[Congressional Record (Bound Edition), Volume 153 (2007), Part 4]
[Senate]
[Pages 5152-5157]
[From the U.S. Government Publishing Office, www.gpo.gov]




                               TAX RELIEF

  Mr. GRASSLEY. Mr. President, I rise to discuss the tax relief that 
was passed by Congress and signed into law by President Bush in 2001 
and 2003, and to bring some reality to an upcoming debate this month 
that involves the budget resolution. Since that tax relief was enacted 
in 2001 and 2003, and especially since last November, we have heard 
from the liberal establishment in Washington and elsewhere that this 
bipartisan tax relief must be ended and that taxes should be increased 
on millions of Americans of all income levels.
  Today, I am going to look at what is driving the tax increase crowd 
and talk about why they are wrong and why increasing taxes is a bad 
idea. The liberal

[[Page 5153]]

establishment uses deficit reduction as a primary excuse for their 
craving to raise taxes, but before we applaud their efforts to balance 
the budget, let's think about their solution. When anyone says we need 
to increase taxes to balance the budget, what they are saying is they 
are unwilling to cut Government spending. In actuality, the tax 
increase crowd wants to increase Government spending.
  Yesterday, I focused on what extending the bipartisan tax relief 
package means to nearly every American who pays income tax. So today, 
as I promised yesterday, I want to examine the tax relief and to look 
at the impact it has on our economy.
  Regardless of whether you look at Federal revenues, employment, 
household wealth, or market indexes, the impact of tax relief has been 
overwhelmingly positive. I am going to put a chart up that gives the 
figures I want you to consider as I go through the points I am making.
  The first chart illustrates the growth of revenue with the red line 
and the growth in GDP with the green line. As we can see, revenues are 
currently increasing, and are projected to increase in the near future, 
even before tax relief is scheduled to sunset under current law in the 
year 2010. Clearly, tax relief has not destroyed the Government's 
revenue base. I want to point out that this chart shows percentage 
changes in revenue and percentage changes in GDP. So if the lines are 
flat in places, it means revenues and GDP are increasing at a constant 
rate.
  The next chart graphs the Standard & Poor's 500 equity price index 
over a period of several years. So, here again, the lowest point of 
both the red line, representing the weekly S&P, and the green line, 
representing an average, seems to correspond closely with May of 2003, 
which, not coincidentally, is when dividend and capital gains tax cuts 
were signed into law. Aside from benefiting Americans directly invested 
in the stock market, this is good news for anyone with a pension who 
invests in the stock market as well. Of course, that happens to be well 
over half the people. I think somewhere between 56 and 60 percent of 
the people, either through pensions or directly investing in the stock 
market, have money reserves in the stock market. So this is not 
something that affects 10 or 15 percent of maybe the wealthiest people 
in the country, as it did 20, 25 years ago; more people are vested in 
the stock market, mostly through pensions.
  According to the Federal Reserve--I have another chart--net wealth of 
households and nonprofit organizations has increased from a low of 
around $39 trillion in 2002 to more than $54 trillion in the third 
quarter of 2006. Since tax relief went into effect, our Nation's 
households and nonprofit organizations have benefited from more than 
$15 trillion of new wealth.
  This trend is also apparent when we are looking at employment. I show 
you yet another chart. Total nonfarm employment was calculated to 
consist of around 130 million jobs in the summer of 2003 but is 
projected to be 137 million jobs in January of this year. This shows a 
7 million increase in nonfarm employment since the 2003 tax relief bill 
was signed into law.
  I have just described to you four indicators of prosperity. All four 
of them have increased since bipartisan tax relief was passed by 
Congress and signed into law. I wish to emphasize that word 
``bipartisan'' tax relief legislation of 2001 and 2003. Federal 
revenues are growing steadily at a rate, then, greater than the gross 
domestic product. The S&P 500 ended a downward slide and began moving 
upward around the time of the 2003 tax bill. Also, since the 2003 tax 
bill became law, household and nonprofit wealth has steadily increased, 
and literally millions of new jobs have been created. I think it is 
more than a coincidence that all of these positive economic indicators 
are correlated with tax relief. I do not think anything short of 
willful ignorance could lead anyone to say tax relief has been bad for 
this country.
  Now, going back to what I was saying before, the liberal 
establishment wants to reverse the tax relief that has done all the 
good things I was just talking about and that we demonstrated by chart, 
and all in the name of deficit reduction. However, this same crowd has 
not expressed any interest in reducing the deficit through reduced 
spending. I believe the reason for this is that this crowd, comprised 
of lobbyists, the big-city press, and the entrenched Federal 
bureaucracy, wants to raise taxes--your taxes--to spend your money on 
growing Government rather than working to trim spending. In fact, the 
more Government spends, the more power these interests are able to 
accumulate. The Federal bureaucracy gets to control more money, which 
will lead to more people hiring high-paid lobbyists to apply pressure 
to take a bigger piece of the pie the taxpayers are paying for. While 
these interests have no trouble thinking of themselves, they are not 
thinking of America's families, America's senior citizens, America's 
small business owners, and hard-working workers across America. These 
people may not be able to hire lobbyists or write syndicated columns, 
but their welfare should be our top priority.
  I am going to talk in greater detail about America's families, 
seniors, small business owners, and workers, but for now, I just want 
to mention some more about our economy as a whole and how rolling back 
the 2001 and 2003 tax relief would have dire consequences for our whole 
economy.
  There is an old saying that goes something like this: Figures don't 
lie, but liars can figure. This saying is especially true in 
Washington, DC. Any given issue has champions on both sides of the 
aisle able to generate studies and research that just happens to 
support their position. I say this because the source for the 
information I am going to present now is not one of those groups but, 
rather, the Goldman Sachs Group.
  Goldman Sachs is an enormously successful and well-respected 
financial services firm. I do not think it is possible for any 
Democratic politician, liberal think-tanker, or liberal journalist to 
accuse Goldman Sachs of being a tool of my party, the Republican Party. 
Clinton Treasury Secretary Robert Rubin served as cosenior partner and 
cochairman, and current New Jersey Governor and former Senator Jon 
Corzine served as chairman and CEO of Goldman Sachs. Our current 
Treasury Secretary also enjoyed a prominent career at that firm. So I 
would recommend that Republicans, but especially Democrats, pay 
attention when a Goldman economist sends up a red flag.
  In a report that is titled ``Fiscal Policy: Marking Time until the 
Tax Cut Sunsets,'' the U.S. Economic Research Group at Goldman Sachs, 
in this report, projects a recession--projects a recession--if the 2001 
and 2003 tax relief is allowed to sunset. Now, this study actually came 
out in November of 2006, so I am a little surprised we have not heard 
more about it.
  For this report, Goldman Sachs economists used the Washington 
University macro model. To give a little background on the Washington 
model, it is a quarterly econometric system of 611 variables, 442 
equations, and 169 exogenous variables. The Washington model was 
developed and is maintained by Macroeconomic Advisers, Limited 
Liability Corporation, out of St. Louis, MO. Macroeconomic Advisers is 
where former Congressional Budget Office Director Douglas Holtz-Eakin 
serves as a senior adviser. Plus, the firm won the prestigious 2005-
2006 National Association for Business Economics Outlook Forecast Award 
for their accurate GDP and Treasury bill rate forecasts. That ought to 
give them a great deal of credibility. Now, of course, Macroeconomic 
Advisers and their Washington model must be accurate enough for people 
to pay to use it, which is not true for every organization that has 
been modeling the effects on the economy of letting tax relief expire.
  Getting back to the Goldman Sachs study, the authors assumed that 
Congress would let the 2001 and 2003 tax relief expire, so they reset 
taxes to their year 2000 levels, grossed them up slightly to match the 
Congressional Budget Office estimate of the revenue impact of letting 
the tax cuts expire, and allowed for an appropriate monetary response. 
For monetary policy, the study's authors assumed that the

