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Wednesday, April 30, 2003
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.

    The committee met, pursuant to call, at 10:00 a.m., in Room 2128, Rayburn House Office Building, Hon. Michael G. Oxley [chairman of the committee] presiding.
    Present: Representatives Leach, King, Lucas of Oklahoma, Paul, Gillmor, Ryun, Manzullo, Ose, Biggert, Miller of California, Hart, Capito, Tiberi, Feeney, Hensarling, Murphy, Brown-Waite, Barrett, Harris, Frank, Waters, Maloney, Gutierrez, Velazquez, Watt, Hooley, Carson, Sherman, Meeks, Lee, Inslee, Gonzalez, Capuano, Ford, Hinojosa, Lucas of Kentucky, Crowley, Israel, McCarthy, Baca, Matheson, Miller of North Carolina, Emanuel, Scott, and Davis.
    The CHAIRMAN. The committee will come to order. Today's hearing is on U.S. economic and monetary policy, and we are honored to be joined again by the Honorable Alan Greenspan, Chairman of the Federal Reserve Board of Governors. Before we get started the Chair has a few housekeeping announcements.
    First, pursuant to the Chair's prior announcement in the rules of the committee, opening statements will be limited to the Chair and ranking minority member of the full committee and the Chair and ranking member of the Subcommittee on Domestic and International Monetary Policy, Trade and Technology for a total of 16 minutes evenly divided between majority and minority. All members' opening statements will be made part of the record.
    Secondly, in an effort to permit all members an opportunity to question Chairman Greenspan, for purposes of questioning the witness under the 5-minute rule, the Chair will first recognize majority members who did not get an opportunity to question Chairman Greenspan at his last appearance before recognizing other members. The Chair will recognize minority members based on the list submitted by the ranking minority member. The Chair recognizes himself for a brief opening statement.
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    Good morning, Mr. Chairman, and welcome back. First of all, I would like to thank you for your generosity in agreeing to come back to the committee and continue the round of questions for members who weren't able to speak with you in February. Second, let me offer my congratulations on the President's comments last week that he would reappoint you to another term as Chairman when your term expires next summer. I am sure I speak for the entire committee when I say we appreciate the strong and steady hand you have exerted in the control of monetary policy.
    A great deal has happened in the 10 short weeks since you testified before this committee. On February 12, when you were last here, the war on Iraq seemed certain but its length and outcome were certainly less so. Today we know that the war was quick, the dictator was ousted and a free Iraqi people are on their way to a new and more democratic government. Back in February, the economy's fundamentals looked good, but uncertainties about the war and energy prices made it difficult to predict an economic turnaround. Now with those issues out of the way, the consensus is for gradual but steady recovery.
    Of course, Mr. Chairman, as you know, there are plenty of things that can throw the recovery off track; namely, the continued weakness of the global economy and, as yet unknown, the facts of the SARS epidemic. That is why I believe it is so important to enact the President's jobs in growth program. It is important to note that the President isn't seeking a short-term stimulus. Instead, Mr. Chairman, the President is seeking long-term restructuring of the Tax Code of the sort that you have tended to favor over time and that you embraced in your February appearance. I am particularly interested in the dividend tax cut and its benefits to investors for the capital markets and for corporate governance. As to the other parts of the President's jobs in growth package, you have always said, Mr. Chairman, you believe that tax predictability is important and that in general the lower taxes are and the less government spends, the better, and I certainly couldn't agree more.
    Mr. Chairman, I think most in this room would agree that there is no better time to cut taxes than during an economic slowdown. It is a little harder to reach into the wallet but now is when it really counts.
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    In closing, I think the early indicators are moving in the right direction and that the economy may finally be ready to rally. Since the war we have had indications that consumer spending is up, the market seems to be recovering, and just yesterday we learned that consumer confidence took its biggest jump since March of 1991.
    Again, Mr. Chairman, I thank you for your consideration in returning to the committee, and I now yield to the ranking member, the gentleman from Massachusetts, Mr. Frank.
    Mr. FRANK. I join the Chairman in extending our appreciation to Mr. Greenspan for giving us this return engagement to accommodate this large number of members and also I have had a longtime interest in trying to rebut stereotypes. And Mr. Greenspan, I mean this quite seriously, for you, given where you are, what you have done, your age, your health, for you to be continuing as if none of this was of any moment and that the only important thing was doing your job really is an important lesson that I hope other people learn from. So I appreciate not just what you do but the way in which you do it. And I apologize for making a big deal out of something which I am congratulating you for not making a big deal out of, but I do think that needed to be said.
    When you were here last time, you were asked and will be asked again about one central question, which is what is the relevance of a deficit, an ongoing deficit, an increasing national debt to our economic performance. We have had a great deal of debate back and forth about the role of the deficit. When I first got into politics, deficits were considered to be a bad thing and they were used as weapons against people held responsible for them. In the 1990s, a consensus appeared to have emerged in a bipartisan way that deficits should be brought down, that the debt should be brought down, and surpluses were a good thing particularly in normal economic times, particularly in good economic times and we were making progress in bringing it down. There was some general sense this contributed to the climate in which long-term interest rates could be lowered.
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    We are now in a reverse situation. We are in a situation in which the national debt is climbing back up again. You noted when you were here before us last time that we will begin to run into a problem in the teens of this century with regard to the demands of Medicare and Social Security. Many of us believe that this is directly relevant because the question is do we get to that point with a very large debt or have we begun to bring that debt down. They are not two separate entities. But what happens leading up to that period in terms of the debt has a lot to do with our capacity to deal with it. And in particular, we have this public policy issue, which is whether or not at this point it is appropriate to substantially reduce Federal revenues. I say substantially reduce, because quantity has become a new issue here. And I have to say as a liberal I am used to people saying oh, we don't value money enough and people have said you treat a couple of billion of dollars as if it is nothing. Well, I guess in that category now I am officially a piker because the President of the United States has just announced that $350 billion is, to use his technical economic term, itty-bitty. If $350 billion is itty-bitty, then I guess I have more ability to talk about money than before.
    And I assume, by the way, and I look forward to seeing this graphically represented, there is this group, the Club for Growth, or the Clubbers for Growth, who have begun to put pressure on Republicans who dare dissent and having accused Senator Voinovich and Senator Snowe of French leanings, I can just imagine what they will do with itty-bitty. I look forward frankly to seeing the next commercial in which Senators Voinovich and Snowe are in yellow polka dot bikinis. I guess I really don't look forward to that, but it may happen. So when we have the President announcing that $35 billion a year, $350 billion over 10 years is itty-bitty then I am worried. Unfortunately, you know, to quote another former Senator, an itty-bitty here and an itty-bitty there and pretty soon you are talking about a lot of itty-bitty. And the question we have for you is what is the impact of this.
    Now I was interested to note the study from Mr. Laubach which does argue what many have argued that there is a correlation between increasing national debt and interest rates, and I would be interested in your evaluation. I realize that not everything is official and one of the things for which we value the Fed is the first rate economic research you turn out, and not everybody agrees with everything but this seems to me to be pretty persuasive.
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    Finally, let me say here is what worries me. I think we are in the midst of bait and switch. We have had people who argued that deficits were a terrible thing suddenly changing their position. Indeed, I am reminded of—unfortunately he is French, Henry of Navarre, who became Henry IV of France. When he was the heir to the French throne, he was told that as a Protestant he could not become the King of France so he converted, and when asked about that said Paris is worth a mass. Well, we have had people, we have the Secretary of the Treasury, the Chairman of the Council of Economic Advisers-to-be, the Chief Economic Advisers to the President, there are people who historically have been critical of deficits. And I suddenly find now that their past criticism of deficits has somewhat changed. And I wonder whether the modern version of Paris is worth a mass has become Washington is worth a deficit. And I wonder why people would have changed.
    What I am afraid of is this: If they haven't really changed, if it is bait and switch, that people are now pooh-poohing the deficit because they want to get a tax cut. But the real reason for the tax cut is not to be stimulative. As the chairman said, it is not aimed at short-term stimulus. The real reason is they want to reduce the revenues of the Federal Government because philosophically they don't think it is a good idea to have a country in which there are program expansions. And once they have succeeded in getting a tax cut, a double itty-bitty, and have increased the deficit, they will return to their previous deficit professions and try to use that as an argument for reducing Social Security benefits, for further cutting Medicare and for making other cuts.
    I appreciate again your willingness to come here and I look forward to your evaluation of this important issue with the interactivity of deficits and interest rates.
    The CHAIRMAN. The gentleman's time has expired. The gentleman from New York, Mr. King.
    Mr. KING. Thank you, Mr. Chairman. Mr. Chairman, it is a pleasure to have you here. I commend you on your quick recovery and on your stamina. I am going to make a very brief statement, but I look forward to the questions today. I look forward to your statement. And if you could cover certain areas, one of which Chairman Oxley touched on in his opening statement, the economic impact, the potential economic impact of having a quick victory in Iraq to the extent that that is going to restore investor confidence, that perhaps is going to bring in businesses that were on the sidelines waiting to see what was going to happen with the war, the positive impact, if any, that will have on the economy; also on the decrease in energy, decrease in oil prices, the impact that will have on the economy as far as putting more money into people's pockets, the stimulative effect that that could have in the short term and perhaps even the long term.
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    On a negative aside, I would be interested in the impact that the financial crisis that State and local governments are facing, what that will have on the overall economy as to whether or not Federal policy or national policy could be enough to bring it forward or whether or not that is going to be a permanent anchor on overall economic growth, the fact that there are so many large deficits being faced by local governments which are going to cause tax increases in some cases, layoffs in another, combinations of both in others and the negative impact that will have.
    Also following up on what Congressman Frank said, I am obviously on the other side of this issue. I would be interested to the extent that you could address the long-term impact of tax cuts as far as actually increasing revenues, providing long-term growth and restructuring that is, I believe, necessary to the long-term growth of the economy.
    With all of that, all of us look forward to your testimony, and again I want to commend you on making such a quick recovery and being here. I think some of us could have used your condition—if it was me I would probably use it as an excuse to take 6 weeks off and tell my constituents how sick I was and how they should pray for me. But as I said you are an inspiration to all of us.
    The CHAIRMAN. The gentleman's time has expired. The gentlelady from New York, Mrs. Maloney.
    Mrs. MALONEY. Thank you, Mr. Chairman, and thank you, Mr. Chairman, for being here today. Your appearance before this committee is extremely timely. Just yesterday, Treasury announced that it will need to borrow $79 billion this quarter, a startling reversal of more than $100 billion from recent projections. This is just another step in the massive fiscal reversal the Federal Government has experienced in the last two years. Today, using the administration's own estimates, the deficit is forecast at $304 billion for 2003, in contrast to the $236 billion surplus the President inherited when he took office. When the costs of war and rebuilding Iraq are factored in, the forecasts are even bleaker. In the short term, deficits may be acceptable if they are forecasted on getting the economy moving.
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    Unfortunately, the Congressional Budget Office macroeconomic analysis of the President's budget found little economic benefit from his financial and tax plan. CBO did note the impact on the deficit of the President's budget, a staggering $2.7 trillion through 2013. Independent economists at the IMF issued similar findings recently, saying of the economic plan and tax cuts, and I quote from the IMF, if enacted in full, they will significantly worsen the medium term fiscal position, unquote.
    Perhaps the most unfortunate aspect of this deficit growth is that the administration's plan is overwhelmingly backloaded and not focused on putting people back to work today. This is an exceptionally serious problem as unemployment is close to 6 percent nationally. In my home city it is 8.8 percent. And nationally for African Americans it is 10.2 percent. These numbers, as you know, only cover those who are looking for work, not the growing number of people who are underemployed or who have given up looking for work, nor does it include the 100,000 reservists who have gone to the Gulf and will come home to reclaim their jobs.
    I hope you will address the impact of the administration's economic tax plan on job creation, and I also look forward to your comments on inflation. Inflation appears to have fallen below the Fed's implicit target, specifically a measure that I know that you watch closely. The deflector for personal consumption expenditure has dropped to .9 percent, very close to zero. I hope that you will express your level of concern with this number and what changes and tactics or strategy the Federal Reserve is contemplating to deal with it.
    Again, I thank you for your service to our country and I thank you very much for being with us today.
    The CHAIRMAN. Gentlelady's time has expired. We now return to the distinguished gentleman, Chairman of the Fed, Mr. Greenspan.

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    Mr. GREENSPAN. Mr. Chairman and members of the committee, I am pleased to have this opportunity to update you on the developments of the U.S. economy since mid-February, when I presented the Federal Reserve's semiannual monetary policy report.
    At that time, I noted that the economic expansion over the preceding year had been modest. Spending by households had contributed importantly to the gains in economic activity. The Nation's strong underlying productivity performance was providing ongoing support for household income. That rise in income combined with low interest rates, reduced taxes, and the availability of substantial home equity had spurred solid gains in consumer spending and a robust advance in residential construction.
    In contrast, although the contraction in capital spending appeared to have slowed, we had yet to see any convincing signs that a sustained pickup in business spending was emerging. Moreover, heightened geopolitical tensions were adding to the already considerable uncertainties that had clouded the business outlook over the preceding three years. The general climate of caution in the business sector was manifest in a number of ways, including restrained hiring, reluctance to invest in new capacity, and aggressive actions to maintain low levels of inventories.
    In late February and early March, the risks and uncertainties surrounding the economic outlook intensified as the range of possibilities for the timing, duration, and economic consequences of the impending war in Iraq appeared to widen. In financial markets, a greater sense of caution among investors seemed to bolster the demand for Treasury and other fixed-income securities at the expense of equities. The price of crude oil moved up as did the prices of gasoline and home heating oil and consumer confidence sagged further.
    After picking up in January, payroll employment and manufacturing production turned down again in February and March. When the onset of the war became imminent, financial markets rallied and the price of crude oil dropped back. Market participants seemed buoyed simply by the elimination of uncertainty about the timing of the start and hence the end of hostilities, although still a significant amount of unease inevitably remained about the way the war might progress and how severely it might disrupt oil production and economic activity.
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    In such an environment, we had little ability to distinguish temporary changes from more persistent shifts in underlying economic trends. For that reason, the Federal Open Market Committee at its March 18 meeting refrained from making a determination about the balance of risks with respect to its long run goals of price stability and sustainable economic growth. At the same time, we stepped up our surveillance of economic developments. As part of that surveillance, we received virtually continuous information from commodity and financial markets. The price of crude oil is now well below its peak of early March as the potential for serious supply disruptions in world oil markets has diminished. Broad equity indexes remain well above their lows of mid-March and have been boosted most recently by incoming information on first quarter earnings that market participants appear to view as generally positive.
    In contrast, six weeks after the beginning of the war, we have only limited readings on broader economic conditions and that information has been mixed. Households appear to have become somewhat less apprehensive about the economic outlook in recent weeks, though reports from businesses have not exhibited a similar improvement in tone. Consistent with this, the persistent high level of new claims for unemployment insurance suggests that firms may still be finding it possible to meet their customers' tepid increases in demand with a leaner workforce.
    Going forward, some further unwinding of the economic tensions that have been associated with the situation in Iraq seems likely. As that occurs, the fundamental trends shaping the economic outlook should emerge more clearly.
    As I indicated when I met with you earlier this year, I continue to believe the economy is positioned to expand at a noticeably better pace than it has during the past year, though the timing and extent of that improvement remains uncertain. Fundamentally, the long run growth potential of the economy remains solid and the enhanced flexibility inherent in that trend imparts resilience against shocks of the kinds that we have experienced in the past few years.     Unfortunately, the future path of the economy is likely to come into sharper focus only gradually. In the interim, we will need to remain mindful of the possibility that lingering business caution could be an impediment to improved economic performance.
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    As you may know, the consensus of economic forecasters is that a material rebound in economic activity will develop in the second half of this year and certainly a number of elements should be working in that direction. The recent improvements in financial markets that I noted earlier, if maintained, would seem to suggest a turnaround in capital spending. In this regard, the ongoing decline in risk spreads in corporate bond markets so far this year is an encouraging development. To be sure, spreads remain high by historical standards but the constraint imposed by last fall's huge run-up in risk premiums now appears to have been put largely behind us.
    In addition, businesses should see some relief from the pressure on profit margins that had developed in recent months as energy prices rose sharply. An improvement on this front could be a positive development for capital spending. A modestly encouraging sign is provided by the backlog of orders for nondefense capital goods, excluding aircraft, which has been moving up in recent months. Households, too, are likely to welcome lower energy bills and a continuation of favorable conditions in mortgage and credit markets.
    As you know, core prices by many measures have increased very slowly over the last six months. With price inflation already at a low level, substantial further disinflation would be an unwelcomed development, especially to the extent it put pressure on profit margins and impeded the revival of business spending. The balance of influences on inflation and economic activity will be among the subjects of discussion by the Federal Open Market Committee when it meets in six days.
    Mr. Chairman, I look forward to your questions.

