
    The Members of this Committee, and all of your Congressional 
colleagues, should recognize that they will be making crucial decisions 
on deficit reduction in the midst of this economic and financial 
fragility. The right decisions can help to alleviate it. But, poor ones 
can worsen it, even to the point of serious crisis.
    We all know that the U.S. is on the wrong track when it comes to 
deficits and debt. CBO recently projected that the amount of Federal 
debt held by the public will equate to 67 percent of U.S. GDP. That 
will be the highest ratio since 1951. Worse, CBO forecasts that, based 
on current policies, this proportion will be 82 percent by 2020. That 
would be the highest level incurred since record keeping began in 1792, 
excepting the period during and immediately after WWII. All of this is 
depicted in Table 2.



    The Federal debt grows, of course, in proportion to the size of the 
budget deficit. And, you well know that, in absolute terms, deficits 
hit all-time record highs in 2009 and 2010 and were still stratospheric 
at $1.3 trillion for the Federal fiscal year which ended a few days 
ago.
    These deficits reflect a historically wide gap between spending and 
revenue levels. Federal spending has been hovering around 23 percent of 
GDP and revenue around a modern historic low of 16 percent. This seven 
point difference appears to be the largest in our modern history.
    It is obvious that this mismatch, and the scary rate at which it is 
increasing our debt/GDP relationship, is not sustainable. Everyone 
agrees that, unchecked, it will reduce productivity, incomes and our 
standards of living. There is also reasonable agreement on the 
magnitude of deficit reduction which America needs to cure this 
disparity. The Bowles/Simpson Commission set a goal of stabilizing the 
debt/GDP ratio by 2015 and beginning to turn it downwards from there. 
The amount of 10 year deficit reduction necessary to achieve this 
approximates ($5 trillion).
    Fortunately, the tide of public opinion has moved, and moved 
sharply on deficits and debt. It would seem that the basic wisdom of 
the American people has asserted itself. For, polls indicate that the 
public is deeply unhappy over continued, record deficits and the 
explosion in Federal debt, realizes the inherent dangers, and wants 
this path altered.
    While this past summer's dispute over extending the Federal debt 
limit was difficult, it did provide a modest breakthrough. A 10-year 
package of specific deficit reduction actions totaling $917 billion was 
agreed then. And, the twelve member so-called Congressional Super 
Committee was established. It is charged, as we all know, with devising 
an additional $1.5 trillion program of deficit reduction actions and 
submitting them to the full Congress by November 23. If the Super 
Committee cannot agree on a package, or the Congress votes down its 
recommendations, then $1.2 trillion of reductions in domestic 
discretionary spending over 10 years will be automatically triggered. 
Essentially, these would take effect in 2013 and cuts would be divided 
equally between the defense and nondefense portions of the budget.
    All of this means that a minimum of $2 trillion in 10-year deficit 
reduction actions will be set motion by the end of this year. That is a 
good start but not enough. Further, difficult decisions by the Super 
Committee, the full Congress and the President would be necessary to 
properly adjust U.S. fiscal policy.

A Growth and Jobs Initiative
    The economic slowdown and recession risk which I initially 
discussed represents a huge short term risk. Slipping back into 
negative growth, and seeing the unemployment rate rise again, would 
deliver a psychological blow to consumers, businesses and financial 
markets. They could retrench further and a downward economic and 
financial spiral could result. And, that could occur when the fiscal 
and monetary authorities are largely out of ammunition.
    Therefore, it makes sense to undertake a short term, entirely 
temporary growth and jobs agenda. This would represent a form of 
insurance policy.
    President Obama has proposed a $447 billion program of tax cuts, 
infrastructure spending and extended unemployment insurance benefits. 
The core element is a deeper 1-year extension of the 2010 payroll tax 
cut for employees and a similar 1-year payroll tax cut for small 
businesses.
    In my view, the President's proposal is a sound one. And, it is 
clear to me that such actions, like the 2009/2010 stimulus program, 
would have a beneficial economic impact. But, there also are numerous, 
possible variations on the President's package. The point is that a 
short term growth and jobs package of this approximately magnitude 
should be undertaken now. Economic conditions demand it, and financial 
markets would welcome it.

Long Term Deficit Reduction
    At this very moment, financial markets are pre-occupied with the 
European Sovereign debt crisis and the risks of renewed recession in 
the U.S. and Europe. That is why yields on U.S. Treasury securities, 
and German and British government bonds, are at all-time lows. Concerns 
over the long term deficit outlook, poor as it is, are secondary.
    But, such views can change in an instant. It is just a matter of 
time before financial markets again are preoccupied with the 
threatening U.S. fiscal outlook.
    At that point, the trajectory of interest rates will reverse 
itself. After all, the 10-year average yield on 10-year U.S. Treasuries 
is nearly three times the present yield. Then, if our deficits actually 
follow the CBO path, exceeding 80 percent of GDP, family incomes would 
be lower, productivity would be lower and our standards of living would 
be lower. That is not an acceptable outcome, which is why a major, long 
term deficit reduction package is necessary.
    There are three possible outcomes for the Super Committee process. 
The first is, unfortunately, the most widely expected result. Namely, 
that the Committee cannot find a majority to support the necessary $1.5 
trillion package of reductions and does not submit a recommendation to 
the full Congress. On that basis, the so-called trigger would be 
pulled, and $1.2 trillion of discretionary spending reductions would be 
initiated.
    This outcome would be disappointing across the board. It would 
vividly underscore an inability to address such a fundamental and 
important problem. And, if financial markets were as unstable then as 
they are now, this outcome also could further destabilize them. I would 
urge the Members of the Committee to work with other Senators to avoid 
this disappointment.
    The second outcome would involve the Super Committee finding a 
majority on a credible $1.5 trillion deficit reduction package, 
submitting the related recommendations to the full Congress and having 
those pass and become law. This would send a reassuring signal to the 
public, and to the business and financial communities. At a time of 
such economic and financial weakness, this would be particularly 
helpful.
    The third outcome, albeit unlikely, would be the optimal one. This 
is the ``Go Big'' scenario under which the Super Committee reaches 
agreement, on a much larger, and balanced package of deficit reduction 
actions. In effect, it solves the debt/GDP problem in one fell swoop 
with a $3-4 trillion 10-year agreement along the lines of Bowles/
Simpson. And, one which wins the support of President Obama and a 
majority of the full Congress.
    Provided that this did not take effect too quickly in such a weak 
economic environment, this is just the type of solution which could 
shore up consumer and business confidence, reassure financial markets 
and begin to restore public faith in Government itself.
                                 ______
                                 