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Federal Reserve would call for interest rate cuts when output falls 
below its trend and for interest rate increases when inflation rises 
above its comfort zone.
  The study states that:

       In the first quarter of 2011, real GDP growth drops more 
     than 3 percentage points below what it would otherwise be. 
     Absent a strong tailwind to growth from some other source, 
     this would almost surely mark the onset of a recession.

  If tax relief is allowed to expire, this study shows that a recession 
is likely to result. By not extending or making tax relief permanent, 
Congress will be deliberately inflicting a recession on the American 
people. Is a lot of hollow, high-sounding rhetoric about balanced 
budgets worth the job losses or business closures that would result in 
such a recession?
  The study eventually predicts higher output but notes that 
consumption would be lower.
  So that everyone has the opportunity to review this study, I ask 
unanimous consent, Mr. President, that it be printed in the Record, 
along with one of the very few news stories to note its findings.
  There being no objection, the material was ordered to be printed in 
the Record, as follows:

            [From the U.S. Economic Analyst, Nov. 10, 2006]

         Fiscal Policy: Marking Time Until the Tax Cut Sunsets

       Near-term changes in US fiscal policy are unlikely despite 
     the shift in control of the Congress. Key decisions on 
     extending tax cuts are not forced until 2010, after the next 
     election, while efforts to roll back these cuts before then 
     would surely trigger a veto.
       As the tax cut ``sunsets'' approach, the Congress regains 
     power, as legislation will then be needed to extend the cuts. 
     The choice will not be easy given the magnitude of the tax 
     increase--about 1\1/2\% of GDP--that would occur if the tax 
     cuts all expired and its likely impact on near-term growth.
       In a simulation exercise, we confirm that this ``do nothing 
     Congress'' scenario would quickly balance the budget but at 
     the cost of a sharp hit to growth in the short term. Farther 
     out, the benefits are higher output and lower inflation and 
     interest rates, at the expense of less consumption--an 
     inevitable price for this decade's tax cuts.
       The Democratic Party has regained control of both houses of 
     Congress with a surprisingly strong showing in the mid-term 
     election. Although the new leadership will clash with 
     President Bush on many issues, several areas appear ripe for 
     compromise, including immigration policy, a minimum wage 
     hike, and Iraq policy. Each could have significant impact on 
     the economy.
       Third-quarter real GDP growth could be revised up to about 
     2% (annualized), but the fourth-quarter prognosis remains 
     murky. Early reads on retail sales suggesting that October 
     spending was weak, and the factory sector must begin to work 
     off an inventory overhang. The labor market continues to 
     impress, though we expect the jobless rate to begin trending 
     higher soon as the housing correction triggers more job 
     losses.

