[House Report 107-347]
[From the U.S. Government Publishing Office]



                                                 Union Calendar No. 206
107th Congress                                                   Report
                        HOUSE OF REPRESENTATIVES
 1st Session                                                    107-347
_______________________________________________________________________



                        THE 2001 JOINT ECONOMIC


                                REPORT


                               __________


                              R E P O R T

                                 of the

                        JOINT ECONOMIC COMMITTEE

                     CONGRESS OF THE UNITED STATES

                                 on the

                          2001 ECONOMIC REPORT

                            OF THE PRESIDENT

                             together with

                            ADDITIONAL VIEWS


                               __________

                    U.S. GOVERNMENT PRINTING OFFICE
99-006                     WASHINGTON : 2002



                        JOINT ECONOMIC COMMITTEE

    [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
      HOUSE OF REPRESENTATIVES                     SENATE
Jim Saxton, New Jersey, Chairman     Jack Reed, Rhode Island, Vice 
Paul Ryan, Wisconsin                     Chairman
Lamar Smith, Texas                   Edward M. Kennedy, Massachusetts
Jennifer Dunn, Washington            Paul S. Sarbanes, Maryland
Phil English, Pennsylvania           Jeff Bingaman, New Mexico
Adam H. Putnam, Florida              Jon Corzine, New Jersey
Fortney ``Pete'' Stark, California   Robert Torricelli, New Jersey
Carolyn B. Maloney, New York         Robert F. Bennett, Utah
Melvin L. Watt, North Carolina       Sam Brownback, Kansas
                                     Jeff Sessions, Alabama
                                     Mike Crapo, Idaho
                                     Lincoln Chafee, Rhode Island
                 Christopher Frenze, Executive Director
                  Robert Keleher, Chief Macroeconomist
              Patricia Ruggles, Democratic Staff Director

                         LETTER OF TRANSMITTAL

                              ----------                              

                     Congress of the United States,
                                  Joint Economic Committee,
                                 Washington, DC, December 19, 2001.
Hon. J. Dennis Hastert,
Speaker of the House, House of Representatives,
Washington, DC.
    Dear Mr. Speaker: Pursuant to the requirements of the 
Employment Act of 1946, as amended, I hereby transmit the 2001 
Joint Economic Report. The analyses and conclusions of this 
Report are to assist the several Committees of the Congress and 
its Members as they deal with economic issues and legislation 
pertaining thereto.
            Sincerely, 
            
            
                                                Jim Saxton,
                                                          Chairman.
                            C O N T E N T S

                                 ------                                
                                                                   Page
Overview of Current Macroeconomic Conditions ....................     1
Chairman's Views and Republican Staff Reports ...................     3
    Overview of the Current Macroeconomy ........................     3
    The Performance of Current Monetary Policy Indicators .......     8
    Information Technology and the New Economy ..................    21
    Economic Benefits of Personal Income Tax Rate Reductions ....    33
    Tax Policy For Economic Growth ..............................    54
    A Guide to Tax Policy Analysis: The Central Tendency of 
      Federal Income Tax Liabilities in Distributional Analysis .    72
    Hidden Costs of Government Spending .........................   102
Vice Chairman's Views and Democratic Staff Reports ..............   114
    Vice Chairman's Statement ...................................   115
    Effective Economic Stimulus .................................   120
    Economic Stimulus Principles and Options ....................   163
    A Return to Deficits ........................................   197
    What Do Families Get From the Tax Cut .......................   213
    Estate Tax Myths ............................................   229
    Highest Marginal Tax Rates ..................................   239
    Airline Bailout .............................................   248

                                                 Union Calendar No. 206
107th Congress                                                   Report
                        HOUSE OF REPRESENTATIVES
 1st Session                                                    107-347

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



 
                     THE 2001 JOINT ECONOMIC REPORT

                                _______
                                

 December 19, 2001.--Committed to the Committee of the Whole House on 
            the State of the Union and ordered to be printed