               PREPARED STATEMENT OF DOUGLAS HOLTZ-EAKIN
                    President, American Action Forum
                            October 5, 2011

Introduction
    Chairman Tester, Ranking Member Vitter, and Members of the 
Subcommittee thank you for the privilege of appearing today. In this 
short statement,* I wish to make the following points:
---------------------------------------------------------------------------
     * The opinions expressed herein are mine alone and do not 
represent the position of the American Action Forum. I thank Cameron 
Smith for her assistance.

    The outlook for deficits and debt threatens the Nation's 
        prosperity and freedom. Changing the fiscal course should be 
---------------------------------------------------------------------------
        our top national priority.

    Controlling the growth of future Federal spending should be 
        the central objective of policy makers in pursing this goal. 
        Effectively controlling spending, reducing deficits, and 
        eliminating future debt accumulation can aid near-term economic 
        growth.

    Businesses, entrepreneurs, and investors perceive the 
        future deficits as an implicit promise of higher taxes and 
        higher interest rates.

    There are no fixed statistical indicators that will signal 
        imminent loss of confidence in the U.S. by global capital 
        markets, but Federal debt is already in the danger zone.

    Let me discuss each in turn.

The Threat of Future Debt
    The Fiscal Outlook. The Federal Government faces enormous budgetary 
difficulties, largely due to long-term pension, health, and other 
spending promises coupled with recent programmatic expansions. The 
core, long-term issue has been outlined in successive versions of the 
Congressional Budget Office's (CBO's) Long-Term Budget Outlook. \1\ In 
broad terms, over the next 30 years, the inexorable dynamics of current 
law will raise Federal outlays from an historic norm of about 20 
percent of Gross Domestic Product (GDP) to anywhere from 30 to 40 
percent of GDP. Any attempt to keep taxes at their postwar norm of 18 
percent of GDP will generate an unmanageable Federal debt spiral.
---------------------------------------------------------------------------
     \1\ Congressional Budget Office. 2011. ``The Long-Term Budget 
Outlook''. Pub. No. 4277. http://www.cbo.gov/ftpdocs/122xx/doc12212/06-
21-Long-Term_Budget_Outlook.pdf
---------------------------------------------------------------------------
    This depiction of the Federal budgetary future and its diagnosis 
and prescription has all remained unchanged for at least a decade. 
Despite this, action (in the right direction) has yet to be seen.
    Those were the good old days. In the past several years, the 
outlook has worsened significantly.
    Over the next 10 years, according to the Congressional Budget 
Office's (CBO's) analysis of the President's Budgetary Proposals for 
Fiscal Year 2012, \2\ the deficit would never fall below $750 billion. 
Ten years from now, in 2021, the deficit would be 4.9 percent of GDP, 
roughly $1.2 trillion, of which over $900 billion would be devoted to 
servicing debt on previous borrowing.
---------------------------------------------------------------------------
     \2\ Congressional Budget Office. 2011. ``An Analysis of the 
President's Budgetary Proposals for Fiscal Year 2012''. Pub. No. 4258. 
http://www.cbo.gov/ftpdocs/121xx/doc12130/04-15-
AnalysisPresidentsBudget.pdf
---------------------------------------------------------------------------
    As a result of the spending binge, in 2021 public debt would have 
more than doubled from its 2008 level to 90 (87.4) percent of GDP and 
will continue its upward trajectory.
    The ``Bad News'' Future under Massive Debt Accumulation. A United 
States fiscal crisis is now a threatening reality. It wasn't always so, 
even though--as noted above--the Congressional Budget Office has long 
published a pessimistic Long-Term Budget Outlook. Despite these gloomy 
forecasts, nobody seemed to care. Bond markets were quiescent. Voters 
were indifferent. And politicians were positively in denial that the 
``spend now, worry later'' era would ever end.
    Those days have passed. Now Greece, Portugal, Spain, Ireland, and 
even Britain are under the scrutiny of skeptical financial markets. And 
there are signs that the U.S. is next. The Federal Government ran a 
fiscal 2010 deficit of $1.3 trillion--nearly 9 percent of GDP, as 
spending reached nearly 24 percent of GDP and receipts fell below 15 
percent of GDP.
    What happened? First, the U.S. frittered away its lead time. It was 
widely recognized that the crunch would only arrive when the baby 
boomers began to retire. Guess what? The very first official baby 
boomer already chose to retire early at age 62, and the number of 
retirees will rise as the years progress. Crunch time has arrived and 
nothing was done in the interim to solve the basic spending problem--
indeed the passage of the Medicare prescription drug bill in 2003 made 
it worse.
    Second, the events of the financial crisis and recession used up 
the Federal Government's cushion. In 2008, debt outstanding was only 40 
percent of GDP. Already it is over 60 percent and rising rapidly.
    Third, active steps continue to make the problem worse. The 
Affordable Care Act ``reform'' adds two new entitlement programs for 
insurance subsidies and long-term care insurance without fixing the 
existing problems in Social Security, Medicare, and Medicaid.
    Thus, the U.S. faces squarely a future that potentially includes 
sufficient Federal indebtedness to generate sovereign debt distress. 
What is at stake for the average citizen?
    For Main Street America, the ``bad news'' version of the fiscal 
crisis occurs when international lenders revolt over the outlook for 
debt and cut off U.S. access to international credit. In an eerie 
reprise of the recent financial crisis, the credit freeze would drag 
down business activity and household spending. The resulting deep 
recession would be exacerbated by the inability of the Federal 
Government's automatic stabilizers--unemployment insurance, lower 
taxes, etc.--to operate freely.
    Worse, the crisis would arrive without the U.S. having fixed the 
fundamental problems. Getting spending under control in a crisis will 
be much more painful than a thoughtful, proactive approach. In a 
crisis, there will be a greater pressure to resort to damaging tax 
increases. The upshot will be a threat to the ability of the United 
States to bequeath to future generations a standard of living greater 
than experienced at the present.
    Future generations will find their freedoms diminished as well. The 
ability of the United States to project its values around the globe is 
fundamentally dependent upon its large, robust economy. Its diminished 
state will have security repercussions, as will the need to negotiate 
with less-than-friendly international lenders.
    The ``Good News'' Future under Massive Debt Accumulation. Some will 
argue that it is unrealistic to anticipate a cataclysmic financial 
market upheaval for the United States. Perhaps so. But an alternative 
future that simply skirts the major crisis would likely entail 
piecemeal revenue increases and spending cuts--just enough to keep an 
explosion from occurring. Under this ``good news'' version, the debt 
would continue to edge northward--perhaps at times slowed by modest and 
ineffectual ``reforms''--and borrowing costs in the United States would 
remain elevated.
    Profitable innovation and investment will flow elsewhere in the 
global economy. As U.S. productivity growth suffers, wage growth 
stagnates, and standards of living stall. With little economic 
advancement prior to tax, and a very large tax burden from the debt, 
the next generation will inherit a standard of living inferior to that 
bequeathed to this one.