                    I. Return to Divided Government

       The Democratic Party has regained control of both houses of 
     Congress with a surprisingly strong showing in the mid-term 
     election. Although the new leadership will clash with 
     President Bush on many issues, several areas appear ripe for 
     compromise, including immigration policy, a minimum wage 
     hike, and Iraq policy. Each could have significant impact on 
     the economy.
       Third-quarter real GDP growth may have been a bit stronger 
     than first reported, with data in hand suggesting an upward 
     revision to about 2% (annualized). However, the fourth-
     quarter prognosis is murky, with early reads on retail sales 
     suggesting that spending was weak in October, and a 
     substantial inventory overhang in the manufacturing sector. 
     The labor market continues to impress, though we expect the 
     unemployment rate to begin trending higher soon as the 
     housing correction triggers more job losses.
     Democrats Retake Congress
       With surprisingly strong mid-term election gains, the 
     Democratic Party has retaken a majority not only in the House 
     of Representatives, but also in the Senate with a much 
     thinner 51-49 edge (counting two independents who will caucus 
     with the Democrats). This marks the first time that Democrats 
     have controlled both houses of Congress since 1994; the size 
     of the net changes (6 in the Senate, about 30 in the House) 
     approaches those of previous ``landslide'' mid-term 
     elections, especially given the relatively small number of 
     competitive races.
       With Democrats setting the agenda, the initial focus of 
     Congress next year is likely to be on the six issues 
     highlighted in the campaign: (1) reinstatement of PAYGO 
     budget rules; (2) repeal of tax preferences for integrated 
     oil companies; (3) reductions in student loan rates; (4) 
     direct negotiation of Medicare prescription drug prices; (5) 
     an increase in the minimum wage, and (6) implementation of 
     the September 11th Commission recommendations.
       Although President Bush and the Democratic Congress are 
     likely to clash on many fronts, several major issues with 
     ramification, for the economy appear ripe for compromise:
       1. Immigration. Continued large inflows of undocumented 
     immigrants and bipartisan acknowledgement that current 
     policies are insufficient to address the situation have 
     created fertile ground for legislative progress. A potential 
     compromise on immigration policy would likely involve a 
     combination of increased quotas for legal immigration, 
     tougher enforcement of those quotas, and some sort of 
     procedure through which illegal immigrants could eventually 
     apply for US citizenship.
       2. Minimum wage. As noted above, Democrats have targeted a 
     significant increase in the national minimum wage, to $7.25 
     from $5.15 per hour, as part of their initial agenda. A 
     majority in both houses of the current Congress had already 
     supported an increase even before the election, but the deal 
     was never consummated. More than half (26) of the states 
     already have higher minimums, covering a significant portion 
     of the US labor force.
       3. Iraq. Iraq policy could see a fundamental shift, with 
     Donald Rumsfeld's departure as Secretary of Defense an 
     indicator of possible changes ahead. The upcoming report by a 
     special commission chaired by former Secretary of State James 
     Baker and former Congressman Lee Hamilton (who also co-
     chaired the September 11 Commission) could offer both parties 
     political cover for a change of course. This might ultimately 
     reduce the drain on the federal budget from Iraq-related 
     expenditures.
       However, compromise is less likely on many other issues. 
     The White House appeared to be considering making entitlement 
     reform its top priority in Bush's last two years in office, 
     but this now seems unlikely given the huge political 
     obstacles and the likelihood that lawmakers' focus will soon 
     turn to the 2008 presidential election. Federal spending is 
     unlikely to be dramatically different, though divided 
     government historically has meant more controlled spending 
     about in line with GDP growth (-0.02 points per year) versus 
     slightly faster (+0.23 points) when government was under 
     control of a single party.
       Tax policy seems unlikely to change either. Most important 
     tax cuts don't expire until 2010, and there is little 
     Democrats in Congress can do to alter tax policy, given the 
     likelihood of a Bush veto. In addition, Democrats appear far 
     from unified on repealing many of these tax cuts, and the 
     resulting fiscal tightening would pose temporary downside 
     risks to the economic outlook. There is a small risk that 
     tighter budget rules could force the cost of extending these 
     cuts to be offset by tax increases elsewhere. Most likely, 
     these would come from the closing of corporate ``loopholes'' 
     or other business-related revenue raisers. Relief from the 
     Alternative Minimum Tax (AMT) will be extended, but plans to 
     require the cost of any tax cuts to be offset could put two 
     of the Democrats' priorities in conflict (see this week's 
     center section for a fuller discussion of the fiscal 
     outlook).
     More Growth Then, Less Now?
       Economic news this week implied that third-quarter growth 
     might turn out to be a bit stronger than initially estimated. 
     In particular, better export performance and lower oil 
     imports resulted in a substantially narrower trade deficit 
     for September--$64.3 billion versus August's downward-revised 
     $69.0 billion shortfall. This, combined with more inventory 
     building than Commerce officials assumed, puts our best guess 
     for third-quarter real GDP growth slightly above 2% 
     (annualized). Upcoming reports on retail sales and 
     inventories could still swing this figure.
       However, the market's focus is on the outlook, and here we 
     remain cautious. In theory, the sharp drop in energy prices 
     over the past three months should boost consumer spending in 
     the fourth quarter, but this acceleration has yet to 
     materialize. Early reads on retail sales activity--the 
     official government data are due out Tuesday--suggest that 
     October spending was weak. In fact, we have trimmed 0.2 
     points from our retail sales estimates, to -0.4% overall and 
     -0.3% excluding autos. Meanwhile, the manufacturing sector 
     will have to begin working off a significant inventory 
     overhang.
       The labor market continues to impress. For example, initial 
     jobless claims moved back down near the 300,000 level, 
     implying that last week's rise was a head fake and 
     reinforcing the generally strong tone of the October 
     employment report. Although the labor market is clearly tight 
     at present, we expect job losses--particularly from the 
     housing sector--to begin pushing up the unemployment rate 
     within the next few months.