    [The prepared statement of Hon. Alan Greenspan can be found on page 71 in the appendix.]

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    The CHAIRMAN. Thank you, Mr. Chairman. And let me recognize first the gentleman from Iowa, Mr. Leach.
    Mr. LEACH. Thank you, Mr. Chairman. Mr. Chairman, could you comment on the reasons and implications of weakening exchange rate of the dollar vis-a-vis the Euro. And secondly, has the Fed done any studies or are you prepared to comment on the economic implications of the spread of disease, particularly AIDS and SARS?
    Mr. GREENSPAN. Mr. Leach, as I think I have indicated on numerous occasions, we in this government have a special agreement amongst us that stipulates that any comments with respect to the exchange rate be left to the Secretary of the Treasury as our general spokesman. And as much as I would like to comment, I am obligated not to and I apologize.
    Mr. LEACH. Do you have the same rule with the NIH on disease?
    Mr. GREENSPAN. No. And therefore I am fully able to expose to you my lack of knowledge on a lot of these issues. There is not terribly much I can add to the issue of AIDS. That is a fairly well understood and very devastating process, and it is clearly doing extraordinarily unfortunate and negative things to a number of areas in the world, especially in Africa.
    The SARS issue is more recent, more uncertain and more difficult to pin down, but we know certain things. We know it has had a very major negative impact on air transport obviously, vacations, all aspects of the type of holiday parts of our economy, if I may put it that way, which rests on travel and visits. Since a fairly significant part of Southeast Asia does rest on travel and tourism, it is beginning to have some effect specifically in Hong Kong, to a lesser extent in Singapore and China, but it is pretty much contained in that area. As you know, the World Health Organization just recently indicated that Vietnam has contained SARS. There is very little evidence that outside of the tourist-related aspects of the economies in Southeast Asia that much has been impacted.
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    You have to remember that there are one-and-a-quarter billion people in China and even though the numbers on SARS are large, they are clearly just a negligible part of the total at this stage. But it is clearing having some modest effects.
    Our concern would largely be the fact that in the manufacturing area, because we have just-in-time techniques fairly sophisticatedly tied into many of the production operations in Southeast Asia, that if the production part began to be eroded by absenteeism or other issues which would contain production, it could feed back into the United States through the just-in-time processes. To date, there is just no evidence of that. Apparently, production is being maintained and we see no backing up in any significant way of supply lines in the United States.
    Mr. LEACH. Thank you, sir.
    The CHAIRMAN. Gentleman yields back. The gentlelady from New York, Ms. Velazquez.
    Ms. VELAZQUEZ. Thank you, Mr. Chairman. Chairman Greenspan, the questions I am going to ask you I am going to make them based on the role that I play in the House Small Business Committee, and I want to take advantage of your presence here to help me understand the President's stimulus package. He is proposing an enormous stimulus package, the centerpiece of which is a dividend tax cut for large corporations. During previous testimony before Congress, you stated that you support the principle of the repeal of the dividend tax. One of the many problems I have with the dividend tax cut is that it offers no relief to millions of small businesses that are organized as S corporations, partnerships and individual owners who will see no benefit from the repeal. The dividend tax cut is going to create a tremendous incentive to put your investment dollars into companies that can issue these tax cut free dividends.
    Mr. Chairman, can you explain how investment dollars will not be shifted away from small and mid-sized firms to these large corporations who benefit from the repeal of the dividend tax cut?
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    Mr. GREENSPAN. Well, Congresswoman, I think it is important in the context of the President's proposal to recognize that there is not only a significant reduction or in fact, depending on how one ultimately decides this, the potential full elimination of the double taxation of dividends, but there are also significant cuts in marginal tax rates. So far as Subchapter S corporations owners are concerned, that clearly is a far more significant factor for them than would be the issue of elimination of the double taxation of dividends, although obviously I am certain that owners of Subchapter S corporations are significant holders of common stock.
    I must say to you, Congresswoman, I am a very strong supporter of expanding the scope of Subchapter S corporations, because in a sense that also eliminates the double taxation of dividends. That is in fact what a Subchapter S corporation does. So in that regard, owners of Subchapter S corporations have already had the double taxation eliminated. And I would hope that we could expand that particular form of organization, because as I am sure you are more aware than I, a major part of economic growth in this country comes out of small business, certainly the vast proportion comes out of small business. Anything we can do in that regard to enhance expansion of small business I think is in the national interest without question.
    Ms. VELAZQUEZ. Small businesses represent nearly 99.7 percent of all businesses. Small businesses employ collectively more than half the private sector workforce and generate about three-fourths of net new jobs each year. In addition, these firms also generate more than half the revenue of all U.S. Firms. As Congress continues to consider the size of the final tax cut package, it is unlikely that both the dividend tax repeal that large businesses favor and the accelerated income tax cut and expensing provisions that small businesses favor will both pass. If you had to choose which of these provisions will better stimulate domestic economic growth, which one would you choose?
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    Mr. GREENSPAN. I would choose to abstain from answering that question. First of all, I will not and hope I don't have to be pressed to get into answering details of the President's package. But these are complex issues and there are a lot of different analysts who come up with different judgments, and I think the second panel will be glad to address that in some detail. In fact, you will probably not be able to prevent them.
    Ms. VELAZQUEZ. Mr. Greenspan, I am tired of hearing all the time when people want to lecture us about our economy how great small businesses are for our economy, that they are the fuel for the engine of our economy and they are the ones who take us out of recession, but when it comes to the final package I just want to make sure that those provisions that are going to help small businesses who will stimulate economic growth will be there.
    Thank you, Mr. Chairman.
    The CHAIRMAN. The gentlelady's time has expired. The gentleman from New York, Mr. King.
    Mr. KING. Chairman Greenspan, in your statement and other economists seem to feel that the economy is growing stronger and especially in the second half of this year we should see more growth. Let me ask two questions, one involving national and one international, as to what could be the impediments to that growth and see what your response is.
    One is that no matter how strongly based our economy is, how far forward can we go if overseas economies continue to be weak, particularly Western Europe and Japan? And secondly on that line, especially Japan, how tied to our economy is Japan? How tied is Japan's economy? Are we—as far as talking about large scale long-term growth, is there an opportunity for Japan to do anything more, because there is economic malaise there that seems to have been going on up for a better part of a decade.
    Secondly, on the domestic front, one of the strong points of our economy consistently in recent years has been the housing market and the housing starts. With local and State governments faced with budget cutbacks or budget problems, that is inevitably going to result in property tax increases. How will those property tax increases impact on housing starts and on the housing segment of the economy?
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    Mr. GREENSPAN. First of all, if you look across the spectrum of major economies in the world, we are clearly the most resilient and potentially the most productive of all. There is no doubt that we depend upon and have gained very significantly from international trade and obviously that is determined to a substantial extent by the general level of economic activity in the world at large. So clearly, if Europe and Japan are weakened, it will impact on us. But we are still very substantially a self-contained economy and we have huge markets here, indeed everyone wants to come here as you well know. So I would think that yes, residual weakness in Europe and Japan will have a negative effect but not a very large one.
    Far more important is the apparent underlying, still unexploited, fairly significant capital investments with potentially significant profitability over the longer run, which I mentioned here on numerous occasions and specifically did so last February. That outlook has not changed and, if anything, it is something that is far more important to project in the longer-term U.S. outlook than anything else that is going on elsewhere.
    To be sure, Japan is having very considerable difficulties. They have had them for quite a long period of time. That underlying trend is already built-in, if I may put it that way, to our relationship with them in an economic sense. I am not going to say it is discounted, but we have adjusted to that particular state of affairs. So I am not terribly concerned about the international impact on the American economy as such.
    So far as the housing issue is concerned, it is certainly the case that it just remains continuously buoyant. Mortgage interest rates have been kept down quite significantly. There is still significant refinancing going on even though it is clearly off some of the astronomical peaks that we have just seen, but it is pretty viable. And housing starts and sales and existing home sales all continue to look reasonably good. To be sure, if you raise property taxes, it will have some effect, but my impression is that the order of magnitude of the types of changes that are likely to occur are sufficiently small as to probably be lost in the rounding with respect to the viability of home construction and its importance to the American economy.
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    Mr. KING. Thank you.
    The CHAIRMAN. The gentleman yields back. The Chair now recognizes the gentlelady from Indiana, Ms. Carson.
    Ms. CARSON. Thank you, Mr. Chairman, for being here and I am glad to see you are on the rebound. Hope you continue to do that. I have a very quick question here and I know that you said you don't want to get into defending the President's tax package and if it is one of these questions, I will yield back. The President has now equated tax cuts with jobs and called for a first round tax cut bill of at least $550 billion. The recovery is now through 2013. Given that I represent Indianapolis, where we experience a high rate of bankruptcies, high rate of home foreclosures, high rates of unemployment, probably one of the highest segments around the country, I am wondering if you could feel free to say whether or not you believe that in fact the stimulus in terms of job recovery, the $550 billion tax cut.
    Mr. GREENSPAN. Well, Congresswoman, I haven't changed my view from where I was at this committee in February. I am in favor of the elimination of the double taxation of dividends. In fact, I am very strongly in favor of reducing taxes on capital per se on the grounds that I believe it slows the economy and effectively undercuts income growth through all areas of the income distribution.
    So in general, I strongly support those types of tax cuts which remove burdens off capital. But as I also indicated in February, and indeed as I indicated back in September, I was very much concerned that the budget rules—which had been, in my judgment, surprisingly effective, specifically PAYGO and discretionary caps—were being essentially allowed to lapse and that I strongly supported their continuation, which in my recollection, was due to terminate in the House on September 30, and I strongly advocated continuing those.
    Now if they had been continued, if I were testifying on a particular project, I could be strongly supportive of certain types of tax cuts, as indeed I am but in the context of PAYGO and a recognition of the necessity to contain what I perceive to be a trend toward increasing budget deficits. And that left me with the conclusion that we needed to curb spending far more significantly than we did. In my judgment, that type of package would, over the long run, be conducive to a better degree of economic growth and one would presume that at least part of that would be reflective in a significant increase in job creation.
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    Ms. CARSON. I yield back, Mr. Chairman.
    The CHAIRMAN. Gentlelady yields back. The gentleman from Ohio, Mr. Gillmor.
    Mr. GILLMOR. Thank you, Mr. Chairman. I have a couple of questions regarding the Fair Credit Reporting Act. You have stated that the FCRA national standards ought to be made permanent because, among other things, limits on the flow of information among financial market participants or increased costs resulting from restrictions that differ based on geography may lead to an increase in the price of or reduction in the availability of credit. In light of the important role that consumer credit has on the economy, could you explain whether such limits or information flow or increased costs would have a positive or negative effect on the economy?
    Mr. GREENSPAN. Well, Congressman, we have a really extraordinary consumer credit market. It has become unbelievably complex and sophisticated. It was not that many decades ago that most small bankers, and most bankers were small bankers, pretty much knew the credit capability of those to whom they lent and they had pretty sophisticated ways of controlling credit risks and those markets worked.
    But as we got ever larger and more sophisticated, it was no longer possible for each individual borrower to be readily evaluated in that old-fashioned way. And what occurred was the development of a rather extensive credit bureau-type system which collected information on the credit characteristics of various different borrowers and set up the capability of being able to judge individuals more or less on the basis of their credit records.
    There have been a lot of complaints about inaccuracies and all of that and I am fully aware of that, and I think efforts are being made to minimize that sort of problem. But there is just no question that unless we have some major sophisticated system of credit evaluation continuously updated, we will have great difficulty in maintaining the level of consumer credit currently available because clearly without the information that comes from various credit bureaus and other sources, lenders would have to impose an additional risk premium, because of the uncertainty, before they make such loans or indeed choose not to make those loans at all.
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    So it is clearly in the interests of consumers to have information continuously flowing into these markets. It keeps credit available to everybody, including the most marginal buyers. It keeps interest rates lower than they would otherwise be because the uncertainties which would be there otherwise will not be there. And as I have indicated previously to a similar question the last time I was here, I think it is terribly important that we continue forward in this type of credit evaluation process.
    Mr. GILLMOR. I think you answered what my second question is, how that might lead to a reduction of the ultimate sharing of risks and rewards. Where do you think the likely market impact of State imposed restrictions on prescreen offers of creditor insurance and in particular would consumers in rural or underserved areas have less access to creditor insurance or pay more?
    Mr. GREENSPAN. I have been in favor of national standards here for reasons which are technically required. If you have very significant differences State by State, it would be very hard to maintain as viable a system as we currently have.
    Mr. GILLMOR. Thank you, Mr. Chairman.
    The CHAIRMAN. Gentleman yields back. The gentleman from Massachusetts, Mr. Frank.
    Mr. FRANK. Mr. Greenspan, the study that was done by Thomas Laubach, if I pronounced it correctly, in March and I understand it is not officially endorsed, but his conclusion is that there is a four or five basis point increase in long-term interest rates in response to a percentage point increase in the debt to GDP ratio. That is in his conclusion on page 13. As I look at CBO's official statements here, in 2013, the end of our 10-year projection, according to CBO, on the baseline, the percentage ratio there was to be 16.8 percent. That was the baseline. Their estimate based on the President's submitted budget is 32.2 percent. That is an increase of 14 points. Now using Mr. Laubach's formula, that becomes about a .6 percent increase, about 60 basis points, between 56 and 64 percent. We are not in an area of exactitude and I realize the President's budget was not enacted or adopted, but it is a close approximation. Do you think that is a plausible estimate of the effects of the President's budget as opposed to the baseline?
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    Mr. GREENSPAN. Congressman, I can't comment on the specific calculations, but I can comment on the study itself. I thought it was an exceptionally good study. It is interesting because in years past it has always been difficult to infer the impact of what deficits did to interest rates, and the reason for that is there was a tendency to use as the interest rate involved either the 10-year Treasury note or in some cases the 30-year bond. Now what we know about interest rates is that a 10-year note, for example, is effectively a weighted average of a whole series of short-term rates between zero or one day and 10 years and that with the business cycle inducing very significant movements in short-term rates, what tended to happen in periods of recession when deficits went up, you would find that the 10-year note went down contrary to what one would expect.
    What Laubach did, which a number of economists do for other reasons, was essentially to endeavor to smooth out the business cycle and the short-term rate impact on the 10-year Treasury and effectively ask what is the impact on that part of the Treasury note, as I recall it, that is essentially five-year interest rates five years from today. And somewhat to my surprise, it came out far more robust as the relationship indicated that the greater the deficit, the greater the long-run interest rate.
    Mr. FRANK. In other words, your sense, deficits affect long-term interest rates if anything has been strengthened since you were last here because you found in Mr. Laubach's study a more robust relationship than people might have expected?
    Mr. GREENSPAN. The difference between his analysis and previous ones, which had difficulty finding that relationship——
    Mr. FRANK. I think this is very relevant and it is a current issue. There are people who have denied that there is any deficit long-term interest relationship. I was interested in reading Mr. Laubach's paper. I skipped over the regressions. I will do those later. But he does quote another very distinguished economist who is saying the interest rates effects of deficits depend on how persistent those deficits are assumed to be. Now of course we are talking about deficits as far literally as the eye can see under rules. And the economist he is quoting is Martin Feldstein. So the consensus of deficits here seems to be a strong one. I appreciate that and I think that is a very important point.
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    We are talking about stimulus. We have had a significant increase in unemployment with all of the social distress that complicates everything else. You discussed how trade policies become harder when people are more afraid of losing their jobs and health care. You say here that you begin—you see the economy perhaps getting better. My question is how much short-term stimulus do you think we need right now, especially given your view that there was a trade-off between increasing that debt ratio and interest rates? What is your sense of how much short-term stimulus we ought to be enacting right away?
    Mr. GREENSPAN. Well, that is an ongoing question in the sense that we already have a significant amount of stimulus in place. I mean, clearly, as of now we have got a fairly large government expenditure trend and clearly low interest rates. Obviously, I have said in the past, and my belief is that it is very difficult to fine-tune fiscal policy for short-term stimulus purposes and I have tended to be strongly supportive of the employment and fiscal policy for long-term structural growth issues and leave monetary policy to be applied in the short run. If it turns out that, contrary to my expectation, we somehow can fine-tune fiscal policy in timing and in content, I would change my mind but I have seen no evidence that that is the case, although I do admit that the 2001 tax cut did turn out to be extraordinarily well-timed from the point of view of the economy, but I don't think we can count on that generally.
    Mr. FRANK. You would not be wanting to repeat that and especially given that we have the deficit interest rate impact?
    Mr. GREENSPAN. Yes. My view is that clearly we still have room in monetary policy if we choose to move and if stimulus was required. So I still have not essentially changed my view about what the appropriate balance is between——
    Mr. FRANK. Mr. Chairman, just a second, I would like unanimous consent to introduce into the record the study by Mr. Laubach that Mr. Greenspan and I were discussing and maybe want to pause so that the journalists can run out and call in the fact that he said there is room for reducing monetary policy.
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    [The following information can be found on page 115 in the appendix.]