Controlling Spending To Reduce Deficits and Debt
    The policy problem facing the United States is that spending rises 
above any reasonable metric of taxation for the indefinite future. 
Period. There is a mini-industry devoted to producing alternative 
numerical estimates of this mismatch, but the diagnosis of the basic 
problem is not complicated. The diagnosis leads as well to the 
prescription for action. Over the long-term, the budget problem is 
primarily a spending problem and correcting it requires reductions in 
the growth of large mandatory spending programs and the appetite for 
Federal outlays, in general.
    As an example, using the President's 2012 Budget, the CBO projects 
that over the next decade the economy will fully recover and revenues 
in 2021 will be 19.3 percent of GDP--over $300 billion more than the 
historic norm of 18 percent. Instead, the problem is spending. Federal 
outlays in 2021 are expected to be 24.2 percent of GDP--about $1 
trillion higher than the 20 percent that has been business as usual in 
the postwar era.
    Just as some would mistakenly believe that the Federal Government 
can easily ``tax its way out'' of this budgetary box there is an 
equally misguided notion in other quarters that it can ``grow its way 
out.'' The pace of spending growth simply must be reduced.
    Most importantly, mandatory spending programs cannot be left to 
evolve as dictated by current law. It is equally important to quickly 
undertake entitlement reform. To see the need for urgency, consider 
first Social Security.
    Social Security contributes to the current deficit. At present, 
Social Security is running a modest cash-flow deficit, increasing the 
overall shortfall. As the years progress, these Social Security 
deficits will become increasingly larger. They are central to the 
deficit outlook. More importantly, the stream of future outlays is 
heavily driven by demography. In particular, if the future benefits of 
the baby boom generation are exempted from reform, either by design or 
a failure to move quickly, then the outlay ``problem'' will have been 
effectively exempted from reform. This would be a fundamental policy 
failure.
    For these reasons, an immediate reform and improvement in the 
outlook for entitlement spending would send a valuable signal to credit 
markets and improve the economic outlook.
    Naturally, it would be desirable to focus on the larger future 
growth in outlays associated with Medicare, Medicaid, and the Patient 
Protection and Affordable Care Act (ACA). These share the demographic 
pressures that drive Social Security, but include the inexorable 
increase in health care spending per person in the United States. From 
a policy perspective, it would be desirable to replace the ACA with 
reforms that raised the efficiency of health care spending and slowed 
the growth of per capita health care outlays. At the centerpiece of 
such reforms would be reforms to the Medicare and Medicaid programs. 
However, in the absence of a political consensus to revisit the ACA, 
Medicare and Medicaid reforms will remain paralyzed and the most 
promising area for bipartisan entitlement reform is Social Security.