                                _______
                                

 Mr. Saxton, from the Joint Economic Committee, submitted the following

                              R E P O R T

                             together with

                      ADDITIONAL VIEWS AND STUDIES

 Report of the Joint Economic Committee on the 2001 Economic Report of 
                             the President

              Overview of Current Macroeconomic Conditions

    After ten years, the longest U.S. economic expansion on 
record ended in March of this year, according to the National 
Bureau of Economic Research (NBER). Most economists would 
identify several contributing factors to the economic slowdown 
in 2000, although they might disagree as to the relative 
importance of each:

          1. Tighter monetary policy beginning in mid-1999;
          2. A sharp increase in energy prices in 1999-2000; 
        and
          3. A sharp decline in equity prices.

Those contributing factors were not independent of each other.
    First, the Federal Reserve intended to slow the growth of 
the economy. Between June 1999 and May 2000, the central bank 
raised interest rates six times and by a total of 175 basis 
points, sending the federal funds rate up to 6.5 percent, its 
highest level since 1991. According to the statements of the 
Federal Open Market Committee (FOMC), the central bank believed 
that even with the extraordinary productivity growth, economic 
demands were outpacing growth in supply--a condition that could 
not be sustained without some acceleration in inflation. The 
FOMC's intent was to head off such an inflationary surge before 
it arrived. The central bank's restrictive monetary policy 
affected financial (including equity) markets, some (though not 
all) interest sensitive sectors of the economy, as well as 
several categories of business investment. Secondly, 
substantial energy price increases in 1999-2000 also had an 
adverse effect on the economy. Consumers, spending more on 
higher-priced energy products, had less to spend on 
discretionary items. The rise in energy prices also raised the 
cost of energy inputs to production, squeezing businesses' 
earnings and profits in the non-energy sectors.
    Third, these factors worked in concert with other forces to 
weaken a somewhat overvalued stock market. This, in turn, 
reduced household wealth, thereby weakening household 
consumption. The higher cost of capital associated with 
declining equity prices may also have diminished incentives for 
businesses to invest. For the most part, those factors were in 
operation by the middle of 2000. To some extent, however, they 
have reversed their effects during 2001. In particular, the 
Federal Reserve has lowered interest rates eleven times since 
the beginning of the year, cutting the funds rate by a total of 
475 basis points. Additionally, energy prices retreated to 
levels that are well below their peaks. As a consequence, by 
late summer, many economists were expecting a near-term 
economic rebound.

The Terrorist Attacks

    The economic impact of the terrorist attacks of September 
11, however, changed this outlook in several important ways. In 
the short-term, the attack increased overall uncertainty and 
apprehension in financial markets and affected consumption and 
investment as confidence waned. Moreover, the attacks had 
direct impacts on certain industries, most notably airlines, 
aerospace, travel, insurance, hotels, and related areas. 
Employment in air travel, travel services, lodgings and 
recreation has declined significantly since August. In response 
to the attacks, business investment and government spending to 
repair and replace buildings and shore-up our security, 
intelligence, and defenses will increase.

Current Prospects

    As a consequence of the events of September 11, the 
prospects for the economic outlook have changed considerably. 
The expected economic rebound has been pushed back in time and 
two quarters of negative real growth appear likely. Currently, 
the consensus forecast is that the recovery will begin during 
the first half of 2002.

Macroeconomic Policy Response

    The prospects for a rebound, of course, are due, in part, 
to recent policy actions. The Federal Reserve continued to 
lower interest rates following September 11 to 1.75 percent, a 
forty year low. The Administration and Congress have enacted a 
series of measures to support the economy, and some may provide 
additional support before the end of the year.

Uncertainties and Risks

    Despite consensus forecasts of a near-term economic 
rebound, currently there is little hard evidence that a 
turnaround has begun. Furthermore, a number of significant 
uncertainties and risks--mostly on the downside--now litter the 
economic landscape, suggesting a robust rebound is by no means 
assured. Debt burdens are sizable and will take time to work 
off. The international economy appears quite weak and 
vulnerable with no obvious source of strength. The risks of 
further terrorist attacks remain. All of this suggests that 
substantial risks exist and pose substantial challenges to 
economic policymakers.
    The preponderance of downside risks suggests that a further 
stimulus package may be prudent. Such a package should address 
the weakness in the economy that has led to the recession and 
aim to offset the adverse effects described above.