    Mr. GREENSPAN. That is not news. I have said that on many occasions.
    The CHAIRMAN. The gentleman from Illinois, Mr. Manzullo.
    Mr. MANZULLO. Thank you, Mr. Chairman. I represent Rockford, Illinois, which in 1981 led the Nation in unemployment at 24.9 percent. We have a 25 percent manufacturing base. Our unemployment now is at 11 percent and it is going right through the roof. The manufacturing orders and the manufacturing output—the figures that the Fed uses do not reflect the percentage of imported parts that are going into manufactured items as they are completed in the United States. Those figures simply do not exist with the exception of bonded matter going to Mexico under NAFTA and the NAFTA content on automobiles. And continuing is the fact that the Defense Department, particularly the Air Force continues to grant massive waivers of the Berry amendment and the Buy America amendment that has allowed, for example, the Russians to dominate our titanium market and destroy tens of thousands of jobs related to nickel and titanium and the people who fabricate those, especially in the State of Pennsylvania and Ohio. In fact, Ingersoll, 122 years old company in Rockford, Illinois, went bankrupt last week, and one of the reasons is that Northrop Grumman decided to send a contract to Spain as opposed to keeping it in the United States for the U.S. Portion of the production of the Joint Strike Fighter with NATO, and Spain is not a member of that seven nation consortium.
    My question to you is this. As I read the Fed figures, it does not indicate the hollowing out of American manufacturing and the systematic destruction of tens of thousands and now 2-1/2 million jobs of manufacturing that are never going to come back. Does the Fed have any way to try to have new studies to indicate the true nature of the loss of manufacturing jobs so that we can state that the recovery in this country will not start until we restart and reestablish our manufacturing base?
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    Mr. GREENSPAN. Well, Congressman, I think one of the problems in a statistical sense is that the share of manufacturing in the total gross domestic product is not changing all that much. What is occurring is extraordinary productivity gains in the manufacturing area, which has to a very large extent accounted for—as you point out—the dramatic decline in jobs. There is no question that open borders and international trade create huge degrees of competition throughout the system and very specifically in a number of areas to which you alluded. But overall, as I indicated earlier, the net effect of general trade has been very advantageous to the United States for the post-World War II period.
    Mr. MANZULLO. I am not talking about trade. What I am talking about is the fact that there is a coring out of our domestic manufacturing industry that the trade figures do not—I have lost 19 percent of my manufacturing jobs in the past year-and-a-half. That is 10,000 jobs.
    Mr. GREENSPAN. I understand that.
    Mr. MANZULLO. It is not really trade related.
    Mr. GREENSPAN. It is in a sense that there is a very significant shift in the capital structure in the United States from industry to industry and the consequence of that are the types of numbers to which you allude. I don't want to get into the national security aspects of some of the issues that you raised, but that is a different type of issue when we get to how that is handled. That is more a DOD issue.
    Mr. MANZULLO. I wish it was yours because the Air Force doesn't understand.
    Mr. GREENSPAN. The bottom line is that we at the Federal Reserve endeavor to adjust our policies to maximize long-term economic growth in the economy as a whole and we cannot and should not endeavor to implement policies which differentiate or endeavor to differentiate various different aspects of our economic structure.
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    Mr. MANZULLO. And you are doing a super job at it, and thank you for coming.
    Mr. GREENSPAN. Thank you very much.
    The CHAIRMAN. Gentleman from Illinois Mr. Gutierrez.
    Mr. GUTIERREZ. Mr. Chairman, yesterday, we received Treasury's final rule regarding section 236 of the U.S. Patriot Act, which provides guidelines for financial institutions to identify their customers. Section 326 states, and I quote, ''if the customer is a non-U.S. Person and does not have a U.S. Taxpayer identification number, the bank may obtain an identification number from some other form of government-issued document evidencing nationality or residence and bearing a photograph or similar safeguard.''
    As I interpret the rule, financial institutions could have the flexibility to accept government-issued IDs such, as the Mexican Government's matricular consular card that allows Mexican nationals currently under FDIC rules and others to open up bank accounts in the United States.
    Given the fact that we have estimated, depending on whose estimate, Mr. Chairman, 6, 7, 8, maybe 10 million undocumented workers in the United States of America, and given the fact that just days prior to September 11 people forget that President Bush and President Fox were discussing a way of regularizing the economic activity of Mexican nationals in the United States, and given that this makes up the fifth pillar of the Mexican economy, that is remittances back to the United States, and if you bank, you know, you and I want them to have the same rate as you and I would at a beach in Acapulco with our ATM card versus a Western Union or Monogram, which sometimes fluctuates as much as 16 or 17 percent fewer dollars than the Wall Street, what do you think of the idea of using the Mexican Government's consular card and other consular cards, and is the Fed ready to join the FDIC and others in supporting the use of the Mexican consular ID card as a form of identification?
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    Mr. GREENSPAN. Congressman, I am familiar with the particular issues which you raised, but my general view, at least with the state of my knowledge now, is that I was not able yet to be exposed to the complexity of the choices and the alternatives because these are very complex issues, especially as they have arisen subsequent to September 11. I would prefer to go back and take a look at some of the details of the arguments here and perhaps respond to you in writing to give you a more informed view than I could at this particular point.
    Mr. GUTIERREZ. It is very fair. Thank you very much. We would just like you to look at it because it seems to me that, you know, when we listen to the Justice Department and we listen to others, it is at one moment we are talking about regularizing a work force, and we are passing all—we are spending all of this money and passing all of these laws so that we can find out the activity of everyone, and it just seems to me that a very simple way of identifying, having a picture and fingerprints of millions of people in the United States you would not otherwise be able to get, and so, therefore, in terms of national security issues it seems that this is the way to do it. And I called the IRS, and the IRS really does not care. They just want them to pay their taxes. I am sorry, Mr. Chairman, that's all the IRS. I talked to Social Security, and they said, well, just make sure they do not put any dependents down. So when I talk to them about undocumented workers, even our Federal Government said, oh, do not worry, Congressman, just send their applications in, and we will give them a tax ID number, and then they can go with the matricular consular and open up their bank accounts. So obviously our Federal Government is taking their tax dollars in and even allowing them to submit income tax returns.
    A second question, Mr. Chairman, in 2002 you remarked that the ABA conference, and I will quote you, ''the use of credit scoring models, whether turnkey models purchased from providers or proprietary models developed in house, has taught bankers sometimes through costly experience the value of continually updating the database on which the model operates,'' end quote. I would like to get your opinion as to whether there is value in providing customers, particularly mortgage applicants, information about their credit score. I mean, not limiting it just—limiting it to just handing over a number, but providing sufficient explanation of the rationale for the key factors that influenced the mortgage applicant's credit score, the date of the score, the source of the score. Will not disclosure of this information also help in updating the databases by consumers who are, in my opinion, in the best position to ensure the accuracy of the information? Also, does not the lack of information put consumers who are shopping for a mortgage at a disadvantage, especially when banks advertise APRs for only the best-qualified applicant, a near perfect score?
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    Mr. GREENSPAN. Well, in general I just want to say that over the years we have developed a really quite extraordinary mortgage market, which has been in the last year exhibited in the form of a huge interaction of the American public with our mortgage system. We have had, as you know, a huge number of refinancings, very substantial cashouts, and millions of transactions, which in general, I think, has helped both homeowners and the economy in general.
    There is no question, however, that it is crucially important that individual borrowers be fully cognizant of precisely what they are doing and various choices that they are making. And having looked at some of the detailed data and material available in the mortgage processing area, I hope we can sharpen it somewhat better if we can make it clearer in many cases.
    The CHAIRMAN. The gentleman's time has expired.
    The gentleman from California Mr. Miller.
    Mr. MILLER OF CALIFORNIA. Thank you, Mr. Chairman. It is great to have you here. I am glad you are well and life's treating you good.
    I really appreciate the gentlewoman's comment regarding small business and your concerns, and I applaud that. However, I continue to hear arguments against tax cuts for those in the upper income tax brackets; yet those are generally the brackets where small business owners fall within if they are doing a reasonably good business. If they do not, they are generally not providing many jobs, and I think we need to do what is necessary to encourage consumer spending, to promote investment, both individual and business, and if people do not have a job, we need to do what we can to create more jobs.
    But I am convinced if people do not have cash in their pocket, they cannot spend it. They can continue to go into debt, and many will go into debt regardless. They will use credit cards or whatever. But I know you do not want to defend the President's tax package, and I am not asking you to do that, but as you notice, Congress is unwilling to cut spending, so we keep spending, deficits grow, and things do not seem to change in Washington. But I think we need to look at what the market impact might be on the economy with the President's new package in place, and can you respond to that?
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    Mr. GREENSPAN. I cannot specifically, because that would get involved in certain elements of the program. As I said, Congressman, I find much to support in the President's program, provided it is matched by cuts in spending, because——
    Mr. MILLER OF CALIFORNIA. That is the key with cuts and not spending for——
    Mr. GREENSPAN. Let me tell you why it is, and it does rest on the issue of whether deficits, or expectations of long-term structural deficits, which is the more important question, affect long-term interest rates.
    Indeed, there are powerful reasons to suspect that, for example, the elimination of the double taxation of dividends and significant cuts in higher marginal rates will elevate long-term productivity in the country. If, however, in the process you get significant increases in deficits which induce a rise in long-term interest rates, you will be significantly undercutting the benefits that would be achieved from the tax cuts, and therefore, I have concluded all along and continue to conclude that it is very important for us to maintain the degree of fiscal restraint over the years ahead, because it is only under those conditions that I think we can create a fiscal policy which significantly assists in acceleration of economic growth, which we will sorely need as we move beyond this particular decade and run into the very large increase in baby boomer retirements.
    Mr. MILLER OF CALIFORNIA. It seems rather disingenuous on our part, hearing what you have said, to say on the one hand we need to stimulate the economy, we need to create more jobs, yet, on the other hand, we are unwilling to cut spending. I mean, we tried to do that this time, and it pared way back from what we were even trying, which was minimal, I believe, in this budget.
    On the other hand, being in the development industry for probably 30 years myself, I am still doing some investments in that, and having many friends in there, I am convinced that they invest money if they have it. And if you look at the upper brackets, and if a person is paying State income taxes and such, he is probably paying 50 percent plus other user fees and taxes that you locally pay. So when you are taking 50 percent out of the pocket of a business owner that they would otherwise put back into their business through job creation or investment—because there is no sense, as you know, putting money in a bank today and getting a percent and a quarter interest—they are going to find a better source for their funds, and that is generally investing it in something that they will make a profit on, and that in and of itself creates a job.
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    It's difficult for me to accept the fact when some say, well, we need to provide jobs, we need to do what we can to get people back to work, yet we are unwilling to do our job by cutting spending, because it creates the deficits if we provide tax cuts, and yet the only way I see we are going to get job creation moving in this country is to put more money in the economy, and that is by allowing people to keep more of their money by not just giving them a grant, but say keep more of what you earn; thereby you are able to invest that back into your business.
    Would you comment on if we were willing to cut spending from the Federal perspective and provide tax cuts to people, would that not be more beneficial to the economy?
    Mr. GREENSPAN. Oh, indeed. I have argued that over the years.
    Mr. MILLER OF CALIFORNIA. I hope my friends on the other side of the aisle are listening very closely because I hear other things than they think they hear. Repeat that again. I want to make sure everybody heard that.
    Mr. GREENSPAN. I have argued before this committee on numerous occasions that curtailing deficits and at the same time lowering taxes on capital is a major way to expand economic growth in this country and increase the incomes of all Americans eventually in the process.
    Mr. MILLER OF CALIFORNIA. I agree with you.
    The CHAIRMAN. The gentleman's time has expired.
    The gentlewoman from Oregon Ms. Hooley.
    Ms. HOOLEY. Thank you, Mr. Chairman, and thank you for being here. I thank you for helping keeping the interest rates low. It's allowed me to refinance my house, as well as many other people.
    I am go going to ask you a couple of questions, and one is I am very concerned about jobs and job creation. I think most people here are. I come from a State where we have the highest unemployment rate at 7.6 percent, so I am very interested in what is going to help create jobs for people. And we all know what happens when people do not have those jobs.
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    I am troubled by a seeming conflict of some numbers. I sit on the Budget Committee, and in March we were talking about the President's tax relief package, and they were talking something like 190,000 jobs would be created with this. More recently, a month and a half later, we are now talking about 1.4 million jobs created with this same amount of money. Do you have any explanation for why that may have changed so dramatically from 190,000 job creations to 1.4 million?
    Mr. GREENSPAN. No, I do not, but I want to point out that there is a very important issue that I alluded to in my prepared remarks, and it is that productivity has really been impressively strong, especially in recent quarters when this economy has been weak, and what that has meant is that, as I put it in my prepared remarks, businesses were able to meet increasing demand, although weak increases, with an ever lesser work force, which is another way of saying that output per laborer has gone up significantly.
    So part of the weakness in the labor market is the numerical consequence of this really quite strong and, I must say from a long-term point of view, highly desirable improvement in productivity. So we are going to need to get economic growth rising at a pace sufficiently in excess of the rate of growth of productivity in order to get the job market to be far more viable again, and most people's forecasts, in fact, imply that. If you look across the spectrum of most economic analysts, even though they and we do not see the immediate effects of the end of the Iraqi war, and we cannot, obviously, because it is too soon, most people have got fairly strong increases in demand and enough to cause a marked increase in the level of employment.
    But it is going to require more than historically has usually been the case in getting increased growth in the GDP because the productivity growth is so impressive.
    Ms. HOOLEY. So you think the productivity growth—I mean, we have just lost—in the last 22 months we have lost 450,000 job. Is that because of productivity?
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    Mr. GREENSPAN. We have no evidence that the GDP has been going down in the current quarter, for example, although its growth is very low, but clearly a very significant part of the loss in jobs reflects the fact that economic growth is being very closely matched by growth in output per hour, leaving very little room for significant increases in jobs.
    I think that will change. I think this is a temporary phenomenon, and that as we get into the second half, and a number of the positive forces again begin to emerge, I think that is going to change, and that has been a view which I think a very substantial proportion of economic forecasters now hold.
    Ms. HOOLEY. Mr. Chairman, one of the things that I think all of us are looking for are, in fact, how do we stimulate the economy, what is the best thing we could do, what is the best thing we can do short term? So if I ask you to put together a package, or ask you if there was something in the President's budget that would provide the most immediate stimulative impact for jobs, because for the people of my State and, I think, across the United States, that is what people are interested in right now, how do we make sure we can create jobs? What would that one piece or one thing be that would have an immediate stimulus impact for job creation?
    Mr. GREENSPAN. That is an exceptionally difficult question to answer in general, and I do not want to get into it because it will, I am certain, get me more involved in discussing the relevant choices in the programs which the Congress has now got to address, and I don't have anything more to add to that than I did back in February.
    The CHAIRMAN. The gentlewoman's time has expired.
    The gentlewoman from Pennsylvania Ms. Hart.
    Ms. HART. Thank you, Mr. Chairman.
    Thank you, Chairman Greenspan, for coming back to visit so quickly, and I am glad to hear you are doing better healthwise.
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    I had a question specifically, actually two questions, regarding the Check 21 Initiative, and I understand that the legislation that is being considered by our committee has been supported by the Fed.
    Mr. GREENSPAN. Are you talking about Check 21?
    Ms. HART. It still is supported by the Fed; is that correct?
    Mr. GREENSPAN. Indeed.
    Ms. HART. Okay. As you know, it would greatly expand the ability of financial institutions to move checks through the payment system electronically without the need to have actually the cancelled check itself move through the system. But there is a portion of the bill regarding expedited recredit language that I am especially interested in. It is included in our proposal on the basis that the compliance burdens would outweigh the benefits of the recredit. I understand the Fed's position on that has changed, and I am——
    Mr. GREENSPAN. That is correct.
    Ms. HART. I am interested in why the Fed believes the current protections under the existing check law are sufficient to ensure that consumers are not adversely affected by legislation if the recredit provision was removed, and what would happen if the expedited recredit provision were extended to cover all checks?
    Mr. GREENSPAN. We originally included that, as you know, in our early recommendations with respect to check truncation legislation. Subsequently, on evaluation in far more detail, it turns out that most, almost all, of the protection that one would envisage from that provision is already fairly conclusively achieved under current law, and that it was our conclusion, having reviewed this in more detail, that indeed the additional costs of compliance that the new provision would impose exceeded by any measure we could find the benefits over and above the protections currently in the law.
    So we have chosen to alter our proposal on the grounds that we think that it is more balanced, and indeed, as we all hopefully do when we find out that we can do something better, we change, and we did.
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    Ms. HART. I thank you for that explanation.
    Also, on the check truncation issue, can you share with the committee the images that the check truncation would provide to the domestic banking system? Some have indicated, not the members of the committee that is, but others who have testified have indicated, that they are wary of the legislation because they believe it will result in confusion with the elimination of the original check, possible double use of the original check and the image check. I am interested in your view of that. Is there a reasonable concern attached to that concern about the creation of substitute checks and the technology associated with check imaging?
    Mr. GREENSPAN. I think not. I think we have reviewed all of the potential things that can go wrong in a system of that nature, and I do not want to say to you that we know for certain that upon enactment various things will or will not happen, but from everything we can see, those are not concerns which we think are of significance.
    Ms. HART. I thank you for that as well as I yield back.
    Thank you, Mr. Chairman.
    The CHAIRMAN. The gentleman from California Mr. Sherman.
    Mr. SHERMAN. Thank you, Mr. Chairman.
    One thing where I guess we will just have to agree to disagree, Mr. Chairman, is the assumption that private sector spending is good, it stimulates the economy, and public sector spending is bad and must be cut back. It would seem to me that purchasing as a society one more school bus than we have today creates the same level of expenditure, the same stimulus as if as a society we buy one more of those new $300,000 Mercedes Maybachs. But I guess we will have to agree to disagree. Apparently if we can just make sure that one more very rich individual buys one more $300,000 Mercedes, that is going to help the economy.
    But, Mr. Chairman, there is in your statement, there is an implied criticism made—almost an attack, by the more explicit statements by my friend the gentleman from California Mr. Gary Miller—in which, it has almost become the joke or cliche where the serial murderer sends in a note saying, ''stop me before I kill again.'' What we seem to be hearing from the other side is, ''stop us before we waste again.'' I would hope that in a city dominated by Republicans and a White House that has promised not to spend a single penny more than is necessary, that we wouldn't need to have to undermine fiscal responsibility on the tax side in order to get an OMB that actually limits us to necessary expenditures.
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    So, Mr. Chairman, I will ask you to consider a parallel universe, a hypothetical situation in which there is a government dominated by people who want to avoid unnecessary expenditures, and they have eliminated all the unnecessary expenditures, and they will not make any unnecessary expenditures. Those expenditures are fixed. In other ways this parallel universe is just like our own. Should that hypothetical United States run a $200 or $300 billion deficit, or should it have tax laws to bring in as much revenue as those necessary expenditures, every one of them signed by a President dedicated to eliminating every unnecessary expenditure?
    Mr. GREENSPAN. Mr. Sherman, your hypothetical example would require about 55,000 footnotes to get it into a measure with which I could deal.
    Let me, however, just address, I think, an important point that you are making about the source of spending and whether or not it matters where you spend. First of all, I do not think anybody would argue that a school bus is not necessary, and that one does that. But we are talking about long-term economic growth and standards of living of the American people, and that at root is what we are really all about. It is important to discuss how you distribute it in certain aspects, but if it is not there to distribute, you do not have anything.
    All of the evidence suggests that what creates economic growth is capital investment and incentives to innovation, and that investment in those types of assets does indeed increase long-term economic growth, whereas other expenditures will not. And I do say to you that the real criterion is not whether it is government or nongovernment, it is the question of whether it is investment or noninvestment.
    Mr. SHERMAN. Mr. Chairman, with my limited time I just want to underline that comment. We are underinvesting in education, we are underinvesting in infrastructure, and we are told that here in Congress that if we can just give millions of dollars, hundreds of thousands of dollars, to the richest in our society, they will go out and spend it, and that will be good, and at the same time we are cutting expenditures on so many aspects of education.
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    I gather from your comment that investing in education may be just as helpful to an economy as private sector investments, and, of course, our colleagues on the other side of the aisle preach the importance of not a private sector investment so much as private sector spending.