The Economics of Spending Control
    The top issue facing Americans is the need for robust job growth. 
According to the National Bureau of Economic Research the recession 
began in December 2007. Their data show that there were 142.0 million 
jobs in December of 2007--the average of payroll and household survey 
data. In June 2009, NBER's date for the end of the recession, the same 
method showed 135.3 million jobs, for a total job loss of 6.7 million 
attributed to the recession. These numbers are quite close to those 
using the Bureau of Labor Statistics nonfarm payroll data, which showed 
a loss of 6.8 million.
    There are glimmers of promise. Since December 2009, 1.8 million 
payroll employment jobs have been added. However at the same time, 
there are 14 million unemployed persons in the economy and many more 
discouraged workers. Since the start of the recession the labor force 
has fallen nearly 535,000.
    For these reasons, the current unemployment rate of 9.1 percent 
likely understates the real duress. Using the BLS alternative 
unemployment rate (U-6), one finds that unemployed, underutilized and 
discouraged workers are 16.2 percent of the total. As evidence of the 
difficulties, the number of long-term unemployed (27 weeks or more) is 
currently 6 million and accounts for 43 percent of all unemployed 
persons.
    The fiscal future outlined above represents a direct impediment to 
job creation and growth. The United States is courting continued 
downgrade as a sovereign borrower and a commensurate increase in 
borrowing costs. In a world characterized by financial market 
volatility stemming from Ireland, Greece, Portugal, and other locations 
this raises the possibility that the United States could find itself 
facing a financial crisis. Any sharp rise in interest rates would have 
dramatically negative economic impacts; even worse an actual liquidity 
panic would replicate (or worse) the experience of the fall of 2008.
    Alternatively, businesses, entrepreneurs and investors perceive the 
future deficits as an implicit promise of higher taxes, higher interest 
rates, or both. For any employer contemplating locating in the United 
States or expansion of existing facilities and payrolls, rudimentary 
business planning reveals this to be an extremely unpalatable 
environment.
    In short, cutting spending is a pro-growth policy move at this 
juncture. As summarized by recent American Action Forum research, the 
best strategy to both grow and eliminate deficits is to keep taxes low 
and reduce public employee costs and transfer payments. \3\
---------------------------------------------------------------------------
     \3\ See, http://americanactionforum.org/news/repairing-fiscal-
hole-how-and-why-spending-cuts-trump-tax-increases.
---------------------------------------------------------------------------
    Keynesian Arguments and Reducing Spending. Analyses of H.R. 1, the 
continuing resolution that called for $61 billion in reduced Federal 
spending, by Goldman Sachs and Economy.com have been touted by some as 
evidence that it is not feasible to engage in spending reductions. 
Similarly, one hears frequently that the Budget Control Act of 2011 
runs the risk of choking off the recovery.
    I believe these arguments miss several key points.
    Begin, for illustration, with the debate surrounding the CR. The 
first thing to note is that while Members are aware that a reduction of 
$61 billion in budget authority does not translate into an immediate 
$61 billion cut in outlays, many analysts appear to not understand 
these budgetary facts. Indeed, on average, a $1 cut would translate 
into only 52 cents during the current fiscal year.
    To generate their estimates, Goldman Sachs assumed outlay 
reductions of $15 billion in the 2nd quarter and $30 billion in the 3rd 
quarter of calendar 2011. Naively interpreted, this could produce 
noticeable impacts on quarter-to-quarter GDP growth. But this is a 
misleading and highly overstated estimate of the likely impact because:

    The CBO estimates an outlay reduction of only $9 billion in 
        fiscal 2011, or an impact of at most 0.3 percentage points;

    The calculation assumes full dollar-for-dollar reduction in 
        GDP as spending declines. This is too large, especially 
        because;

    Not all outlay reductions are actual cuts in the purchases 
        of goods and services to contribute to measured GDP. Instead, 
        some are transfers payments to States or individuals that will 
        have a more muted impact. Indeed, while FY2010 showed outlays 
        of $3,456 billion on a budget basis, the National Income and 
        Product Accounts \4\ showed under 30 percent ($1,030 billion) 
        as consumption purchases;
---------------------------------------------------------------------------
     \4\ Congressional Budget Office. 2011. ``CBO's Projections of 
Federal Receipts and Expenditures in the Framework of the National 
Income and Product Accounts''. Pub. No. 4250.

    Not all of the budget authority cuts are from new spending. 
        Instead, some are rescissions of the authority for spending 
---------------------------------------------------------------------------
        that never occurred and might never occur; and

    Most importantly this is a static calculation that assumes 
        no beneficial offset in private sector spending because of the 
        improved budget outlook and prospect of lower future taxes and 
        interest rates. Put differently, the criticisms ignore the 
        rationale for making these beneficial cuts to begin with: to 
        clear the way for private sector jobs and growth.

    A different way to make the last point is to note that these 
``Keynesian'' arguments invoke a sterile, mechanical view of his 
economic views. In fact, Lord Keynes placed considerable importance on 
the role of expectations and optimism regarding the economic 
environment--so-called animal spirits. Policies that enhance the 
willingness and desirability of businesses to invest fit neatly in to 
his view of business cycles and economic growth.
    Similar considerations apply to the recently enacted Budget Control 
Act of 2011. Much publicity has accompanied the discretionary caps in 
the bill, which ``cut'' over $800 billion in budget authority relative 
to CBO's adjusted 2011 baseline. In reality, no such cuts have yet 
taken place, as the FY2012 appropriations have not yet been completed. 
Moreover, the future ``cuts'' imposed by the caps are only as concrete 
as the collective will of future Congresses and Administrations to 
impose them.
    In this light, it is interesting to examine recent movements in 
indexes of economic confidence ranging from small businesses, to CEOs, 
to households (see Table).



    No definitive explanation of month-to-month movements in measures 
of confidence will emerge from this hearing. However, one could make 
the case that markedly as the election and Congressional debate shifted 
toward control of future spending, deficits, and debt. Unfortunately, 
with the passage of a Budget Control Act that revealed partisan 
differences and less-than-definitive commitments to reduced spending, 
confidence tailed. Off.
    Two final aspects of the recent, Keynesian-based opposition to 
controlling spending are perplexing. Often those who make the claim 
that, for example, a $61 billion cut in spending will endanger the 
recovery are equally willing to argue that tax increases are needed to 
close the deficit. However, in a Keynesian model tax increases and 
transfer decreases enter in exactly the same manner. If the latter 
endanger the recovery, so must the former!
    More importantly, entitlement reform--the repeal of the Affordable 
Care Act, Medicare reform, Medicaid reform, or Social Security reform--
is likely to have no immediate impact on Federal outlays. Instead, they 
are commitments in the present to reduced spending in the future. By 
construction, they can have no negative, Keynesian impacts on recovery. 
Instead, they carry only beneficial impacts on the expectations of 
employers and other market participants.