                                 Representative Jim Saxton,
                                                          Chairman.
                                         Senator Jack Reed,
                                                     Vice Chairman.

                          CHAIRMAN'S STATEMENT


                  Overview of the Current Macroeconomy


Background

    According to the National Bureau of Economic Research 
(NBER), the recent economic expansion peaked in March 2001. 
This expansion was the longest on record; it followed the 
second-longest peacetime expansion on record, which lasted for 
most of the 1980s. The recession between the expansions was 
mild and just eight months long. Accordingly, over the last 20 
years, the U.S. economy experienced exceptionally sustained 
economic growth.

The Mid-2000 Slowdown

    While the expansion officially peaked in March 2001, the 
growth of the economy began to slow much earlier from the 
robust rates experienced in the mid and late 1990s. The 
slowdown became obvious in mid-2000. Real GDP growth slowed 
dramatically from its rates of the late 1990s. The growth of 
key components of GDP, especially investment, also fell 
sharply. Growth in fixed nonresidential business investment has 
fallen significantly in recent quarters. The growth of 
consumption has registered more modest declines. The declines 
were reinforced by a weakening manufacturing sector; industrial 
production and capacity utilization of industry fell sharply. 
The National Association of Purchasing Managers (NAPM) index 
also weakened starting in mid-2000.
    The labor market was affected by the slowdown. Employment 
gains slowed significantly; average monthly payrolls increased 
much more slowly after mid-2000. Manufacturing employment fell 
sharply after July 2000, and the unemployment rate began to 
increase in the autumn.

Causal Factors

    The speed of the slowdown surprised most economic 
forecasters, who quickly revised their projections downward. 
Although forecasters were surprised, they had already been 
worried about several factors that contributed to the slowdown: 
(1) tightening monetary policy, (2) a sharp increase in energy 
prices in 1999-2000, and (3) a concomitant sharp decline in 
stock prices.
    (1) The Federal Reserve raised interest rates six times, by 
a total of 175 basis points, from June 1999 to May 2000. The 
Federal funds rate peaked at 6.5 percent, the highest level 
since 1991. For the most part, the Federal Reserve acted 
without convincing evidence that a resurgence of core inflation 
was imminent. Restrictive monetary policy affected financial 
markets (including the stock market), interest-sensitive 
sectors of the economy, and investment.
    (2) Substantial energy price increases in 1999-2000 hurt 
the economy. Consumers spent more on energy and had less to 
spend on other things. Energy price increases had a negative 
impact on economic activity, since purchasing power was 
transferred to oil-producing countries from the United States 
and other countries that are net consumers of oil. The price 
increases also affected the supply side of the U.S. economy, by 
raising costs, reducing aggregate supply, and leading to 
reductions in output. Higher energy costs squeezed business 
earnings and profits, which affected the firms' stock prices.
    (3) These factors and other forces weakened a somewhat 
overvalued stock market, reversing the stock market's ``wealth 
effect'' boost to consumption. The associated higher cost of 
capital also contributed to a slowdown in investment activity. 
The reverse wealth effect has become potentially more 
significant because of the spread of stock ownership in recent 
years. This is the first downturn the United States has faced 
in which more than half of households are invested in the stock 
market. Widespread stock ownership has led to a more 
sophisticated appreciation of the workings of financial markets 
on the part of the public, and to the realization that 
Americans' economic welfare is now closely related to the 
performance of stocks they own either directly or indirectly 
(through mutual funds, 401(k) plans, or other retirement and 
pension plans). Perhaps this realization explains broader 
popular support for economic stimulus legislation to enhance 
incentives for investment.
    Most of the factors contributing to the slowdown were in 
place by mid-2000, but because of long and variable lags, their 
full influence was not felt for some months afterward. As the 
economy remained sluggish, many of the factors that had 
contributed to the slowdown reversed themselves in 2001. The 
Federal Reserve lowered interest rates; energy prices retreated 
and stabilized well below their earlier peaks; and the stock 
market stopped falling and began to stabilize. As a 
consequence, by late summer 2001 many economists were expecting 
an economic rebound to begin soon.