    Mr. GREENSPAN. I think it is a question of fact, and you have to demonstrate that a particular type of capital investment or innovation increases productivity and long-term growth, which is easy to do. The difficulty is endeavoring to trace various different types of educational expenditures into economic growth, a relationship which one would assume has got to be there because clearly the quality of the education of your work force has got to be relevant to what you have got.
    So I think the question is a question of fact; I mean, what is the evidence as best we can infer? But I would emphasize that the question is essentially consumption versus investment as the statement number one.
    The CHAIRMAN. The gentleman's time has expired.
    The Chair would announce there is a vote on the floor of the House. The Chair would indicate we will keep going, and I will be relieved in the Chair hopefully soon, but in the meantime we will keep going, recognizing the Chairman has to leave by noon. And with that, we will recognize the gentleman from Florida Mr. Feeney.
    Mr. FEENEY. Thank you, Mr. Chairman.
    Mr. Greenspan, thank you for being here today, and just very quickly, to follow up on my colleague's immediate question, you indicated that the ideal thing is to eventually—in terms of growth production is to stimulate capital investment and incentives to innovate. Without the 50,000 footnotes, in general over the U.S. Economy history and over the world economy history, which sector has been more efficient in investing in those two items, the private sector, a free market, or the public sector?
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    Mr. GREENSPAN. It has been my experience that it is clearly the private sector that has done so. I indeed remember that there has been an endeavor in this society to move a good deal of public services into the private sector on exactly that premise.
    Mr. FEENEY. Thank you, Mr. Chairman, because I think that undermines the argument that a lot of us are making.
    Now I have a very specific question and then a general question, if you can, that I am going to leave you with. And the specific question relates to the Basel Accords and the rulemaking regarding our unique banking system. We have been getting some mixed signals in terms of how the Fed intends to react to the rules that have been promulgated in Switzerland by the international regulators, and I guess the specific question, if you can answer it, is whether or not the Fed would be prepared to take on some major sections of the rules being promulgated as part of the Basel drawing board if it becomes clear that they will not work well here under our American banking system.
    Secondly, and then I will end up here, the debate has focused on whether deficits matter, and I don't remember anybody saying that deficits never mattered at any time. But I was thrilled to hear you say earlier today that the recipe for long-term success is to cut spending and to cut tax rates on capital, and I think I was using your words, it will raise the income of all Americans, which is certainly something we would all aspire to, and is not the more significant ratio, as opposed to what the temporary debt or deficit is on any given year, even the more significant ratio be the rate of spending as a percentage of gross domestic product.
    And I say that because the way to pay for that spending is one of three ways that I know of. You can either print money by fiat, which has some negative implications for inflation; you can borrow money, which is deficit spending, which potentially crowds out some private sector borrowing; or you can raise tax rates by doing exactly the opposite of your suggestion we need to be doing in terms of encouraging capital bottom line. Any one of those three ways to deal with the level of spending has some adverse consequences at any given time. One way will be more or less adverse for the economy as a whole than the other two.
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    Mr. GREENSPAN. Well, Congressman, you can preempt private resources by spending, taxes, regulation, guarantees, a whole series of mechanisms in which you move private resources into the public sector. Clearly the ratio of federal outlays to GDP is a measure of the degree of shifting of resources that are going on, but you have to distinguish between the issue of what the interest rate is, which exists either in very heavy preemption or very light preemption, and the issue of deficits and finance. In other words, it is possible to have a fairly high ratio of spending to GDP and low interest rates.
    The problem is that if you have a very high ratio of spending to GDP, history suggests that economic growth suffers as a consequence, but that can occur with high or low interest rates, and I say that the deficit interest rate relationship while I do not deny is not partially related to spending as a percentage of the GDP obviously, but I think is more appropriately thought of as a separate issue, related but not the same thing.
    Mr. FEENEY. And because of the response to the Basel rulemaking on banks.
    Mr. GREENSPAN. We have been very careful in the rulemaking to be highly cognizant that it has to be consistent with rules in the United States which are effective for us. We have gone through very detailed analyses of what we call Basel II, and as best we can judge, these are rules which will clearly be effective in the United States and not burdensome, in fact less burdensome and more effective than the previous sets of rules.
    It has certainly been our view that we would not in any way agree to a set of Basel II rules which would serve to the detriment of the American financial system.
    The CHAIRMAN. The gentleman's time has expired.
    The gentleman from Texas Mr. Gonzalez.
    Mr. GONZALEZ. Thank you very much, and welcome back, Chairman Greenspan. And we do have a vote, so I am going to try to abbreviate everything, including your answer. I am going to attempt to, because I have been here five years—and to be honest with you, Mr. Chairman, I will ask something, and later it's like law school, you are not sure what happened after the professor turned you around, and you are going to be limited to the choices of answer. And what would be the appropriate size of the tax package currently being considered by Congress? I am not going to give you the perfect choice of the three. It is just going to be the best under all circumstances. It will not be the Greenspan answer that will take into consideration everything that should be taken in consideration, because Congress is not going to do that, but we are going to arrive at a figure, so you have a chance under the circumstances today.
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    Congress is going to make a decision on one of these. Which would be the most appropriate in the way of the size of the tax package being considered: A, $728 billion; B, $550 billion; or C, $350 billion?
    Mr. GREENSPAN. None of the above.
    Mr. GONZALEZ. There is not a D.
    Mr. GREENSPAN. Look, I am not going to answer that question, Congressman. I do not have a vote in the Congress, you do. You have to answer that question.
    Mr. GONZALEZ. But we rely on people with tremendous knowledge and expertise, and you fall in that category. And I know that you defer to us all the time, but the truth is we do not make these decisions independent of opinions by individuals such as yourself.
    Mr. GREENSPAN. Congressman, I appreciate that, but there are certain questions which I do not think are appropriately answered A or B if A or B is not the way they should come at them, and I am not going to get involved in what I think is a very complex set of issues with a simple conclusion because I don't know what a simple conclusion is.
    Mr. GONZALEZ. But the end of the process, you are going to end up with one of the process—Congress is going to end up with one of these numbers.
    Mr. GREENSPAN. Yes, I understand that.
    Mr. GONZALEZ. So you could render an opinion relatively speaking as to which number would best serve the economic interests of this Nation.
    Mr. GREENSPAN. I cannot answer it in the context in which you put the question, Congressman. I am sorry.
    Mr. GONZALEZ. And quickly because I want to, Martin Feldstein in today's Post—you probably have read the article about the CBO's analysis of dynamic tax analysis or the valuation. And I will read the paragraph, then I will ask the question.
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    The good feature of the CBO analysis is that it distinguishes the short-term demand-side effects of the President's plan from the longer-term supply-side effects. This distinction is important because the ability of any tax cut to raise GDP in the short term by stimulating demand depends on the Federal Reserve's response to the tax cut. There are times when the Fed responds by raising interest rates to prevent an increase in demand because it fears the resulting rise in inflation. But the Fed is now eager to see stronger growth and would not take any such offsetting action.
    So it's the last sentence, obviously, but the Fed is now eager to see stronger growth and would not take any such offsetting action, and so again we will go, A, you agree with that analysis, or, B, you disagree?
    Mr. GREENSPAN. You father was kinder to me, Congressman.
    In general I thought that was a thoughtful piece, but I cannot respond, obviously, because six days from now we have a Federal Open Market Committee meeting, at which we will be discussing a lot of these various things.
    Mr. GONZALEZ. Mr. Chairman, in a very serious way, we cannot spend ourselves, government cannot spend itself into prosperity. Nor can it tax-cut itself into prosperity. Somehow we really have to start bridging the differences and come to what is prudent government spending, which is investment, because if dynamic scoring works on the tax side, it should work for the expenditure side, as Brad was alluding to. If you spend a dollar on education, what is its return? If you cut taxes by a dollar, what is its return?
    So we really do need your advice and counsel, and maybe it will not be given to us in this particular forum, but I do look forward to maybe some private discussions with you. Thank you very much.
    Mr. GREENSPAN. Thank you.
    Mr. GILLMOR. [Presiding.] The Chair recognizes the gentleman from Massachusetts for questions.
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    Mr. CAPUANO. Thank you, Mr. Chairman.
    Thank you, Chairman Greenspan, for being here again and for coming back as you said you would. I think you would be happy to know that since you started speaking, though the market is down, it's up about 46 points from the time you started speaking, so keep going. Do not stop.
    Deficits in and of itself mean nothing to me. The consequences of deficits means a lot. The consequences of deficits to—the short-term consequences of deficit is increased interest payments, increased debt interest payments. We are fortunate at the moment to have low interest rates, fortunately to you, and hopefully you will keep them that way in a few days, but one thing at a time. But it does bother me that over the last two years we have had the largest increase in publicly held debt back to—I don't know how far back, at least back to the mid-1980s.
    Publicly held debt has increased almost $559 billion, just publicly held. Government-held debt has also increased $423 billion. That is the largest increase we have had since actually 1990, 1991.
    Now, if my memory serves me correctly, the last time we did this in those early 1990s, the result in the economy was not very good. It took a big dip, lots of tax cuts, lots of spending cuts, lots of problems all across the economy. It concerns me. It concerns me that I have not heard more from people such as yourself as to what to do about the deficit, how to deal with the deficit.
    For the sake of discussion, we had a roll call at the end of last year whether to utilize or to discontinue temporarily, I guess, or permanently at the time, the use of the PAYGO rules, which I always had problems with on some levels, but I also thought they kept us disciplined in a crude way, but they worked. Yet I didn't hear a word from the Fed or very many other leading economists. That was troubling.
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    I would like to see you and others speak out more forcefully not just about the deficit, which is a concept, but about specifically what this Congress should be doing relative to that deficit. If you believe tax cuts are necessary, fair enough, but would that also—if you really do believe deficits are problematic, that would then, I think, lead to no other conclusion other than much deeper cuts in spending. There is no other way.
    So I guess at some point I would like to hear more specifics on that from you or from others, because we do listen to you. We do not always agree with you, but we do listen, we take into consideration, and I actually agree with your concerns about deficits. But again, I am not really terribly worried—I guess I am a little bit worried about what happens five and ten years from now, but right now I think we need an economic stimulus of some sort. We will disagree on some levels as to what that could be, what that should be, but no matter how you work it, increasing the deficit is going to lead to more debt, which can lead to higher interest payments, which is going to hurt the economy probably in the short run, but certainly in the long run.
    And I would like to hear you be more specific on that as we go along. I am not silly enough to think that you are going to do that now, but as time goes, certainly as other votes come up on things like PAYGO rules or whatever, they might be—if not tax cuts, fair enough, I understand you want to leave that to us, but there are some things I think that should be a little bit more aggressive on speaking about.
    I do not want to talk about productivity. We have had this discussion pretty much every time you come. I agree with you on the issue of productivity. I actually like the fact that you tied part of the increase of productivity to the lack of job creation. I think you are 150 percent correct. But an increase in productivity does not help the guy who is out of work. They need a job. To get back to that, I particularly look at the last quarter's increase in productivity, very, very small; very, very small. If I am reading it correctly, it is .3 percent just in the last quarter of 2002.
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    Mr. GREENSPAN. It is higher in the first quarter.
    Mr. CAPUANO. Okay. Good. If that is the case, if it is lower or if it is a little higher, then it is back up into the 5 and 6 percent range yet?
    Mr. GREENSPAN. No. The fact that it is increasing at all in this context is telling you that there is an underlying structure which is favorably disposed in that direction.
    Mr. CAPUANO. I agree with that. That is good to hear. But if that is the case, we should have at least stopped losing jobs in theory if they aren't tied together, and if there is a delay factor in that connection, how long is that delay? In your testimony I believe you said that—you did not say, but you attributed to others that we hope there will be a recovery in the next half of the year. Does that include jobs, or is this continuation of a jobless recovery?
    Mr. GREENSPAN. No. I think it includes jobs.
    Mr. CAPUANO. So you think the jobless rate will go down; jobs will start being created in significant quantities?
    Mr. GREENSPAN. The unemployment rate had in it, in the last month, a fairly significant increase in the number of people who still want a job, but are not activity seeking one, according to the definition of the Bureau of Labor Statistics. So it is a question of the unemployment rate coming down from a level of measured joblessness, which includes the standard definition, plus those who, although they are not as actively seeking a job as previously, nonetheless would still be willing and desirous of taking one.
    Mr. CAPUANO. Also has an increase in the level of people who have had the longer-term unemployment as well.
    Mr. GREENSPAN. That is correct.
    Mr. GILLMOR. The gentleman's time has expired.
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    The gentleman from Texas Mr. Hensarling.
    Mr. HENSARLING. Thank you, Mr. Chairman.
    Chairman Greenspan, before I left to go for a vote, I heard at least one Member announce or articulate that he thinks the difference between the two parties is a fundamental disagreement between whether private spending or government spending is somehow equivalent, I think, with respect to economic growth. Certainly for those who long for state-dominated economies, you can no longer look to the Soviet Union as a model, but certainly Cuba and North Korea and several other regimes on the face of the planet do have state-dominated economies.
    Do you have an opinion on the difference in economic growth between State spending and private spending?
    Mr. GREENSPAN. Well, indeed that question came up, I presume, while you were out of the room, and I indicated that the evidence strongly suggests that economic growth from investment in the private sector is greater than that in the public sector, and indeed I argued further that the indication that that is apparently the case has moved numerous municipalities and even states to move a good number of previously government-funded services essentially into the private sector in a more direct way.
    So I have—I am clearly of the opinion and have stated so that I strongly support private investment over public investment as an issue increasing the rate of growth in our economy.
    Mr. HENSARLING. If I have listened to your testimony carefully, obviously you have a concern about budget deficits. But for budget deficits, I understand in your testimony that you are an enthusiastic advocate of eliminating the double taxation on dividends. Is that correct?
    Mr. GREENSPAN. That is correct, Congressman.
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    Mr. HENSARLING. There was questioning earlier about the impact of lowering rates on small businesses. I believe it was your observation that lowering marginal rates is favored by small business. Do you believe that lowering marginal rates, assuming that such a move would be definitely neutral, would have a positive effect on the economy?
    Mr. GREENSPAN. That is correct.
    Mr. HENSARLING. Okay. We also heard a characterization about the tax relief being proposed, whether it was itty bitty or not. I do not want to get into the characterization business, but if I have looked at the numbers carefully in the budget that was recently passed, we are proposing $28 trillion of spending over the next 10 years. It seems like the relevant number today of tax relief is $550 billion over the same 10-year period. So if I am doing the math correctly, that is roughly 2 percent assuming that the tax relief promotes no economic growth whatsoever.
    So when once asked why Willie Sutton robbed banks, he said, the money was there. If we wanted to be focused on deficit reduction, it would appear to me that perhaps 98 percent of the problem might be on the spending side as opposed to the 2 percent on the tax relief side. So if Congress is to get serious about deficit reduction do you have an opinion about whether restraining the growth of government spending or tax relief would be a preferred method, or for purposes of economic growth would you be indifferent between the two?
    Mr. GREENSPAN. Congressman, I have testified before this committee many times over the years that I strongly support constraint on the expenditure side, which I think has a chronic tendency to press on our revenue resources, and that unless we contain expenditures, it will be very difficult to maintain balanced budgets.
    Mr. HENSARLING. I believe earlier in your testimony you advocated returning to PAYGO and discretionary caps. Are there other government growth restraint measures that you advocate at this time?
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    Mr. GREENSPAN. One which I raised, I believe implicitly in February, is the recognition that we have a set of laws in place on entitlements specifically related to retirement, which includes, of course, Social Security and Medicare amongst the major items, which, because of the huge demographic changes which are inevitable starting next decade, creates more excess claims on federal revenues than I think we are capable of creating. So that it is not too soon to begin to evaluate the impact of what that will mean, and I do not get the impression that we are moving sufficiently expeditiously to address that problem.
    Mr. HENSARLING. Thank you, Mr. Chairman.
    Mr. GILLMOR. The gentleman from Tennessee Mr. Ford.
    Mr. FORD. Thank you, Chairman Greenspan, for coming. Let me jump right into it, Chairman.
    I know you have talked a lot about the taxes, and you don't want to comment on tax cuts and the impact they may have, but the reality is that is what we are dealing with, and you have come in the middle of a time in which the country is focused on what we are going to do on tax cuts or not.
    I happen to be for a tax cut. I take issue with what some of you said regarding the 2001 tax cut. I can't figure out how it helped as much as you claim it helped. It certainly didn't help people in my district as much, but that's perhaps another conversation.
    With regard to the lack of help that we are proposing to provide for hospitals and schools, particularly through State aid, I'd asked you this question before because I am not as smart as you, I don't know math as well as you, but I couldn't understand how you reconcile the fact that States are faced with these growing budget shortfalls and by law are required to balance their budgets. Yet our stimulus package here, the President's growth plan—and I have done the math in his growth plan just by—I did do that—that for $726 billion, the President has promised it will create 1.4 million jobs. Now if the math is right, that's $519,000 per job to create under the President's plan. So I guess I have a few questions.
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    One, is there a more cost-effective way to create jobs? Number two, as we all know, and you know it far better than me with your economist background, it seems to be a procyclical aspect to State budgets. When the economy is good, they do really good. When it is bad, they have to raise taxes or cut services, which worsens the situation.
    Wouldn't it be in our interests in terms of creating jobs and helping to put us back on a trajectory that you played a role in with the former President to help this thing grow to figure out a way to help the States avoid undermining what we do here at the Federal level, whatever the tax cut may be? And two, isn't there a better way to cut taxes to create the things that you talk about wanting to do in terms of growing this economy, in growing jobs?
    I am opposed to double taxation. I think tax reform should take place, but if we are going to do something, we ought to reform the AMT before we go about doing some of the things that this President has proposed doing.
    I know you are reluctant to talk about it, but you kind of talk around it. I understand there have been some developments in the last few days about appointments and reappointment, but I want to know directly and specifically, Mr. Chairman, how can we say to States and Governors across this country, balance your budgets, balance your books, cut services, raise taxes, but then allow a President—when you have talked incessantly about debt and that being a problem, how can you come before this committee and suggest that in any way, without responding in any way, that building and piling up more debt—when States cannot do it, when they are forced to raise taxes and cut services, I don't understand how you reconcile that.
    Mr. GREENSPAN. Because I am not advocating piling up more debt.
    Mr. FORD. Won't the President's plan do that?
    Mr. GREENSPAN. No. I am saying in the context of PAYGO and discretionary caps implicitly a very significant reduction in the implicit deficit that would be otherwise indicated.
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    Mr. FORD. Should we not be helping the States, Mr. Chairman?
    Mr. GREENSPAN. Well, that is another question. I mean, remember——
    Mr. FORD. I know. It is what I am asking. Should we not be helping the States as a part of the stimulus plan?
    Mr. GREENSPAN. Congressman, I am not going to get involved in the specifics of these programs, as I said at the beginning. It is an endless conversation which I don't——
    Mr. FORD. I am trying to narrow it down. We helped the airlines, and I thought that was the right thing to do, the two packages we provided for them, including Northwest Airlines, which has a hub in my district. That being the case, would it not be smart, consistent with what you want to accomplish, Mr. Chairman, that we provide some assistance for hospitals, for schools, responsibilities that State and local governments primarily have? Would that not be intelligent and wise and something that we could do that would comport with this growth package?
    Mr. GREENSPAN. I don't think I can effectively deal at the detailed level. All I can suggest is what I think is important on a macro level, and that is where I have been all morning, and I hope to continue to stay there.
    Mr. FORD. Would it not be, in your estimation, a better tax cut, or should I say better and more effective way to help put money in people's pockets, perhaps a payroll tax which 80 percent of Americans pay, would that perhaps be a better way, consistent with what the Business Roundtable and others have called for, to ensure that we can grow jobs and grow this economy, and would that not be cheaper than the $519,000 per job that the $726 billion tax cut package the President has promise will create 1.4 million jobs?
    Mr. GREENSPAN. I am not going to respond, and the reason I am not going to respond is that this gets into issues of tax cuts for encouraging consumption and tax cuts for encouraging investment, and as you well know, as I have said previously, I am very strongly on the side of tax cuts for investment because you do not basically increase economic growth by inducing consumption.
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    Mr. FORD. You have also said that you are opposed to big debt and growing deficits, and it seems to me that we are moving rapidly in that direction.
    I know my time is up. I would like to enter into the record, Mr. Chairman, if I can, in light of the letter in response to Chairman Baker's comments about congressional oversight and study of the role of government-sponsored enterprises in our economy. I know that great steps have been taken by both Fannie Mae and Freddie Mac, voluntary ones undertaken, to comply with the whole range of things, and eight concrete steps that they have taken. I would like to submit that to the record, Mr. Chairman.
    Mr. GILLMOR. Without objection.