The Role of Tax Policy
    While it will not be possible or desirable to rely on pure revenue 
increases to address the looming debt explosion, there is a role for 
improved tax policy to support economic growth. What is needed now is a 
tax policy that has incentives for businesses and entrepreneurs to 
locate in America and spend at a faster rate on innovation, workers, 
repairs, and new plants and equipment.
    The place to start is the corporate income tax, which harms our 
international competitiveness in two important ways. First, the 35 
percent rate is far too high: when combined with State-level taxes, 
American corporations face the highest tax rates among our developed 
competitors. \5\ The rate should be reduced to 25 percent or lower.
---------------------------------------------------------------------------
     \5\ Some defend the high corporate tax rate by arguing that the 
effective corporate tax rate is much lower. This misses an important 
point. Every country's effective tax rate is also lower than its 
statutory rate. A recent study by two economists at the University of 
Calgary (http://www.cato.org/pubs/tbb/tbb_64.pdf) concludes that the 
marginal tax rate in the U.S on new investment is 34.6 percent, higher 
than any other country in the OECD.
---------------------------------------------------------------------------
    Second, the United States remains the only developed country to tax 
corporations based on their worldwide earnings. Our competitors follow 
a territorial approach in which, say, a German corporation pays taxes 
to Germany only on its earnings in Germany, to the U.S. only on its 
earnings here, and so forth. If we were to adopt the territorial 
approach, we would place our firms on a level playing field with their 
competitors.
    Proponents of the worldwide approach argue that because it doesn't 
let American firms enjoy lower taxes when they invest abroad, it gives 
them no incentive to send jobs overseas. Imagine two Ohio firms, they 
say: one invests $100 million in Ohio, the other $100 million in 
Brazil. The worldwide approach treats the profits on these two 
investments equally, wisely giving the company that invests in Brazil 
no advantage over its competitor.
    But this line of reasoning ignores three points. First, because 
firms all over the world will pay lower taxes than the two Ohio 
companies, the likeliest outcome of the scenario is that both firms 
will fail, unable to compete effectively with global rivals. Second, 
when American multinational firms invest and expand employment abroad, 
they tend also to invest and expand employment in the United States. In 
the end, healthy, competitive firms grow and expand, while 
uncompetitive firms do not, meaning that our goal should be to make 
sure that American companies don't end up overtaxed, uncompetitive, and 
eventually out of business. And finally, because the U.S. is the 
holdout using a worldwide approach, it is at a disadvantage as the 
location for the headquarters of large, global firms. As the U.S. loses 
the headquarters, it will lose as well the employment, research and 
manufacturing that typically is located nearby.
    The corporate tax should be reformed further. At present, companies 
must depreciate their capital purchases over time. Instead, they should 
be allowed to deduct immediately the full cost of all investments, 
which would provide a dramatic incentive for spending. We should also 
consider phasing out the tax-deductibility of the interest that 
companies pay on their borrowing. Because this interest is deductible 
and the companies' own dividends are not, firms have an incentive to 
borrow excessively. Removing that incentive--making a firm's tax 
liability dependent not on its financial decisions but on its real 
economic profitability--would discourage financial engineering and 
focus corporations on their core mission.
    A more competitive corporate-tax system would be a good start in 
our effort to encourage private-sector growth. But a lot of private-
sector economic activity in the U.S. isn't affected by the corporate 
tax at all. Activity that takes place in sole proprietorships, 
partnerships, and other ``pass-through entities''--organizations whose 
income is treated solely as that of their investors or owners--is 
instead affected by the individual income tax. Congress' Joint 
Committee on Taxation projects that in 2011, $1 trillion in business 
income will be reported on individual income-tax returns.
    It's important to note that nearly half of that $1 trillion--$470 
billion--will be reported on returns that face the top two income-tax 
rates. A conservative estimate is that more than 20 million workers 
would be employed by firms directly affected by those two tax rates. 
Tax reform should avoid higher marginal tax rates in favor of lower 
rates and a broader base. Marginal tax rates and the taxation of 
dividends and capital gains directly affect companies' decisions about 
innovation, investment, and savings.
    Americans--from homeowners to small businesspeople to the millions 
of unemployed--are in desperate need of faster and prolonged economic 
growth. Congress should therefore evaluate tax proposals based on 
whether they're likely to trigger and support that growth. Tax policy 
can play a key role in spurring an economic recovery--but not without 
sustained reform of both the corporate and individual income-tax 
systems.

The Need for Rapid Action
    Financial markets no longer can comfort themselves with the fact 
that the United States has time and flexibility to get its fiscal act 
together. Time passed, wiggle room vanished, and prior to 2011 the only 
actions taken have made matters worse.
    There are already warning signs on the horizon. S&P has chosen to 
lower the Federal credit rating. While there has been much discussion 
about the timing of the downgrade and the source of the downgrade, 
there should be little dispute regarding the substance of the critique.
    Consider, for example, the analysis by Moody's. As outlined in a 
report, \6\ the credit rating agency Moody's looks at the fraction of 
Federal revenues dedicated to paying interest as a key metric for 
retaining a triple-A rating. Specifically, the large, creditworthy 
sovereign borrowers are expected to devote less than 10 percent of 
their revenues to paying interest. Moody's grants the U.S. extra wiggle 
room based on its judgment that the U.S. has a strong ability to repair 
its condition after a bad shock. The upshot: no downgrade until 
interest equals 14 percent of revenues.
---------------------------------------------------------------------------
     \6\ Moody's determines debt reversibility from a ratio of interest 
payments to revenue on a base of 10 percent. Wider margins are awarded 
to various governments to indicate the additional ``benefit of the 
doubt'' Moody's awards. The U.S. finds itself on the upper end at 14 
percent. The ratios are ``illustrative and are not hard triggers for 
rating decisions.'' See: Aaa Sovereign Monitor Quarterly Monitor No. 3. 
Moody's Investor Service. March 2010.
---------------------------------------------------------------------------
    This is small comfort as the 2012 Obama Administration budget 
targets 2015 as the year when the Federal Government crosses the 
threshold and reaches 14.2 percent. Moreover, the plan is not merely to 
flirt with a modest deterioration in creditworthiness. In 2021, the 
ratio reaches 20.3 percent. The Budget Control Act and actions of the 
Joint Select Committee on Deficit Reduction are intended to alter this 
trajectory, but until their intended actions become budgetary fact, 
international markets will likely remain wary.