       II. Fiscal Policy: Marking Time Until the Tax Cut Sunsets

       Near-term changes in U.S. fiscal policy are unlikely 
     despite the shift in control of the Congress. Key decisions 
     on extending tax cuts are not forced until 2010, after the 
     next election, while any efforts to roll back these

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     cuts before then would surely trigger a presidential veto.
       As the tax cut ``sunsets'' approach, the Congress regains 
     power, as legislation will then be needed if the tax cuts are 
     to be extended. The choice will not be easy given the 
     magnitude of the tax increase--about 1\1/2\ percent of GDP-
     that would occur if the tax cuts all expired and its likely 
     impact on near-term growth.
       In a simulation exercise, we confirm that this ``do nothing 
     Congress'' scenario would quickly balance the budget but at 
     the cost of a sharp hit to growth in the short term. Farther 
     out, the benefits are higher output and lower inflation and 
     interest rates, at the expense of less consumption--an 
     inevitable price for this decade's tax cuts.
     Near-Term Fiscal Policy: No Major Shift
       Talk of imminent change in fiscal policy, focused on tax 
     hikes, has surfaced as Democrats have regained control of the 
     Congress. They netted about 30 more seats in the House of 
     Representatives, giving them a comfortable margin. In the 
     Senate, the Democratic margin is much thinner--a 51-49 edge.
       However, this shift in control of Congress does not 
     translate into an immediate shift in fiscal policy for four 
     reasons. First, the budget deficit has narrowed sharply over 
     the past two years, as shown in Exhibit 1. This may reduce 
     the sense of urgency in the minds of many lawmakers, and 
     therefore their willingness to strike deals even though the 
     longer-term imbalance remains serious and unresolved. Second, 
     the main components of President Bush's signature tax cuts--
     enacted with ``sunsets'' to contain their budget impact--do 
     not expire until the end of 2010. Hence, the thorny issue of 
     extending these cuts need not be addressed until after the 
     next Congress (and president) is elected in 2008. Third, any 
     effort to roll back these cuts before their scheduled 
     expiration would almost surely trigger a presidential veto, 
     which the Congress could not override, and it would provide 
     the GOP with an election issue to boot. Therein lies the 
     fourth reason, that the impending 2008 presidential election 
     will limit the time and scope for meaningful progress.
       Similar logic applies to the spending side of the ledger, 
     where any efforts to trim outlays for defense or homeland 
     security would be fraught with political risk. Our working 
     assumption is that total spending on national security will 
     not change much, although the composition might shift; for 
     other discretionary spending we expect gridlock between a 
     Democratic majority that would like to restore some programs 
     and a Republican president whose veto pen will suddenly be 
     full of ink. The same probably holds for Democrats' announced 
     intention to push for direct negotiation of Medicare 
     prescription drug prices.
       One issue the new congressional leadership will face is how 
     to handle the various tax measures whose renewal has become 
     an annual ritual in recent years. By far the largest of these 
     is the temporary fix of the alternative minimum tax (AMT), 
     without which the number of taxpayers affected by this 
     obscure tax calculation would soar. Although renewing the AMT 
     would boost the deficit by an estimated $65 billion for 
     fiscal year (FY) 2008, it enjoys bipartisan support. This is 
     because many of its unsuspecting victims live in ``blue'' 
     states. Hence, the new Congress will probably find some way 
     to make it happen and pass most of the other ones (another 
     $16 billion) as well. In doing so, the Democrats risk 
     compromising another objective they have championed in recent 
     years, namely to reinstate pay-as-you-go (PAYGO) rules for 
     federal budget legislation. Unlike the administration and the 
     current congressional leadership, who favor PAYGO only for 
     outlays, Democrats have pushed to have these rules apply to 
     taxes as well. Notably, the decision to resurrect PAYGO does 
     not require the president to sign off, as it can be 
     implemented simply as part of the budget resolution. Hence, 
     an early test of the Democrats' resolve to control the budget 
     deficit will be whether they restore PAYGO or something 
     similar and, more critically, whether they adhere to it.
     2010: A Year of Wreckoning?
       On balance, our expectations for significant change in 
     fiscal policy during the next two years are low. Thereafter, 
     the calculus changes radically as the 2010 sunsets approach. 
     Absent legislative action, the tax code essentially reverts 
     to its pre-2001 provisions on January 1, 2011. Marginal tax 
     rates on ordinary income rise significantly, dividend income 
     loses its special treatment, the capital gains tax rate goes 
     back to 20 percent, the marriage penalty reappears, the child 
     tax credit drops, and the estate--oops, death--tax springs 
     back to life.
       One implication of this situation is that the initiative 
     reverts to Congress, specifically the one to be elected in 
     2008. It can opt for fiscal balance simply by doing nothing 
     and letting the tax cuts expire, or it can pass legislation 
     to extend any or all of the cuts. Although the president--
     whoever that may be--obviously still has the right of veto, 
     he/she obviously cannot reject a bill that has not reached 