    [The following information can be found on page 64 in the appendix.]

    Mr. GILLMOR. The gentleman's time has expired. The Chairman has to depart. We have made a commitment to him to get him out. If we could let me recognize Mrs. Capito and Mr. Israel, but ask both of you to be as concise as possible so we can get the Chairman on his way.
    The gentlewoman from West Virginia.
    Mrs. CAPITO. Thank you, Mr. Chairman. Thank you for your presentation. My concern is the high cost of health insurance that is occurring all across the Nation, and many businesses aren't able to reinvest in capital and other things because of the raise in the health insurance premiums. Where do you see this in the long term? And also, I think it will—another strain on the economy will be if businesses drop their health insurance coverage, it creates more uninsured, again causing another economic strain. I would just like to hear your comments on that.
    Mr. GREENSPAN. Congresswoman, a really difficult problem we confront is the fact that our technologies in the medical area are improving so dramatically, they are creating the availability of significant new medical services, which in the context of a third-party payment system which is subsidized, creates an inordinate amount of demand for medical services of all types, and that inevitably spills over into medical insurance costs, and it spills over into the difficulties that a number of companies are involved with.
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    So the issue is a very difficult one which I don't think is resolved other than by considering how we approach our total medical services system and how we finance it. And I doubt very much if we can solve problems individually without looking at the fact that, you know, we have got 14 percent of the GDP going to medical services, and my suspicion is more than that, in the total proportion of employment, and that means a very significant part and a growing part of the economy devoted to health care, which is very important for the American people and is very important for us each individually. But it does not produce goods and services, and we have to make these very difficult trade-offs.
    Mrs. CAPITO. Thank you.
    Mr. GILLMOR. The gentleman from New York.
    Mr. ISRAEL. Thank you, Mr. Chairman. I will try to be as brief as possible.
    Mr. Chairman, in your testimony you note that the persistent high level of new claims for unemployment insurance suggests that firms may still be finding it possible to meet their customers' tepid increases in demand with a leaner work force. I think that is a rather prosaic way of describing job losses. Guy comes home, says, honey, good news and bad news. The bad news is I have been laid off. The good news is that the firm is finding it possible to meet our customers' tepid increases in demand with a leaner work force.
    I would like to focus on that issue. We created the Temporary Emergency Unemployment Compensation Program in March of 2002 and extended it in January, 2003. The Labor Department reported last week that new applications for unemployment insurance hit 455,000 in the week ending April 19. There are now fewer jobs in the labor market than at any point in the current slowdown. 365,000 workers exhausted their regular unemployment benefits in March, and the number of exhaustees has increased for 24 straight months.
    Statistics go on. Percentage of workers beginning to receive unemployment benefits who subsequently exhaust those benefits without finding work was at the highest level ever recorded in February.
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    There are some who say that the best way to help workers who are falling off the cliff is to cut taxes on people who are furthest away from the cliff. There are others who say the best way to stimulate the economy is through unemployment compensation, that every dollar we provide in unemployment compensation is necessarily a dollar invested in the economy because when workers don't have jobs they dramatically scale back their purchases. A dollar in unemployment compensation helps increase those purchases.
    So my question to you is, as a matter of immediate economic stimulus, what is a more useful tool? Is it providing another extension after May 31 of emergency unemployment compensation or is it not providing that extension and instead sticking with some of the tax reduction proposals that are on the table?
    Mr. GREENSPAN. I think the crucial issue gets to the failure to distinguish in a lot of these conversations between stimulus to capital investment which, ultimately over the long run, increases everybody's standard of living and, two, short-term stimulus to consumption which will raise the level of activity almost by definition and short-term employment but does nothing over the longer run. And that is a very difficult trade-off which Congress has got to make because if you do nothing other than short-term stimulus, you will end up with economic growth slowing down.
    Mr. ISRAEL. Mr. Chairman, on May 31 temporary emergency unemployment compensation will end. Is it important for the economy for us to extend that program?
    Mr. GREENSPAN. I frankly have not given that much thought and I couldn't give you an informed answer.
    Mr. GILLMOR. The gentleman yields back. Mr. Chairman, with your indulgence I would like to have one Republican ask one question and one Democrat ask one question and not take the full time.
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    The gentlelady from Florida, Ms. Harris.
    Ms. HARRIS. Thank you, Mr. Chairman. Very quickly, welcome, Mr. Greenspan. It is wonderful having you back again. I represent a largely senior population and given the recent loss of confidence in the markets today, the stock market and other types of investment, what would you advise Americans, particularly those nearing retirement on the retirement plans, specifically the mix between equities and bonds? And can you comment on possible opportunities that Congress can provide to expand retirement savings opportunities for those nearing retirement?
    Mr. GREENSPAN. That is the toughest question I have gotten all day. That really is a job for a specific investment adviser who is knowledgeable about the specific conditions of each person's retirement needs and the like. I think people make generic recommendations in this regard and I think do a disservice to individuals. And I think forecasting markets is very difficult, I would argue at the end of the day, probably with rare exceptions, almost impossible. But what you can do is measure the risks. And the risks essentially are different from somebody who is 30 years old and is saving for retirement or one who is 55. And I think those types of judgments are crucial and important for appropriate investment policies for retirement, and I don't think you can generalize very far down the road.
    Mr. GILLMOR. The gentleman——
    Mr. FRANK. I just wanted to get a little glass of that. So someone 55 might be retiring in 25 or 30 years and he would want to be prudent.
    Mr. GILLMOR. The gentleman from Illinois, Mr. Emanuel, for one question.
    Mr. EMANUEL. Thank you. Fifteen months ago the Congress passed one of the largest tax cuts in the history of the country, the net result has been two-and-a-half million lost jobs. Five million more Americans have lost their health insurance, nearly a trillion dollars worth of corporate assets have been foreclosed on, and 2 million Americans who formerly were in the middle class have entered the rolls of poverty in this country.
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    USA Today in their paper today noted that in the help wanted ads, we have the lowest amount of help wanted ads this March since 1964—available jobs out there. I know I only get one question and I want to clarify a point that I think you answered in responding to the ranking member, Barney Frank, about the role of deficits to the cost of capital. If we have an increasing amount of deficits and they become perceived by the market as structural, not temporary, that would have a direct impact on the cost of capital both to businesses for their investment and ability to borrow in advance, improvement in productivity as well as to family incomes as relates to higher interest rates on mortgages, cars and student loans. The cost of capital due to ever growing deficits would have a direct impact on companies and on the ability of families to meet their needs to provide for their middle class dream?
    Mr. GREENSPAN. That is correct, Congressman. I should say that you drew a connection between the 2001 tax cut and a whole series of issues which occurred subsequently in the economy. I think you would be more proper in saying that they were all associated with that time frame, but cause and effect is not evident to me.
    Mr. EMANUEL. You do see the debt relationship of the deficit as a cause and effect as it relates to a greater rise in interest rates and that we have a perception that we would have a permanent deficit that would have a direct impact on the cost of capital as it relates to businesses and families as it provides for their children and for their own livelihood?
    Mr. GREENSPAN. That's correct.
    Mr. GILLMOR. Mr. Chairman, I want to thank you for appearing before us. Your testimony as always is informative, insightful, and if we do this enough, I might understand most of what you said. Thank you.
    We will proceed to the second panel. If the panelists can take their place at the table we will get underway. Mr. Peterson is not here yet, but we will proceed. And Mr. Aaron was first. And we would like our panelists to summarize their remarks in about 5 minutes and then we can go to questions. Mr. Henry Aaron, Senior Fellow of the Brookings Institution.
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    Mr. AARON. Thank you very much, Mr. Chairman. I wanted to make five main points and respond to one that was raised in the course of Mr. Greenspan's testimony. The first point is a simple confirmation of the evidence from the Congressional Budget Office and virtually every other forecaster that we face substantial budget deficits over the next decade even if no tax cut whatsoever is enacted. Tax cuts will necessarily increase those deficits. The recent report of the Congressional Budget Office confirms that fact, notwithstanding the oped that was referred to this morning by Martin Feldstein. The CBO report shows it is as likely that dynamic scoring would result in increased estimates of the revenue loss from the tax cuts as that it would show decreased costs.
    The more serious point I think is that the longer term budget situation is even more serious than the intermediate term situation because of reasons that were also covered in Mr. Greenspan's testimony; namely, the imminent retirement of the baby boom generation and the attendant increases in pension and health costs. In that situation, I believe it would be unwise to institute any further tax cuts of any kind, including an acceleration of the tax cuts enacted in 2001 or the passage of additional provisions.
    There is a case to be made for some short-term economic stimulus, but it is a mixed case. We have had a massive amount of fiscal stimulus over the last couple of years and a massive amount of monetary stimulus. If there is to be any additional stimulus, in my view it should sunset very quickly. The so-called jobs and growth program of President Bush, in my opinion, is misnamed, because it will create neither jobs nor economic growth over the long term. Indeed, the forecast of the very firm on which the Council of Economic Advisers relies showed precisely that result. Some initial job growth was shown under their projections for about 18 months, but job reductions were shown for the remainder of the decade. The overall effect, therefore, is not increase jobs, despite their assumption that they assumed that there would be no tightening of monetary policy in response to the tax cuts.
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    Finally, I would like to refer back to the discussion that occurred regarding the relative productivity of public and private investment. I rarely heard a falser distinction in my life. The United States has been built on the productive partnership of public and private investment throughout its history. The interstate highway system built with public moneys is the basis for the modern trucking industry, a large private sector investment. Research, funded publicly through the National Institutes of Health, helps support major private investments through the pharmaceutical industry. To be sure, there are wasteful public investments. Each of you no doubt has your list and I have mine. But there are wasteful private investments as well. Consider, for example, the tens of billions of dollars that have gone into fiber-optic cable that is at best premature and may be entirely wasteful. And there are many other cases as well.
    The important thing to recognize is that we should be against wasteful investment, whether it is public or private. We should undertake public investments that help support productive private sector investments, and that includes a good deal of what the Federal Government does. It includes enabling students from the bottom quartile of the socioeconomic ladder to attend college if they have as much ability as those at the upper end of the economic distribution. It includes additional support for biomedical research and in other areas.
    I think it is also hard to make the case that somehow economic stimulus is on net increased if we cut taxes for people to encourage private consumption and at the same time decide not to provide support for States and localities, thereby resulting in Medicaid enrollees from being cut from the rolls, schools being closed because there are no funds available for after school programs and elderly centers being closed because there are no funds for them either. This is a choice of priorities. It is not a choice about economic stimulus.
    Thank you.