Conclusion
    At this juncture, the United States needs a keen focus on enhancing 
the rate of economic growth. Workers and economy as a whole will 
benefit from pro-growth policies. Central aspects of a pro-jobs and 
growth agenda are controlling Federal spending growth; eliminating the 
potential for debt accumulation that generates a fiscal crisis, or 
higher taxes and interest rates; and improved tax policy.
    I look forward to answering your questions.
                                 ______
                                 
                PREPARED STATEMENT OF WILLIAM JOHNSTONE
       President and Chief Executive Officer, Davidson Companies
                            October 5, 2011

    Chairman Tester, Ranking Member Vitter, and Members of the 
Subcommittee, my name is Bill Johnstone. I am the President and Chief 
Executive Officer of Davidson Companies.
    Davidson is an employee-owned financial services holding company, 
headquartered in Great Falls, Montana. We have been in business for 76 
years, have 1,100 employees and operate in 16 States, primarily west of 
the Mississippi.
    Davidson has three principal lines of business:

    We provide investment advice and products to approximately 
        120,000 individual and institutional investors.

    We provide institutional research for approximately 260 
        companies and make markets in approximately 425 stocks (mostly 
        small and mid-cap companies). We also trade stocks with 
        institutional investors and provide underwriting and investment 
        banking advisory services to small and mid-cap companies.

    Last, we trade tax-exempt and taxable bonds with 
        institutional investors and underwrite bonds for and provide 
        advisory services to Government units throughout the Western 
        United States.

    We are not a commercial bank or depository institution and we do 
not originate or underwrite mortgages or mortgaged backed securities or 
engage in proprietary trading or the creation of or trading in complex 
derivatives. We have never received a Government bailout. In the past 
10 years, in the context of challenging financial markets and economic 
conditions and the demise or consolidation of many financial services 
firms, we have remained independent and doubled in size.
    In contrast to the other panelists, I am not an economist, nor do I 
have significant prior academic or Government experience in analyzing 
or developing tax or economic policy. Prior to my current position, I 
practiced finance law, managed an international law firm and was the 
CEO of a regional securities firm in the Southwest.
    My views and observations regarding the deficit are shaped and 
informed by my experiences, particularly my recent experience at 
Davidson.
    In my position, I talk either directly or through our employees 
with a range of investors and businesses. These include retirees, small 
business persons, families saving for retirement and college education, 
businesses trying to raise capital, commercial bank clients, 
institutional investors from small to large and State and local 
governmental units that access the bond market. I also speak with 
colleagues in other similar financial services firms.
    I want to make clear that my views and observations do not 
necessarily represent those of Davidson, its employees or clients.
    My larger views and observations are not materially different from 
those espoused by many others. Perhaps some of my sources and reasoning 
are and will be helpful.
    I want to discuss three key points:

    There is considerable investor concern about the Federal 
        deficit and our ability or will to address it. The concern is 
        negatively influencing the ability of investors and businesses 
        to make business and investment decisions necessary to drive 
        economic growth and job creation.

    Policies to address the deficit should be bold, concrete, 
        and credible, but implementation should be staged to avoid 
        exacerbating the current weakness in the economy. While the 
        particulars of the solution are important, more important is 
        that the development and implementation of a solution is 
        credible and understood. In this situation, perfection, as 
        defined by narrow self-interest, is the enemy of the good.

    To the extent the solution involves changes in tax policy, 
        as I believe it should, we should use this as an opportunity to 
        commence reform of our Federal tax laws.