     his/her desk.
       More importantly, the stakes are high, as the sunsets 
     potentially telescope into one year the reversal of tax cuts 
     implemented in various stages between mid-2001 and early 
     2004. According to Congressional Budget Office (CBO) 
     estimates, tax revenue would rise by $236 billion between FY 
     2010 and FY 2012 if all of the tax cuts were to expire. 
     Scaled to the estimated size of the economy at that time, 
     this is a fiscal drag of about 1\1/2\ percent of GDP.
       Even the most die-hard fiscal hawks are apt to think twice 
     about the implications of this for the near-term performance 
     of the economy. After all, a tax increase of this magnitude, 
     imposed all at once, would likely throw the economy into 
     recession. How bad would it be, and what would the benefit be 
     in terms of budget improvement and longer-term economic 
     performance?
     Costs and Benefits of Letting Tax Cuts Expire
       To provide some perspective on these questions, we 
     simulated the effects of allowing all the tax cuts to expire 
     as scheduled--or, to twist Harry Truman's famous phrase, a 
     ``do nothing Congress'' scenario. Specifically, using the 
     Washington University Macroeconomic Model (WUMM), we reset 
     taxes to their 2000 levels, grossed them up slightly to match 
     CBO's estimate of the revenue impact of letting the tax cuts 
     expire, and allowed for appropriate monetary policy response. 
     On the latter, we assume that the Fed follows a rule calling 
     for rate cuts when output falls below its trend and rate 
     hikes when inflation is above its ``comfort zone.''
       Exhibit 2 illustrates the main results of this exercise, 
     showing how key variables would diverge from a status quo 
     forecast in which the tax cuts are extended. The results are 
     as follows:
       Reversing the tax cuts quickly closes most, if not all, of 
     the fiscal deficit. The immediate effect is to cut the 
     deficit by about 1\1/2\ percent of GDP, as shown in the top 
     panel of Exhibit 2. This is about three-fifths of the 
     shortfall we currently project for FY 2011, based on 
     assumptions we consider realistic. Under the more restrictive 
     assumptions underlying the CBO's baseline projections, the 
     budget comes very close to balance, as indicated in that 
     agency's latest budget update as well as its estimates that 
     extending the tax cuts would boost the deficit by 1.6 percent 
     of GDP relative to its baseline.
       More budget progress occurs in the out years. The budget 
     improvement persists and even increases over time without 
     further changes in tax law. This reflects the beneficial 
     effects of a sharp reduction in interest expense, which 
     results both from reduced borrowing and lower interest rates. 
     Five years out, the budget improvement swells to about 2\1/2\ 
     percent of GDP, covering about three-quarters of our 
     projected deficit and putting the budget into modest surplus 
     under the CBO assumptions.
       The economy suffers a lot of short-term pain. The jump in 
     taxes on January 1, 2011 squeezes disposable income and hence 
     consumption. This feeds through to the rest of the economy, 
     sharply curtailing growth and prompting an aggressive easing 
     in monetary policy. The lower two panels of Exhibit 2 lay out 
     the major elements of the macroeconomic story.
       In the fIrst quarter of 2011, real GDP growth drops more 
     than 3 percentage points below what it would otherwise be. 
     Absent a strong tailwind to growth from some other source, 
     this would almost surely mark the onset of a recession. In an 
     effort to resuscitate demand, the Fed immediately cuts the 
     federal funds rate, bringing it 250 basis points (bp) below 
     the status quo level over the next year and one-half, as 
     shown in the bottom panel of Exhibit 2. Despite this, output 
     growth remains well below trend over that period, putting 
     downward pressure on inflation as slack in the economy 
     increases. Inflation drops by 150 bp during the sag in growth 
     before coming back up as the monetary stimulus pushes output 
     back toward, and eventually above, trend.
       In the longer run, economic growth benefits from ``crowding 
     in.'' When the government runs a large deficit, ``crowding 
     out'' occurs in the capital markets: Its borrowing, backed by 
     the power to tax, takes priority over private borrowing and 
     therefore denies some companies the funds they need for 
     investment that is usually more productive than the 
     government's use of the funds. As a result, growth suffers 
     and real interest rates rise.
       The opposite occurs in our simulation. Restoring better 
     balance to the government's books reduces the deficit and 
     hence the growth in its debt. This frees funds that now flow 
     to the private sector allowing the capital stock to grow more 
     rapidly and pushing down interest rates. As shown by the gap 
     between the lines in the bottom panel, real interest rates 
     end up substantially lower. This, eventually, raises output 
     by about 1 percent above the level that would have prevailed 
     without the tax increase.
       At first glance, this seems like a straightforward case of 
     short term pain (recession) leading to longer term gain 
     (higher output). Unfortunately, this assessment is a bit too 
     optimistic. Although output is higher than it otherwise would 
     be, consumption is lower. Since the 2001 tax cuts helped 
     thrust the budget back into deficit, the federal government 
     has borrowed to fund its spending and, via the tax cuts, some 
     consumer spending as well. A reversion in 2011 to higher 
     taxes simply recognizes that fact and starts paying off