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    [The prepared statement of Henry Aaron can be found on page 66 in the appendix.]

    Mr. GILLMOR. Thank you Mr. Aaron. Mr. David Malpass, Chief Global Economist, Bear Stearns.


    Mr. MALPASS. Thank you, Mr. Chairman, and members of the committee. I am pleased to have the invitation to talk about these issues. I would like to make several points.
    First, I think the economic outlook is actually quite good. We have had a major improvement in macroeconomic policy since 2000. Specifically interest rates have fallen, real interest rates have gone negative just in the last few months, and that is going to encourage inventory and investment. The value of the dollar has changed substantially and moved to a pro-growth level after having been at a deflationary level. Inventories are low now.
    Very important in the economic outlook is the issue of the tax cut and the incentives within the economy. It is true that there are problems facing the economy. That is true all the time. But what I think we see right now is a major improvement in the macro environment since 2000 that will lead to a solid economic recovery in coming months.
    My statement goes through labor market conditions, describes that even though we have lost a lot of jobs in the last year the number of people employed in the U.S. economy is at $130.4 million. That is over a million and-a-half more than in 1999. And remember 1999 was a boom time. The unemployment rate was down at 3.8 percent. With more people employed now than at that time, that will help contribute to the economic recovery.
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    My statement goes through some key variables in the outlook. In general the outlook is good. Some of the variables are oil prices, business investment and then the tax cut. The reason the tax cut is important is because of the capital structure of the United States. We right now have a system that biases heavily the capital structure toward debt instead of toward equity, and that reduces the efficiency. It causes the economy, the private sector to make wrong choices based on tax policy. In my view, the President's proposal would add strongly to both the near and longer term growth outlook. It would provide important benefits in terms of jobs, economic growth, capital mobility, national savings and corporate governance.
    I think the President's proposal is much superior to some of the alternatives that have been mentioned, either doing nothing or doing cash rebates or doing consumption oriented tax cuts or doing targeted investment incentives such as equipment expensing. What we need to make the economy grow is an improvement in the quality of investment, as much as in the quantity, and that would be achieved through the change in the dividend taxation.
    I will mention two side benefits from changing the tax structure. One is the United States is running a big current account deficit now. That shows an investment rate that is above the savings rate. One of the reasons for that is the heavy taxes on savings, and one of those is the taxation of dividends. So we would get a side benefit from the tax cut in added savings.
    Also, there are positive implications for the direction of future tax reforms if this particular tax reform is able to move forward.
    My statement goes through two other issues which I want to mention. First, the scoring issue. Oftentimes we think of this $350 billion number or $550 billion number as something that might be accurate. Remember scoring is distinctly inaccurate. It has no bearing on what is actually going to happen out of a tax cut. It also has no bearing on the benefits that are enjoyed by the economy from a particular change in the tax. In particular, as they think about scoring a tax cut, they are focused on how much revenues the government will lose.
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    Their mission isn't even to try to decide what will happen to the Nation as a whole. It is a limited mission; how much will the government lose. In this particular case, one of the benefits to the economy as a whole is the wealth gain for the Nation when there is a tax cut.
    My statement shows that we have a recent example of the impact of lower asset taxes on the value of assets and the related economic impact.
    In 1997, Congress lowered the capital gains tax on real estate. We saw a major increase in the value of real estate and also in the jobs involved in constructing real estate. I think what we would see similar reactions to a dividend tax cut, a massive increase in national wealth and a surge in economic activity at a relatively small cost to the Federal Government.
    The current dividend tax distorts the capital structure. It creates an expensive wedge or a toll gate between retained earnings and the shareholder, plus it encourages debt and unproductive acquisitions. Its elimination would, in my view, improve the allocation of capital, adding substantially to near-term and long-term U.S. Economic aspects.
    A final part of my testimony is related to the budget deficits. I will leave you with just one point in this area. Recall that the projection of budget deficits is an extremely inexact science. No one really has any idea what the budget deficit is going to be over the next 10 years. CBO is projecting that the tax receipts to the Federal Government over the next 10 years will be $27.4 trillion. So a gigantic amount of revenue is coming in. You should put a confidence integral on that. That is plus or minus 5 percent. They really have no exact way of knowing how much the receipts are, but let us say that they are close to within 5 percent. That means that you have a one-and-a-half trillion dollar uncertainty about what the receipts are going to be.
    Congress is arguing about $200 billion of inaccurate scoring as a way of making tax policies. Instead, Congress should be thinking about what the right tax system is, what the right spending system is and spending less time looking at the budget estimates and the scoring estimates, which everyone is largely in agreement can't be done at all accurately.
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    Thank you, Mr. Chairman.

    [The prepared statement of David Malpass can be found on page 83 in the appendix.]

    The CHAIRMAN. Mr. Peterson, welcome back and it is good to see you. I think we were on the same panel up in the Big Apple. Good to see you and welcome.


    Mr. PETERSON. Mr. Chairman, in March of 2001, a bipartisan group of us from the Concord Coalition; namely, Warren Rudman, Bob Kerrey, Sam Nunn, Paul Volker and myself, stated our views of what ought to be done about a fiscal stimulus, and we said it should be temporary, it should be targeted to taxpayers and businesses most likely to spend it and you should do nothing to aggravate the long-term fiscal outlook. As we look at the current plan, I am sure our group would agree that what we see and the arguments we hear are not terribly persuasive, particularly against those criteria.
    First, a word about worsening fiscal outlook and why it matters. Two years ago, Mr. Chairman, the CBO told us that the 10-year budget balance would be a mountainous $5.6 trillion. We at the Concord Coalition believe there is a more realistic estimate. The 10-year outlook is probably closer to a $4 trillion deficit. That $10 trillion swing is probably the largest in the history of the country except at times of war.
    Also, Mr. Chairman, we have to remember that deficits today can be justified by surpluses tomorrow, but right now the long-term deficit outlook is even worse than the 10-year outlook. Let us keep in mind that we face an unfunded obligation on Social Security, Medicare and Federal pensions of $25 trillion, according to the U.S. Department of Treasury. As a share of payroll, the cost of Social Security and Medicare hospital insurance programs alone would need to rise from today's 14 percent to somewhere between 24 and 34 percent of pay. I think most of us would find that unthinkable and unsustainable.
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    You know, Mr. Chairman, we have gotten used to thinking about entitlements as a long term problem but in fact it is beginning to overlap with our near term. The fact is that in only 5 years the first boomers begin retiring and the entire generation will be on full benefits in 8 years.
    Now why do deficits matter, particularly the long-term deficits? The problem with long-term deficits is they soak up national savings and crowd out productive investment. You all know that America's saving pool is already very shallow and getting shallower. Regardless of this endless debate of the effect of deficits on interest rates, increased budget deficits reduce future income. What really matters is the amount of national savings that is consumed by deficits and whether it is offset by private savings. Others argue that we didn't need to worry about this because foreign savers will pick up the slack.
    In the first place, Mr. Chairman, our foreign friends in Europe face even more daunting entitlement problems than we do because of the rapidly declining birth rates. In any case, whatever we borrow from abroad we have to pay back or else fork over a permanent debt service to foreigners. Any way future American living standards will be affected.
    The current policy, it seems to me, Mr. Chairman, constitutes an explicit decision by today's adults to collectively shift the current cost of government from ourselves to our children and grandchildren. With that background, let us review the basic arguments that I have heard with regard to this tax plan.
    The first is that the American people want and deserve a tax cut and a democratic government should respond to their wish. The administration has described a vision of America in which government takes and spends less of our money and leaves more of it in the pockets of those of us who earned it. It is a vision that resonates with many citizens. But I want to be very clear that neither I nor the Concord Coalition is opposed to smaller governments or lower taxes. We simply require that at the end of the day the revenues are sufficient to cover the outlays. Washington policymakers must not pretend that we can have it all, guns, butter, and tax cuts.
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    In short, I would insist that the bottom line logic of public finance, that the long-term tax burden is determined by long-term spending burden and that unless you reduce the long-term spending burden you don't really cut taxes, you simply shift the burden of taxes from the present to the future. There is no public finance textbook that I know about that teaches you that you can ease the long-term tax burden simply by cutting the tax. Instead of pretending of accomplishing the impossible we should be educating the public that when you face a future of endless huge deficits, you have to cut spending long term before you cut taxes long term.
    Argument number two, okay, let us forget the long-term tax burden. The tax package still makes sense as a near term financial stimulus to bring the economy to full capacity. Today's economy remains fragile largely because business and consumer confidence remains fragile. Under these circumstances a stimulus could have a beneficial impact. The problem with the stimulus justifications that I have heard is it doesn't apply to the plan under consideration. For fiscal stimulus to be effective, it has to be put into the consumers' pockets as quickly as possible. Yet just 5 percent of the administration's economic growth projections, those that explicitly advertise a stimulus, would end up in the consumers' pockets this year and over the 10-year period just 17 percent over the first 3 years.
    Argument three, even if it doesn't deliver much near term stimulus the tax plan does make the Tax Code more efficient, which translates into less economic waste and a higher standard of living.
    Many supporters of the administration's tax plan argue that its provisions to eliminate the double taxation and corporate earnings would make our tax system more efficient. I am sympathetic to this argument. Personally as a matter of tax design I wouldn't do it the same way. A better plan would be to relieve earnings at the corporate level. But my biggest problem with this provision, however, is not its complex design and implementation challenges. My biggest problem is that it is deficit financed. Reducing the taxation on corporate earnings may marginally improve savings behavior, but not nearly enough to compensate for the loss in Federal revenue, which adds directly to Federal debt and in the long term subtracts dollar for dollar from national savings. Far better it seems to me would have been to make any proposal revenue neutral; for example, by genuine tax reform that eliminates many of the obviously inefficient corporate tax subsidies.
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    Argument number four, the critics just don't get it. What this tax package is really about is improving supply side incentives to work, save and invest. We should all be acknowledged that the supply side reductions in a context of punitive tax rates, and indeed they once were, have sometimes been very successful. And if supply side advocates were less theological in their interpretation of the data, we should be able to acknowledge that in other instances the tax rate reductions have had indifferent or ambiguous results. In fact, there is plenty of evidence when marginal tax rates are not high the efficiency gains from cutting them may be modest. The marginal tax rate, as you probably know, on Federal income and payroll taxes is now 30 percent. It is among the lowest in the developed world. And the impact on economic activity can be ambiguous. In other words, while some people may react to more after tax income by working more, others may react by working less. But even if the supply side response to the administration's tax cuts is both positive and sizeable, the gains would be canceled out, perhaps overwhelmed by the sizeable inefficiencies of the deficit that the administration plans to run in order to pay for it.
    According to some of the dynamic models by CBO and several I have reviewed as chairman of the Federal Reserve Bank in New York, the tax plan could actually result in significant GDP losses over the long-term.
    Tax plan argument number five, let us be honest. The ultimate purpose of the tax cut plan has nothing to do with economics. It is about politics or political philosophy. The purpose is to starve the government of revenues so that in the long run the Congress will have no choice but to cut back spending and with that diminish the size of government. This is a seductive apologia, but I have three objections to it.
    First, I think it is unfair because no end, however legitimate, can justify such means. Nothing excuses holding the next generation hostage, including our own children, on the dubious bet that the other party will have the goodwill to relent.
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    Second, it could also be cynical because it assumes that our democratic process is broken and no longer makes sense to advocate a policy for the common good, but we have to rely on a certain amount of subterfuge.
    Third, I think it could be considered hypocritical. One could take the ostensible goal of tax cuts as smaller government more seriously if we saw the party pushing the tax cut were also trying with great energy to cut spending both short term and over the longer term, for example, with genuine reform of what OMB itself calls are unsustainable entitlement programs. But we see nothing of the sort. Indeed it is hard to find the small government argument persuasive when the budget does nothing to reform entitlements, allows debt service cost to rise along with that and urges greater spending on defense and indispensable homeland security when these functions comprise over four-fifths of all Federal outlays.
    Mr. Chairman, our Nation faces at least two history bending challenges, global terrorism and global aging. Meeting the first may require marshalling new resources that are far above the extra spending already legislated. We know that meeting the second will test the ability of our society to provide a decent standard of living for the old without imposing a crushing burden on the young. It seems obvious to me that America should not approach this fiscal gauntlet uncovered by deficits as far as the eye can see. To do so would ignore every principle of public finance, generational equity and long-term economic stewardship.
    Thank you.