    Historically, the Federal deficit and its implications were not 
frequently voiced investor concerns. At least three developments have 
occurred to change it. The growth in the deficit's size (absolutely and 
relatively), this summer's highly publicized debt limit debate and the 
financial crisis in Europe. Most investors, whether institutional or 
individual, have concluded that the deficit, and as important its 
projected growth, will result in substantial damage to our economy 
unless we make meaningful changes. The situation in Europe has 
heightened awareness of the economic implications of fiscal deficits 
and the difficulty of addressing them, particularly if responses are 
delayed. At the same time, the length and nature of the debt limit 
debate raises serious questions among investors and business persons as 
to whether Government has the ability to develop and implement a 
deficit solution.
    Certainly, the deficit is not the only factor inhibiting economic 
growth and, at present, maybe not the most important factor. The 
continuing difficulties in the housing market, high unemployment, the 
apparent increase in regulatory burden and general deleveraging by 
consumers and business are among other important factors that I 
frequently hear in my discussions. But the deficit and the uncertainty 
of whether and how it will be addressed are critical factors in 
reducing investor and business confidence and willingness to take risk 
and make business and investment decisions necessary to drive economic 
growth and job creation. I consistently hear that from investors and 
businesses and their representatives and I see it in their behavior.
    The financial system is short of neither capital nor liquidity to 
fund economic growth. The financial system, businesses and the consumer 
are short of confidence and much of this deficit in confidence is 
related to the Federal deficit.
    I am not here to offer a recommendation regarding the details of a 
policy response to address the deficit. There is a plethora of 
reasonable potential responses, including those suggested or discussed 
by the other panelists. I happen to believe the Simpson-Bowles 
Commission offered a number of thoughtful and sensible suggestions and 
provides a very good starting point. However, I will share my views 
regarding what I believe are three important elements of a solution.
    First, I would be an advocate of a larger rather than smaller 
reduction target more in the range of the Simpson-Bowles suggestions, 
for a couple of reasons. I think it better addresses the issue. And, it 
reflects my skepticism regarding the ultimate outcome of the 
legislative process and the natural inclination to develop overly 
optimistic projections of future revenue growth and expense reduction.
    Second, as has been oft noted by others more expert than I, the 
desire (perhaps zeal) to make a meaningful and quick reduction in the 
deficit has to be balanced with the realities of the current economic 
situation and the scope and economic impact of the policy changes. The 
required changes necessarily will be profound in their scope and 
impact. They have to be evolutionary, not revolutionary. While 
implementation of a plan should be staged, the plan should be agreed to 
sooner than later. The longer we wait the more costly the solution, the 
more limited the policy options and the more damage arising from the 
current uncertainty.
    Last, I am struck by the difference in the narrative I hear in my 
conversations with employees, clients and business persons and the 
narrative I hear from Washington, DC. My audience is probably somewhat 
older and more conservative than the general populace. And certainly, 
there are significant differences of opinion. However, in general, the 
narrative I hear is more pragmatic, balanced and in my view sensible 
relative to the range of appropriate policy options. And, the narrative 
reflects an acknowledgement that change is necessary and that it will 
require some sacrifice and loss of benefit or advantage that is 
conferred by existing policy.
    I will only briefly note my belief that any deficit reduction plan 
should include some effort to reform our Federal income tax, both 
corporate and individual. I am skeptical that the necessary deficit 
reduction can be accomplished entirely on the expense side or that some 
increase in revenue will materially damage our economic prospects, and 
I would not approach the issue on the condition that revenue cannot or 
should not be increased. However, regardless of how you stand on that 
point, we need to move to a tax code that is simpler and fairer, with 
lower marginal rates and with far fewer deductions and exemptions. The 
proliferation of targeted deductions, exemptions or distinctions in 
sources of income too often distorts rational economic and business 
decision making and should be reversed. This has been a widely held 
policy goal for decades. Perhaps the reality of our current challenges 
will produce the will to do something.
    Thank you for allowing me to share my thoughts on this important 
topic.
              Additional Material Supplied for the Record

    STATEMENT SUBMITTED BY ROBERT L. REYNOLDS, PRESIDENT AND CHIEF 
  EXECUTIVE OFFICER, PUTNAM INVESTMENTS, AND PRESIDENT OF THE PUTNAM 
                                 FUNDS