[[Page 5156]]

     the debt. If instead Congress chooses to maintain the cuts, 
     they just push the due date for the 2000s spending bill even 
     further into the future. In that case, the ultimate payment--
     the drop in consumption--would be even higher.
                                  ____


                     [From TCSDAILY, Feb. 6, 2007]

                 Hillary Clinton and Recession of 2011

                         (By James Pethokoukis)

       How predictable. The fiscal 2008 budget that President Bush 
     put forward yesterday gets slammed for being unrealistic--if 
     not downright mendacious. If the $2.9 trillon proposal 
     actually got enacted as written--doubtful given that Bush is 
     dealing with a Democratic-controlled Congress--the plan would 
     theoretically balance the budget by 2012. As Team Bush 
     crunches the numbers, the U.S. government would run a $61 
     billion surplus in 2012 year after running tiny deficits in 
     2010 ($94.4 billion, or 0.6 percent of GDP) and 2011 ($53.8 
     billion, or 0.3 percent of GDP). All that while permanently 
     extending the 2001 and 2003 tax cuts due to expire in 2010.
       Of course, journalists and think-tank analysts had barely 
     scanned the budget when critics started pointing out its 
     supposed flaws. Among them: the budget assumes more upbeat 
     economic conditions--and thus more tax revenue--than does the 
     forecast from the Congressional Budget Office. (In 2011 and 
     2012, the White House forecasts 3.0 percent and 2.9 percent 
     GDP growth vs. 2.7 percent for each of those years by the 
     CBO.) As the liberal Center on Budget and Policy Priorities 
     puts it, ``The budget employs rosy revenue assumptions; it 
     assumes at least $150 billion more in revenue than CBO does 
     for the same policies.''
       Indeed, the CBO viewed by the inside-the-Beltway crowd as 
     the impartial umpire of all budget disputes--also predicts a 
     balanced budget by 2012. The catch is that it assumes the 
     Bush tax cuts are repealed leading to a surge of revenue in 
     2011 and 2012. It forecasts that the budget deficit would 
     drop from $137 billion in 2010 to just $12 billion in 2011. 
     And in 2012, the budget would move into the black with a $170 
     billion surplus. Yet if the Bush tax cuts are extended, CBO 
     predicts total deficits of $407 billion in 2011 and 2012 and 
     then continuing thereafter.
       No wonder Democratic presidential candidates are finding it 
     so easy to pledge or strongly hint that if they are sitting 
     in the White House in 2010, they will veto any effort to 
     extend the tax cuts. One can easily envision President 
     Hillary Rodham Clinton harking back to her husband Bill's 
     1993 tax hikes and economic success as historical 
     justification for a repeat performance. Deficits are often 
     used as reason for higher taxes, such as in 1993 and 1982. 
     But to believe in higher taxes as sound economic policy in 
     coming years, you also have to believe in the CBO's cheery 
     forecast that hundreds of billion of dollars in new taxes 
     will have little or no effect on economic growth.
       Now you don't have to be an acolyte of supply-side guru 
     Arthur Laffer to find that sort of ``static analysis'' a 
     little weird. Most Americans probably would. So, apparently, 
     did the economic team at Goldman Sachs, the old employer of 
     Robet Rubin, President Bill Clinton's second treasury 
     secretary. Thus the firm's econ wonks decided to try and 
     simulate the real world effect of letting the Bush tax cuts 
     expire at the end of 2010. Using the respected Washington 
     University Macro Model, Goldman reset the tax code to its 
     pre-Bush status, assumed all tax cuts expired, and watched 
     how the economy reacted as 2011 began. What did the firm see? 
     Well, in the first quarter of 2011 the economy dropped 3 
     percentage points below what it would have been otherwise. 
     ``Absent a tailwind to growth from some other source,'' the 
     analysis concludes, ``this would almost surely mark the onset 
     of a recession.''
       So actually it's CBO's economic forecast, not Bush's that 
     is overly, optimistic about future economic growth. But 
     wouldn't the Federal Reserve jump in and cut interest rates, 
     offsetting the fiscal drag of the tax hikes with easy 
     monetary policy? The Goldman Sachs experiment assumes it 
     would, but WUMM still shows the economy sinking;
       ``In an effort to resuscitate demand, the Fed immediately 
     cuts the federal funds rate, bringing it 250 basis points 
     below the status quo level over the next year and one-half. . 
     . Despite this, output growth remains well below trend over 
     that period, putting downward pressure on inflation as slack 
     in the economy increases.''
       And guess what? A recession would throw CBO's carefully 
     calculated tax revenue assumptions out the window. Indeed, 
     the CBO admits that recessions in 1981, 1990 and 2001, 
     ``resulted in significantly different budgetary outcomes than 
     CBO had projected few months before the downturns started.''
       Of course, it's been the history of tax increases that they 
     tend not to bring in as much revenue as originally predicted. 
     President Rodham Clinton or President Obama or President 
     Edwards would likely find the same budgetary disappointment--
     and then have to explain to an angry American public during 
     the 2012 election season why their president decided to 
     plunge the economy into a recession.