    [The prepared statement of Peter G. Peterson can be found on page 95 in the appendix.]

    The CHAIRMAN. Thank you, Mr. Peterson. And our final witness, Dr. Kevin Hassett.
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    Mr. HASSETT. Thank you, Mr. Chairman and Mr. Ranking Member. It is a great honor to be here. I guess from looking around it seems like we don't have a baby boomer on the panel but we are on opposite sides, some of us. And I think looking at the baby boom problem as sort of the long run fiscal problem that our Nation faces is very important and provides an interesting perspective on the current fiscal policy debate, and that is the intent of my prepared remarks that you have before you.
    Before we can think about the question what solutions should we pursue, we need to identify the problems. And to my mind, there are really two big clear problems that I don't think that you could ignore responsibly going forward. And I think that once these problems are recognized then when we have a package like the budget proposed by the President, for example, then we should take each of the items in the package and compare them to these problems and see if they help make them better. And if they do then perhaps they are good policy ideas.
    I think the first problem in the long run, as Chairman Greenspan mentioned, the long run budget outlook is terrible. The short run is bad and the long run is terrible. Indeed, the most recent Congressional Budget Office forecast over the next 75 or so years suggests that Federal deficits as large as 20 percent of GDP will be accomplished absent policy changes. So it is not that if we keep doing these crazy things we are doing and spending new moneys on stuff that we are going to have that big deficit. No. If we keep coasting then we are going to have a deficit that large.
    But I think the interesting perspective that I found in the CBO study that came out a year ago, and I understand they are updating this, is that if you try to identify the cause of this 20 percent of GDP deficit, you see that in their forecasts at least and I share Mr. Malpass' criticism of such forecasts—I don't know how accurate they are going to be—but in their forecasts the chart in my testimony which is just reproducing their chart—that the problem is wholly attributable to a surge in outlays. Indeed, relative to GDP the CBO is forecasting that revenues will be about constant but outlays go from a little bit below 20 percent of GDP to about 40 percent of GDP. Now in my testimony, I try to put that in perspective. If the U.S. Were to actually get to the point where we had a Federal Government of about 40 percent of GDP, then that probably means that State and local spending would be about 20 percent of GDP, if it kept up as it normally has, which means about 60 percent of GDP absent policy changes would be spent on government things. Now I don't think that we are going to get there. But again if we did I think it would just be devastating for the economy.
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    In my testimony I provided a chart that gave you an idea of what kind of growth, economic growth experienced countries with large governments or governments close to that large have had and it is pretty darn terrible. So what is going to happen is at some point we are going to recognize that we can't afford the entitlements that we promised. And I think we are going to have to come together with good faith from both sides of the aisle and work out some kind of solution to it. But I think that recognizing that we kind of face this discrete choice going forward, are we going to become like a socialist European country where we have got a very large fraction of GDP devoted to government or not is a key background debate. And when we look at the President's proposal, then, for example, the prescription drug benefit is something that makes this problem worse and doesn't make it better. I am not an expert on Medicare, and it could be that we need a reform that provides drugs as well, but the expenditure on that certainly doesn't help.
    The second problem, I think, and again economic issues can be complex, the second problem is that the U.S. Corporate tax code is out of step with the corporate tax code of the rest of the world. The economics profession has demonstrated I think almost unanimously over the last couple of decades that high capital taxes, as Chairman Greenspan mentioned, can significantly harm economic welfare, even the economic welfare of workers who don't invest in the stock market. And so the idea is that when there is a large capital inflow then that creates jobs and makes wages increase.
    I think one of the most interesting facts that demonstrates this effect is the experience of Ireland. Ireland reduced their corporate taxes, their tax on capital, and saw their manufacturing wages for their blue collar workers closed from about half of that of the U.S. To being almost equal to that of the U.S. over a decade. And so because of this, much of the rest of the world has begun cutting their corporate taxes and their dividend taxes as well to the point where the only country with a higher combined tax on this type of income than the U.S. is Japan. And needless to say, I think the Japanese are not having an economic experience we would like to reproduce. And so I think the second problem is very important to keep in mind.
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    I believe we have reached a point where since we are big and it is not as urgently obvious as it was to European countries but countries have made themselves much more attractive places to operate, it makes sense for our multinationals to locate their operations overseas. And I think ultimately the stress for that and indeed stress that applies to ordinary workers is going to move us to make some kind of change. And I think therefore when you look at the dividend tax proposal—and I will try to finish quickly—then you can see that it does address a very pressing problem.
    I think Chairman Greenspan mentioned today that he thought that it would be a slam dunk no brainer if you could find a pay-for for that so that it was revenue neutral. But I would argue that if you were to look at the net effect, the noneconomic effect of the President's plan absent such a pay-for, that it would still move you to make this reform because again if we don't then we are going to fail to address a very pressing problem.
    And with that, I will conclude my remarks.

    [The prepared statement of Kevin A. Hassett can be found on page 76 in the appendix.]