    I am Robert L. Reynolds, president and chief executive officer of 
Putnam Investments and president of the Putnam Funds. My thanks to the 
Subcommittee for inviting me to share with you our concerns about an 
issue directly related to ongoing efforts to curb Federal deficits: the 
need to also preserve, indeed extend, incentives for retirement savings 
in America.
    Even as we struggle to bring our deficits down and get our national 
debt back onto a sustainable path, I believe that savings, and 
retirement savings specifically have a vital role to play in a 
transition that America absolutely has to make. Simply put, our Nation 
needs to move away from rising debt, leverage and debt-driven 
consumption to a new economic model, grounded on higher savings, and 
greater incentives for investment, business formation and job creation. 
Ultimately, the best way to deal with our deficits and debt will be to 
outgrow them. Robust retirement savings will be key to spurring such 
renewed growth. National solvency and personal solvency go hand in 
hand. Economic policy should never pit one against the other.
    Regrettably, though, there is a real risk that incentives for 
companies to offer workplace savings plans and for individuals to 
participate in them could be undermined by ill-considered policy 
changes aimed at reducing the budget deficit.
    Proposals to cap or roll back tax deferrals for retirement savings 
are particularly dangerous. If adopted, they could have the effect of 
reversing a generation's worth of Congressionally driven progress on 
retirement savings. They would undercut incentives for thousands of 
small and emerging companies to offer their workers retirement plans at 
all, and could send millions of future workers toward retirement with 
no access to workplace savings plans. Moreover, cuts to current 
retirement savings initiatives would likely return far less revenue to 
Treasury than their proponents estimate--even over the short-term--
while placing millions of future retirees at risk.
    The background to this policy debate is well known. Americans today 
live longer, more active lives; the cost of health care, especially in 
later life, has increased dramatically; traditional pension plans have 
declined in number and scope, and only a small fraction of today's 
workers participate in them. Meanwhile, Social Security's projected 
ability to replace preretirement income is declining, even under 
current law, as a result of rising eligibility age and the costs of 
Medicare deductions.
    To supplement these dwindling sources of assured retirement income, 
working Americans have come to rely on a broad spectrum of retirement 
savings programs that Congress has created over the past several 
decades. These include individual retirement accounts (IRAs); defined-
contribution savings vehicles, including 401(k), 403(b) and 457 plans; 
and tax-advantaged variable annuities. These programs have enabled 
millions of workers and their families to enjoy more secure, dignified 
retirements. While they can--and should--be improved on, these programs 
represent a major, made-in-America success story.
    A study of the retirement readiness of nearly 3,300 working 
Americans sponsored by Putnam Investments and Brightwork Partners 
earlier this year underscores the importance of workplace savings 
programs as a vital adjunct to Social Security. The study found that 
working Americans overall are on track to replace 64 percent of their 
current income in retirement. This is somewhat short of what they are 
likely to need but close enough so that most people--though not all--
can still achieve secure retirements if they act now to raise savings.
    The details of these findings are particularly revealing. Including 
future Social Security benefits, the best-prepared quartile of working 
Americans is on track to replace 100 percent of current income in 
retirement. The least-prepared quartile is on track to replace just 46 
percent of preretirement income. Yet the mean household income of both 
groups is an identical $93,000.
    What accounts for this vast difference in retirement readiness? 
Several factors stand out, but one in particular appears crucial: The 
very best-prepared Americans--roughly 19 million workers according to 
Brightwork estimates--both enjoy access to a 401(k) or other defined-
contribution plan at work and contribute 10 percent or more of their 
income to their plan. In other words, today's existing 401(k) plan 
structure can deliver solid retirement security for those workers who 
make the decision to take part and who also defer 10 percent of more of 
their salaries. In effect, we have discovered an antidote to the risk 
of elderly poverty--and it has three simple ingredients: access to a 
workplace savings plan, the decision to save; and willingness to defer 
at rates of 10 percent of more.
    Precisely because the results they can deliver are so clearly in 
the public interest, today's retirement savings programs were given the 
advantage of deferring Federal income taxes in the first place. Tax 
deferrals offer a powerful incentive for workers to maximize their 
savings. They have contributed greatly to the success of these plans. 
Today, roughly 70 percent of American families have tax-advantaged 
retirement savings, and assets held in employer-sponsored retirement 
plans, IRAs and annuities totaled $17.5 trillion at year end 2010. 
(Source: 2011 Investment Company Fact Book, pages 100-102: http://
www.ici.org/pdf/2011_factbook.pdf.)
    Building on these programs, improving them and extending them to 
the tens of millions of Americans who lack access to on-the-job savings 
plans should be among our most important national goals. That is why I 
believe that Congress should not only preserve all existing savings 
incentives, but support solid, bipartisan ideas such as the Auto-IRA, 
which would extend access to workplace savings coverage for the many 
millions of workers who currently lack such on-the-job plans.
    Well-intentioned but misguided advocates for reducing the Federal 
budget deficit would take the Nation in the opposite direction by 
seeking to cut back the tax advantages that help drive retirement 
savings. The rationale behind such proposals is that the tax deferrals 
at the heart of 401(k) plans and similar savings vehicles represent tax 
``expenditures'' that significantly reduce needed tax revenue. Nothing 
could be further from the truth. Retirement savings deferrals are not 
permanent tax expenditure at all, but only temporary postponements of 
tax obligations. When retirement savings are drawn down, the money is 
taxed as ordinary income, even though the retirement accounts 
themselves are typically composed mostly of long-term capital gains.
    Equally misleadingly, the Congressional Budget Office uses a 10-
year window for analyzing the costs of tax deferrals. As a result, it 
cannot accurately measure the true cost of tax provisions that are 
incurred over the periods of decades that make up the typical worker's 
career. Today's tax deferrals are counted as revenue losses, but the 
taxes that will be paid beyond a decade forward not counted at all. 
This practice distorts the true ``full-lifecycle'' costs of these 
incentives, understates their social and economic benefits and 
overstates the revenue that would be generated by cutting back on them.
    Workplace-based retirement programs are particularly beneficial for 
lower- and middle-income workers. Research by the American Society of 
Pension Professionals & Actuaries found that households with annual 
incomes below $100,000 pay 26 percent of income taxes but receive 62 
percent of the benefit from 401(k) plans. In contrast, families earning 
more than $200,000 per year pay more than half (52 percent) of income 
taxes, but receive just 11 percent of the benefits from these plans. 
Source: ``ASPPA Testifies in Defense of 401(k) System'', September 15, 
2011: http://www.asppanews.org/2011/09/15/asppa-testifies-in-defense-
of-401k-system.
    Underscoring the importance of payroll savings plans to low and 
moderate income workers, an analysis by the Employee Benefits Research 
Institute found that that more than 70 percent of workers with annual 
incomes of between $30,000 and $50,000 do save for retirement if they 
have access to a workplace plan. Yet fewer than 5 percent of their 
peers who lack access to a workplace plan save through IRAs. Absent 
access to workplace-based savings, then, most American workers simply 
fail to accumulate any serious savings with which to fund their 
retirements or supplements their Social Security benefits. Reducing the 
incentive for retirement plan sponsors to offer workplace savings 
plans, then, could force millions of low- and moderate-income workers 
to face retirement with little or no savings.
    Cutting into tax advantages for retirement accounts would thus be 
far more than just a marginal revenue measure. It would mark a 
fundamental shift away from highly successful programs that Congress 
has supported for the past several decades. Doing so would risk 
irreparable harm to millions of future retirees and by reducing 
investment flows to the capital markets, might also limit future 
economic growth.
    Without question, the skyrocketing Federal debt is a genuine threat 
to our long-term prosperity. But attempting to reduce Federal dis-
saving by cutting incentives for personal savings is a bizarre and 
short-sighted approach. By definition, every dollars saved by 
individuals is one less dollar that they may need to ask for in public 
assistance in the future. The gain of a dollar in tax revenue today 
would be offset by the immediate loss of capital for investment in new 
business formation, job creation and economic growth. And it will be 
far offset tomorrow by the loss of investment gains in workers' 
retirement portfolios and by the risk that many of these less-well-off 
workers may need public assistance in their later years.
    Policy changes that could diminish retirement security for future 
generations of workers and increase in poverty among elderly Americans, 
would betray the optimistic vision that has driven Americans for 
generations, and erode public confidence and personal dignity.
    For all of these reasons, I urge all members of Congress to oppose 
any policy change that would undermine incentives for employers to 
offer workplace savings plans or for individuals to use them to save 
for their retirement.
    My thanks to the Subcommittee for this chance to express my 
concerns. I request that my longer statement on this issue (Reflections 
on National and Personal Solvency) be included in the record as an 
addendum.

ADDENDUM

























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