  Mr. GRASSLEY. The Goldman Sachs study was clearly not written by 
cheerleaders for tax relief; indeed, the authors seemed to share the 
point of view of many in this Chamber that a cut in spending is not an 
option. The authors regard an eventual drop in consumption as a forgone 
conclusion of tax relief and equate it with the necessity to pay back 
what had been borrowed over the previous decade. At the very least, the 
study says: ``The economy suffers a lot of short-term pain.''
  Congress needs to act to extend or make permanent tax relief enacted 
in 2001 and 2003 or we risk plunging the country into a frivolous 
recession. I say frivolous because the recession will be the result of 
vanity on the part of those who use balancing the budget as a cover for 
tax-and-spend politics.
  More cause for concern of the impact of tax increases comes to us 
from China. I am sure everyone is aware that the Shanghai Composite 
Index lost 8.8 percent of its value this past Tuesday. According to 
various news reports, including a dispatch from the Associated Press, a 
factor in the drop may have been rumors that a capital gains tax on 
stock investment was in order.
  I ask unanimous consent that an ABC NEWS article entitled ``Shanghai 
Shares Rebound Nearly 4 percent'' be printed in the Record.
  There being no objection, the material was ordered to be printed in 
the Record, as follows:

                Shanghai Shares Rebound Nearly 4 Percent

                         (By Elaine Kurtenbach)