The Terrorist Attacks

    The terrorist attacks of September 11 changed the economic 
outlook. In the short term, the attack increased uncertainty 
and apprehension in financial markets, and affected consumption 
and investment as confidence waned. The attack had a direct 
impact on the airline, aerospace, travel, insurance, and hotel 
industries.
    There will be long-term effects of the terrorist attacks as 
well. The economic costs of a permanently increased terrorist 
threat will likely bring major changes to our way of life. 
Americans will bear an increased cost of security; in effect, 
an added ``security tax.'' The ``tax'' will take the form of 
travel delays, additional security checks, longer cross-border 
transfers, higher insurance costs, additional identification 
requirements, and other inconveniences. It will require 
spending money on new security guards and buying metal 
detectors, which do nothing to increase the quantity or quality 
of goods and services provided. The ``security tax'' will raise 
the cost of doing business, stifle gains from free exchange, 
add inefficiencies, and hence constitutes a negative supply 
shock to the economy.
    The attacks will spur near-term investment and defense 
spending to repair or replace buildings and shore up our 
security, intelligence, and defenses. However, the total 
private capital stock will be less than it would otherwise have 
been. The so-called ``peace dividend''--the reduction in 
defense spending made possible by the end of the Cold War--will 
be lessened. Money for a necessary security buildup will to 
some extent crowd out private investment. Thus, the attacks 
will adversely affect aggregate supply and the longer-term 
potential growth rate of the economy.

Current Prospects

    The effects of the September 11 attacks tilted the economy 
into recession and changed considerably its prospects for the 
near future. The expected economic rebound has been pushed 
back, and two more quarters of negative growth (the fourth 
quarter of 2001 and the first quarter of 2002) appear likely. 
Even so, the chances for an economic rebound in 2002 look 
promising; current recessionary conditions appear to be short 
and mild. With an inventory correction near completion, energy 
prices lower than a year ago, a substantial easing of monetary 
policy in the pipeline, tax cuts in place, and a stock market 
that has recovered from its lows of a few months ago, 
projections for a rebound are plausible.

Macroeconomic Policy Response

    The prospects of a rebound are due in part to recent 
macroeconomic policy action. The Federal Reserve has lowered 
short-term interest rates eleven times this year, reducing the 
Federal funds rate 475 basis points to a 40-year low of 1.75 
percent. Several of its rate cuts came after September 11. 
Fiscal policy has also become less restrictive since September 
11. Congress may yet take some additional fiscal action (in the 
form of tax cuts and spending increases) to provide economic 
stimulus. The combined monetary and fiscal response should help 
shorten the current slowdown.

Uncertainties and Risks

    Despite a consensus among forecasters that an economic 
rebound will begin soon, currently there is little hard 
evidence that it has in fact begun. Furthermore, downside risks 
litter the economic landscape. The effects of the ``security 
tax'' will weigh on the economy for some time. Debt burdens are 
sizable and will take time to work off. The international 
economy appears quite weak. The risk of further terrorist 
attacks remains. Substantial risks exist, posing substantial 
challenges to economic policymakers.
    The preponderance of downside risks suggests that a further 
stimulus ``insurance'' package may be prudent. Such a package 
should address the weakness in investment that has led the 
economic slowdown and aim to offset the adverse effects of the 
``security tax.'' Accelerating depreciation allowances, 
liberalizing expensing provisions, and front-loading scheduled 
cuts in tax rates would be especially appropriate elements of 
such a package.

                                 Representative Jim Saxton,
                                                          Chairman.