       Shanghai, China.--Chinese stocks recovered Wednesday 
     following their worst plunge in a decade as regulators 
     shifted into damage control, denying rumors of plans for a 20 
     percent capital gains tax on stock investments.
       The Shanghai Composite Index gained 3.9 percent to 2,881.07 
     after opening 1.3 percent lower. On Tuesday, it tumbled 8.8 
     percent, its largest decline since Feb. 18, 1997.
       Bullish comments in the state-controlled media appeared to 
     reassure jittery domestic investors, who account for 
     virtually all trading.
       China will focus on ensuring financial stability and 
     security, the official Xinhua News Agency cited Premier Wen 
     Jiabao as saying in an essay due to be published in 
     Thursday's issue of the Communist Party magazine Qiushi.
       Markets across Asia were still rattled, with many falling 
     for a second day. Japan's benchmark Nikkei Index sank 2.85 
     percent, while stocks in the Philippines tumbled 7.9 percent. 
     Malaysian shares fell 3.3 percent, while Hong Kong's market 
     fell 2.5 percent.
       On Tuesday, concerns about possible slowdowns in the 
     Chinese and U.S. economies sparked Wall Street's worst drop 
     since the Sept. 11, 2001, terror attacks. The Dow Jones 
     industrial average lost 416 points, or 3.3 percent.
       Analysts said they expected China's stock market to 
     stabilize and keep climbing over time although further near-
     term declines were possible given concerns that prices may 
     have risen too precipitously in recent months.
       Tuesday's ``sell-off does not reflect any fundamental 
     change in the outlook for China's economy,'' Yiping Huang and 
     other Citigroup economists said in a report released 
     Wednesday. ``A sharp contraction in excess liquidity that 
     would reinforce damage in the stock market remains 
     unlikely,'' it said.
       China's big institutional investors are all state-
     controlled and would be unlikely to sell so heavily as to 
     completely reverse gains that more than doubled share prices 
     last year. With a key Communist Party congress due in the 
     autumn, the authorities have a huge stake in keeping the 
     markets on an even keel.
       ``They are acting now to nip a nascent bubble in the bud,'' 
     says Stephen Green, senior economist at Standard Chartered 
     Bank in Shanghai, adding that it's a challenge given 
     generally bullish sentiment and the massive amount of funds 
     available for investment.
       ``So they have to somehow calibrate the rhetoric and policy 
     actions to keep a lid on this, while not triggering a 
     collapse,'' Green says.
       One option is a capital gains tax on stock investments. 
     Rumors that such a tax may be enacted are thought to have 
     been one factor behind Tuesday's sell-off.
       But the Shanghai Securities News ran a front-page report 
     denying those rumors. The newspaper, run by the official 
     Xinhua News Agency and often used to convey official 
     announcements, cited unnamed spokesmen for the Ministry of 
     Finance and State Administration of Taxation.
       China has refrained from imposing a tax on capital gains 
     from stock investments, largely because until last year the 
     markets were languishing near five-year lows. The Shanghai 
     Securities News report cited officials saying that the 
     government had little need to impose such a measure now, 
     given that tax revenues soared by 22 percent last year.

[[Page 5157]]

       The exact cause of Tuesday's decline in China was unclear, 
     given the lack of any significant negative economic or 
     corporate news.
       Some analysts blamed profit taking following recent gains: 
     the market had hit a fresh record high on Monday, with the 
     Shanghai Composite Index closing above 3,000 for the first 
     time.
       Others pointed to comments by former Federal Reserve 
     Chairman Alan Greenspan, who warned in remarks to a 
     conference in Hong Kong that a recession in the U.S. was 
     ``possible'' later this year.
       Adding to those factors was a persisting expectation that 
     China might impose further austerity measures, such as an 
     interest rate hike, to cool torrid growth: China's economy 
     grew 10.7 percent last year the fastest rise since 1995 and 
     most forecasts put growth at between 9.5 percent and 10 
     percent this year.
       China's markets took off after a successful round of 
     shareholding reforms helped alleviate worries over a possible 
     flood of state-held shares into the market. Efforts to clean 
     up the brokerage industry and end market abuses also helped.
       Their confidence renewed, millions of retail investors 
     began shifting their bank savings into the markets in search 
     of higher returns last year. Strong buying by state-
     controlled institutional investors and overseas funds also 
     helped.
       China still limits foreigners' purchases of the yuan-
     denominated stocks that make up the biggest share of the 
     markets, though that is gradually changing as regulators 
     allow increasing participation by so-called qualified foreign 
     institutional investors.
       Stocks have shown unusual volatility this year, with the 
     Shanghai index notching one-day drops of 4.9 percent and 3.7 
     percent already this year before recovering to hit new 
     records.
       But there are limits to how far shares are allowed to drop 
     in a single trading day: total single-day gains and losses 
     are capped at 10 percent.

  Mr. GRASSLEY. The same AP report notes that regulators have already 
denied those rumors and that the Shanghai Securities News ran a front 
page report to the same effect yesterday. Incidentally, the Shanghai 
Composite Index gained 3.9 percent yesterday.
  I think the Chinese regulator's swift debunking of rumors that a 
capital gains tax was going to be enacted shows the negative impact 
such a tax could have on growing markets and expanding economies.
  As I have said before, what is missing from the debate on extending 
tax cuts and clearly missing from the reasoning of the authors of the 
Goldman Sachs study is the option, and necessity, of reducing 
Government spending. The right thing to do is to let Americans keep as 
much of their own money as we can and not seize it from them to promote 
special interests, encourage high-priced lobbyists or give free rein to 
the big city press to tell everyone else what to do.
  It is often said by the Democratic leadership that tax cuts are not 
free. That statement is true. Tax cuts score as revenue losses under 
our budget rules. What is equally true, if you listen to economists 
and, more importantly, the American taxpayer, is that tax increases are 
not free as well. Taxpayers have to write a check to Uncle Sam.
  Tax increases change taxpayer behavior. Tax increases will affect 
work, investment, and other economic activities. From an economic 
policy standpoint, tax increases, especially those that are used to 
cover more Government spending, have a policy cost. Tax increases are 
not free to the taxpayers and are not free to a growing economy.
  So I would ask that the Democrat leadership, as they draw up their 
budget resolution, to hopefully keep this in mind. Tax increases have 
consequences to the American taxpayer and consequences to the American 
economy.

                          ____________________