    The CHAIRMAN. Thank you to all of our panelists. Let me begin just to follow up on what you mentioned, Mr. Hassett and Mr. Malpass; that is, this whole idea of a 10-year budget strikes me as totally unrealistic. We are talking about a $200 billion difference in the House and Senate versions over a 10-year period. If you were to give some advice to the budgeteers and how we work or how we try to make some sense out of this whole budget process, what would each of you recommend maybe in a sentence that Congress should do? Should we abolish the budget process or has it been helpful? If we don't abolish the budget process, should we start to try to focus in on a 5-year period? Why don't we begin with, Mr. Aaron, and go down the line?
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    Mr. AARON. I think the bad mouthing of the budget projections is a classic case of shooting the messenger. We were not of the mind to shoot the messenger two years ago when we looked at those 10-year projections and concluded that there was enough revenue to support a very large tax cut. The current projections dramatically understate the seriousness of the long-term projection, as Mr. Peterson emphasized. The $200 billion number that you cited counts toward the budget all the reserve accumulation now occurring in Social Security, Medicare and Federal employees retirement funds, every penny of which and more besides will be needed to meet current obligations. It doesn't include any allowance for the fix that will be needed for the alternative minimum tax. It doesn't include most of the costs of the war in Iraq. It doesn't include any additional costs that may be necessary for homeland security. We are looking at a very serious 10-year budget projection.
    Could we be lucky? Could growth suddenly blossom and might we avoid that problem? Yes, it is conceivable. But as I said in my testimony, just because we cannot see with perfect accuracy what lies over the crest of the hill doesn't mean we should drive on the wrong side of the road, and that is exactly what we are doing.
    The CHAIRMAN. You basically don't have a problem with 10-year projections?
    Mr. AARON. I have lots of problems with all the projections because we have to make a lot of assumptions. Would we improve matters by adopting a shorter horizon? I don't think we would. I would like to see additional studies and sensitivity analyses. Fortunately, the Congressional Budget Office has started to give us those and I think it has improved the sophistication with which we read their 10-year numbers.
    Mr. MALPASS. I think the 10-year budget is actually harmful. It causes you to make decisions that you wouldn't make under normal circumstances. For example, in the 2001 tax cut the conclusion was reached to let it expire in 2010 because that saved money in the 10-year budget window that people were looking at at that time. This created a complicated set of tax policies that wouldn't have been arrived at under any other concept. So I think it should not be done.
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    What could be put in its place? I think several things. One is a realistic estimate of what the near term spending commitments of the government are. A program that starts small and then grows over time is being heavily underestimated by the 10-year budget window. I am not really a fan of the Medicare expansions that you are considering now. That would be an area where, if you look at the 10-year budget window, it is not really showing you a true look at the cost of what you are really committing to.
    That is of course how we got into the Social Security problem. Commitments were made at the beginning that didn't seem all that big. We didn't have a 10-year budget at that time, but looking beyond 10 years, that is when the problem occurs. The 10-year budget window creates the impression that you are making logical decisions when we know from experience that you are being pushed into illogical decisions. I think I would dispense with the 10-year budget. I would try to have a system of entitlement controls that would look at the long-term effects of the commitments that you are getting into.
    The CHAIRMAN. Thank you. Mr. Peterson.
    Mr. PETERSON. I either have the burden, Mr. Chairman, or the good fortune not to be an economist, so I have great trouble following some of these models, but I would like to make just a few points. First of all, on the cost side I would agree, Mr. Chairman, with Mr. Aaron that it is very likely that we have grossly underestimated. In addition to those that Henry mentioned, let me mention one that I know a little about. I happen to Chair the Council on Foreign Relations and we have a task force working on the Hart-Rudman recommendations with regard to homeland security.
    I would be very surprised, Mr. Chairman, if a few years from now you do not find that those needs are so pressing that you are going to appropriate much more money than you have now. For example, our ports are hideously vulnerable at the moment. There are systems available to do something about that, but we have done almost nothing about it. Now the other big item on the cost side is obviously the entitlement burden. Let me make this point about entitlements. They are quite different than other projections. I heard Bill Safire, I think it was, on Meet the Press decry 10-year projections, but I think a distinction should be made between projecting the costs of something like Social Security and projecting other costs.
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    Why do I say that? The people that are going to retire, Mr. Chairman, have already been born and can be counted. The benefits are in place, and therefore you can make reasonably reliable estimates it seems to me of what those costs are going to be.
    Secondly, as you can tell from my testimony, I don't take it seriously as some would like me to take some of the growth estimates that people have been making for 20 some years now that I have been in this budget business. I want to remind you of something you probably know better than I, but in the case of Social Security the benefits are tied to wages and wages in turn are tied very largely to productivity. Therefore, as productivity goes up, the costs go up. And therefore it is a problem that you are going to have a great deal of trouble by saying we are going to grow out of this because the economy is going to get bigger.
    I remind you of what happened in Great Britain. Lady Thatcher decided in 1980 that their entitlement programs were unsustainable, and she made one very important reform that you may not agree with but it indicates how important this is. They decided to index the benefits only to inflation and not to wages. And because over a period of time, productivity goes up and wages goes up, it reduced the effect of these on the economy but it did not lower the benefits from where they were when the reform went into effect.
    So I think it is extremely important that no one think it is going to be easy to grow out of the entitlement program.
    The CHAIRMAN. Thank you. Mr. Hassett.
    Mr. HASSETT. I am reminded that you said one sentence. I think that the budget process itself is very important. I think that the $200 billion difference between the House and the Senate right now is a small difference relative to standard errors or anything else that we are talking about. But within that spending, you have to ask yourself is the tax reduction, if you have got one in there, something that is designed to get a big bang for the buck or not. And I would argue that certainly there is a lot of disagreement amongst economists about how much taxes affect things. But there is less disagreement about how, say, the user cost of capital, the thing that the dividend tax reduces affects things than just about any other area. And so it is somewhat ironic to me that the dividend tax proposal seems to be the thing that is going to be thrown out the window in the Senate, or at least that is the rumor, given that is the part of the proposal that has the strongest economic merits.
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    In terms of forecasts, I think I agree wholeheartedly with Mr. Aaron and Mr. Peterson that any artificial short run cap on how far out you go or if you stop at 5 years or 10 years introduces games that I think that some in this room are probably quite masterful at playing where you can move revenues forward and expenditures out and make it look like you are doing better than you are in the 10-year window. I would guess that anything that is done with prescription drugs would be the thing that would have the biggest effect in the long run on the problems we are discussing here and be the most subject to such games because you only look at a 10-year window. The fact is we have got these entitlements growing to be 20 percent of GDP over the CBO's forecast horizon, and that is before we had these things. And if we stop at a 10-year window, you might miss that.
    The CHAIRMAN. The gentlelady from New York, Ms. McCarthy.
    Ms. MCCARTHY. Thank you, Mr. Chairman, and thank you all for your testimony. We have been here since 10 o'clock this morning so it is difficult because each person seems to have a different opinion. My job is to try and figure out what is best for the country, and I am not an economist. I am someone who comes from Mineola trying to pay my bills and my mortgage and make sure that when I retire, I am going to have something that I can sustain myself on and not count on my family or anybody else to help me.
    You brought up interesting points in my opinion. You are basically forecasting, in my opinion, a pretty rosy future for the market. And if that is the case, then why are we even talking about tax cuts because you are saying we are going to have a good future. I happen to think this country will come back. And if I was to take the money, I would personally look at all our States and I would take that money out of the Transportation Trust Fund, it is already there, nobody has to pay for it, we already paid for it, and do what many Presidents have done in the past, public works projects, working on inner cities, rebuilding our bridges and our transportation system and our roadways. The money is there and that is what it is supposed to be for.
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    Since I have been here we have been trying to fight to bring down the debt. But I also know when we are looking down at Social Security, we are looking at Medicare. We are going to have a drug plan. I don't know which one will be accepted, but it is going to come down only because the politicians have promised it and the people are demanding it. And to be very honest with you, most of our senior citizens, they actually need it. So the government is going to have to come up with some plan that we can actually afford to keep prescription drug prices down low. And I think that to me is probably the most challenging thing that we are going to face.
    So with all of you, and you all have totally different opinions—I agree with Mr. Peterson, this idea about debt is scaring the dickens out of me, because we will be fighting this war in Iraq for a while, not quite the war but certainly the conflict that is going to be there. We are going to have to adjust the AMT and that is coming down the road rapidly. Politically this place is going to have to do it and they will.
    And then what Mr. Peterson has said, no one is paying attention to our ports. If you want homeland security, this to me is the scariest thing going on there. And you talk to anyone that works down on the docks. We have 121 ports of entry in this country and we are not even going through a dot of the stuff that is coming in. So we have a long way to go.
    So the only thing I can say to all of you is I wish we could all work together and really come up with the solutions that we are going to be facing. But I guess my question to all of you, if you had a choice why can't we have a meeting of the minds, of yes, possibly a small tax cut but also a public works program that is coming out of the Transportation Trust Fund that would help stimulate short term, give our States a 2-year break not having to match it and have people out there working which would stimulate each and every part of our cities, which to me in my own simple little way would be a win-win situation. And I would ask for a comment on that.
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    Mr. MALPASS. Thank you, Ms. McCarthy. Well, we have a good future, yes, but one of my assumptions is there will be a tax cut. I think that is pretty clear. As you think about whether you want to do a tax cut, put it in terms of jobs and of the stock market, the national wealth. Right now, Congress is putting it only in terms of this $350 billion number, which is an inherently very inaccurate number. It is not a good way to judge. I think a better way would be to think about whether you want the unemployment rate 5 years from now to be 5.8 percent or do you want it to be 5.2 percent and do you want the stock market to be up 20 percent this year or up only 5 percent this year. You can put it into concrete terms. I think that is a better way to think about it than the way that is dominating the press right now in terms of this $350 billion number.
    I will leave you with a final thought. I think you should look at each of the policy issues before you decide on its merits. So as you think about the Tax Code, is it going to be improved by reducing the double taxation of dividends? And the answer overwhelmingly is yes. What we do now is wrong on the Tax Code. We tax corporations when they earn the money and then we tax them again or tax their shareholders when they disburse the money. That causes corporations not to disburse. And so it stops up the capital of the country and so it is a bad system. So you have a choice to improve it, have a lower unemployment rate and a higher stock market. And it is at a cost that is within the rounding errors of their ability to really estimate costs.
    Ms. MCCARTHY. From what I understand from business executives because productivity is up I mean the chances of rehiring a lot of people that have been laid off, the executives are saying they are not going to be doing that mainly because they are producing more. I don't know how many jobs we are actually going to bring back in that case.
    Mr. MALPASS. Retained earnings in this country are immobile because there is a huge tax placed on them. So if a corporation has cash, it doesn't really give the cash to the shareholders and then let some other company get it. The corporation hoards the cash. The rich keep their pile of money because otherwise it is subjected to a huge tax rate in order to move it around. If you lower that tax, you are going to get a lot more mobility of capital in the country. That means more machines and that is going to create jobs. Two years and three years out you will have a lot more people working in this country if you reduce the double taxation of dividends.
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    The CHAIRMAN. The gentleman's time has expired. The gentleman from Texas, Mr. Paul.
    Mr. PAUL. Thank you, Mr. Chairman. I would like to try to draw attention to a connection between economic policy and monetary policy. We haven't talked too much about monetary policy but I think that is pretty important. Obviously spending is too high and I consider high levels of spending and deficits to be dangerous to the long-term future of this country. For that reason I vote for the least amount of spending of anybody in the Congress.
    Mr. PAUL. But I also always vote to cut taxes under the assumption that it is the people's money, and it is never a cost to government because all I am doing is returning the money to the people. So, therefore, it doesn't leave a lot of options of what an individual like myself can do, because the momentum, and the appetite, for spending is so great.
    The welfare-warfare state is in place and the odds of that changing, I think, are slim to none, because we do believe in welfare here at home. And both political parties endorse it, and both parties now endorse military adventurism overseas, there is absolutely no limitation on spending.
    So the exploding deficits shouldn't surprise anyone, but I think sometimes, though, we deceive ourselves.
    I hope the markets turn around, and we do real well, but we ought not to forget about what's happened in Japan. And we ought not to deceive ourselves about the GDP, because if we spend a billion dollar on missiles, we add that into the GDP because it's government spending. But when you blow up a missile, it is not like putting a billion dollars into a hospital or into schools or into housing when you actually raise the standard of living.
    So that can be very deceiving, but my point is that sometimes we rely on monetary policy. We rely on the Fed to lower interest rates, that means print more money in order to stimulate the economy, to generate new revenues to help us out in Washington.
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    Generally that worked in 1990s, to a degree, because of capital gains taxes. And the stock market and revenues came in, and it seemed to help, but I do not see how we can depend on the Fed to bail us out as a Congress. Matter of fact, the system of money we have, I think, encourages us to be irresponsible because we know that unlike a State government, if we spend endlessly, and we vote for guns and butter, and we run up a $500 billion deficit, we always know the Fed is there to buy these Treasury bills and keep interest rates down.
    So the question is, do any of you agree that the system of monetary policy, the monetary policy we have and the idea that we can monetize debt is actually an encouragement? Some people would like to argue it helps us out, but doesn't it actually encourage us to be irresponsible and to spend and allow the Fed to pick up the pieces and to buy this debt, because States can't do that? Do any of you care to comment on that?
    Mr. AARON. I would go back to the statement that it is the people's money, and, therefore, tax cuts are desirable.
    When one cuts taxes in a regime of deficits, it's the people's debt that is being increased. It is, as Mr. Peterson said, the obligations that our children will have to bear.
    Would it be better if the debt that the Federal Government wishes to float was liquid and could not be sold on capital markets? No. I don't think it would be. I think it would detract from the efficiency with which the U.S. Capital market operates, which I think all of us here on the panel would agree is really one of the great glories of modern capitalism and one of the great strengths of this Nation.
    The U.S. Capital market is remarkably efficient in moving net savings into productive investments. My view is that the important goal in setting tax policy, the most important goal, is to make sure that the Federal Government, by running deficits, does not subtract from national saving and thereby lower the amount of investment that we can afford to manage ourselves. As Mr. Peterson said, ''We can borrow abroad, but then we pay the profits from those investments abroad.'' We cannot invest a dollar if we don't first save it.
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    Mr. PAUL. So you don't think monetary policy is actually an incentive for us to be irresponsible?
    Mr. AARON. No, I don't. I think you manage it pretty well here in Congress without the assistance of Mr. Greenspan.
    The CHAIRMAN. The gentleman's time has expired.
    The gentleman from North Carolina, Mr. Watt.
    Mr. WATT. Thank you, Mr. Chairman. I actually have a question, but I want to make a couple of comments before I get to the question.
    And so I hope you all will indulge me, since the first comment I want to make is to thank the Chairman for convening this second panel today. The Members tend to show up and the press tends to show up and savor every single word that Chairman Greenspan gives, and he really didn't say much today to be honest with you, but it's this kind of follow-up interchange between people who really don't seem to have a political ax to grind and who really understand the intricacies of all of these things, that I think are a lot more enlightening to us, to me. I won't speak for the whole committee, but they are certainly more enlightening to me than anything that Mr. Greenspan said, at least today. Although, I think historically, he has said some things that have been important.
    Second I want to thank the members of this panel for not bringing a political ax. I think that's very important if we are going to try to work through this.
    Third, I want to give a special thanks to Mr. Peterson. He doesn't know this, but if I go back to 1992 when I came out of the private practice of law and really wasn't paying attention to any of these kinds of discussions, just trying to make a living, and all of a sudden decided I was going to run for Congress because they created a district that I thought I could represent without being a politician, to be honest with you, every single person at that time was calling me a liberal. And the liberal position at that time was that it was okay to have some deficits, and the conservative position at that time was that deficits were the worst thing that could ever happen to the country because, you know, they increased the cost of money and, you know.
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    So I kind of adopted the liberal position because I was supposed to be a liberal. And the truth of the matter is, it was the Concord Coalition, more than any single entity, that started an evolution on my part. And when I hear people say, ''Well, you have changed your position over the years,'' you are absolutely right. I have. They are absolutely correct that I have changed my position, and it was the Concord Coalition that had more to do with that than any other single institution that I can think of.
    Back 1995 or 1996, somewhere in there, we did this big modeling project where you were going around into congressional districts, inviting people into a room and asking them to balance the budget or create their spending priorities, and I started to understand that every decision that we make has some consequences to it. There are short-term consequences; there are long-term consequences. What I think I have heard Secretary Greenspan, and to some extent this panel, say today is, sometimes the short-term impacts of something, the stimulative impacts, don't necessarily correspond with the long-term impacts. They can be—they can actually be different, and I think this discussion has helped me, even Chairman Greenspan's discussion, helped me this morning to understand that.
    I think the thing that is the constant from my perspective is that, while we can run some deficits sometimes and they are not inherently bad periodically, that we cannot constantly do it and, I don't think, regardless of the inaccuracy of the projections for the next 10 years, there is a person at this table that thinks we are not in a hell of a terrible situation for the next 10 years, 15 years when it comes to deficit spending, and there doesn't seem to be any effective way out of it.
    I seemed to have used all of my time without asking the questions.
    The CHAIRMAN. I will yield to the gentleman. Two minutes for questions.
    Mr. WATT. Since I spent 2 minutes for praising the question.
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    The CHAIRMAN. If the record will reflect it accurately, the distinguished ranking minority member, it was his idea to have this panel. So we have to give credit where credit is due.
    Mr. WATT. I am glad to have this bipartisan recognition of a good idea. That's a good sign here, in and of itself.
    I want to focus on the stimulative part of this, I guess. Let us assume that some stimulus is needed in the economy and I am not looking at the long-term benefits of a restructuring the tax thing, just at the stimulative effect.
    Somebody named economy analysis, that said that just the stimulus part of this, if you extend Emergency Federal Unemployment Benefits, you get one $1.73 for every dollar that you spend. If you accelerate the 10 percent bracket, the lowest bracket, you get $1.34 for every dollar that you spend. If you get more aid to State governments, you get $1.24 for every dollar that you spend. All the way down to the dividend taxation reduction, where you get a
$.09 stimulative effect, not long-term effect, but stimulative effect, $.09 for every dollar that you give back on this dividend tax thing.
    Just looking at the stimulative part of this, shouldn't we be—and I had this discussion with some corporate executives from GE who were sitting at my table at a dinner the other night—if we need a stimulus, shouldn't we be looking at extending opportunity employment benefits and accelerating the 10 percent, the lowest bracket increase, so we can get more money into the economy. Both of those things I think do it. Just don't worry about the long-term consequences.
    I am not arguing with Mr. Malpass or Dr. Hassett about whether restructuring the tax on corporate earnings and dividends might be beneficial long-term, but I am looking at whether it would be beneficial to do something stimulative and whether those two things might not be the highest priority.
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    Mr. MALPASS. I will give the short answer, and then maybe others have a longer one.
    I don't agree with those estimates that you cited. The $.09 benefit from the dividend tax cut is simply a gross underexpectation on the economy. That's a really negative statement on the way the economy works.
    Mr. WATT. But that's short-term, now, I am not talking about long-term.
    Mr. MALPASS. Markets and people are forward looking. If I tell you that your tax rate 3 years from now is going to be much lower than it is today, you are going to get more education, work harder now, get a better job. You are going to start today. You are not going to wait for 3 years. You are going to know that if you are in a better position 3 years from now, you are going to do more. And that's the same for these S corporations. If businesses in America know that the capital structure is going to be more liquid, they are going to start working harder and more efficiently today.
    Mr. WATT. That's exactly the opposite of what the GE executives told me. They told me they would take the money and put it in a savings account, and when the economy turned around, it would have some benefit because they would invest it. And I acknowledged that, but short-term stimulation, the next 6 months to a year, is what I'm talking about.
    I absolutely disagree with what you just said.
    Mr. AARON. If you want to stimulate in the short run, you must do it through consumption. Investment plans take a while. They are not made overnight. For that reason, I think Mr. Greenspan was entirely right, it does not contribute to long-term growth by building up the capacity of the Nation to stimulate consumption in the short run. But he is talking about stimulating growth through expanding the supply side of the economy.
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    Short-term stimulation is about spurring demand, and for that purpose, you want to get the money out into purchases fast. The quick way to do that is to cut taxes for people who have high propensities to spend out of current income. And that would involve ideally, in my view, a repetition of the per capita rebate. Not all of it gets spent, much of it does not because it is temporary. A suspension of part of the payroll tax with compensation to the trust funds from the general fund would also stimulate immediate consumption.
    Dividend cuts may indeed have long-term effects on investment and may indeed have long-term effects on consumption by those who receive the dividend relief. But if you want to get a big bang for the buck, quick, put it in the hands of middle- and lower-income households who need to spend essentially all their income in order to get by.
    The CHAIRMAN. You may respond briefly, then we will move on.
    Mr. HASSETT. It is—I disagree with Mr. Aaron on that, Mr. Watt, as have most previous Congresses during recessions. We have very often had investment tax credits during recessions. They have very often stimulated investment, and the investment tax credit equivalent of the President's proposal is about a 5 percent investment, not as big as 10 percent ITCs that we have seen in the past, but it's not tremendously different from the types of things that President Kennedy was one of the first ones——
    Mr. AARON. The key to an investment tax credit is that it has to be temporary. This provision is not a temporary tax credit. It is a permanent one. The idea of a temporary tax credit is, you put investment goods on sale, go out and buy them right now, and you get the discount. If you say that the price is going to be cut indefinitely, then the stimulus to go out and buy now is dramatically reduced.
    I would agree with Mr. Hassett if he is talking about a temporary investment tax credit, but not a permanent one.
    The CHAIRMAN. Gentleman from Washington, Mr. Inslee.
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    Mr. INSLEE. Thank you, Mr. Chairman.
    I want to thank all the members of the panel, but again particularly Mr. Peterson. And just to dovetail, what Mr. Watt talked about, about his sort of epiphany or renaissance in regard to the budget deficits, I want to thank you for a different reason. I came to Congress, at least the first time, the same year Mr. Watt did, 1993, but I had a different view. The deficit was one of the reasons I first ran because on Sunday morning when I would open up the newspaper and be having a nice omelet, it would be spoiled by looking at what these idiots in the U.S. Congress were doing, creating this enormous debt burden for my kids. And I have got three sons, and so I kind of had that epiphany maybe a little earlier than Mr. Watt, but I think with the——
    Mr. WATT. You are always smarter than me.
    Mr. INSLEE. It has been in large part because of Concord Coalition works that you have been instrumental in, and I want to thank you for getting Americans to understand the depth of this problem and the source of the problem which is the U.S. Congress and the Executive Branch.
    I just want to give you an impression that I have and just ask for your comment. My impression is almost on an issue perhaps of morality as much as economic theory, in that I believe there is a moral component of when we create this debt burden for our children. Regardless of economic theory, it's something we ought not to do and I look at this, I heard one of the speakers, I think it was maybe John Tanner, during the floor debate about this, he actually likened this tax cut as actually the largest tax increase in American society because, ultimately, it will increase interest rates on the Federal debt. And you and I know, tax payers pay a debt tax, right now almost 14 percent of all the income taxes they pay go to pay the interest on the Federal debt. And in one way or another, I appreciate your testimony because what you talked about is that this basically is just shifting the burden to pay for this to a later period of time. Obviously, at some time, the paper will have to be paid, and this is shifting it down a generation, perhaps, and I look at this, I look at this tax cut as an abject failure of my generation. They talk about the greatest generation, World War II, well, my generation is the baby boom generation, and when we retire, this tax cut is an explicit promise to our kids that they are going to have an enormous tax increase. They are going to finance my generation's retirement, and I think there is a moral component to this, and that's why I feel strongly about it.
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    So, I guess, I ask you to comment on some of the sentiments.
    Mr. PETERSON. If I may, a lecture on morality doesn't come very convincingly from somebody on Wall Street, but let me take a crack at it.
    There was a German philosopher named Bonhoffer who said, ''The ultimate test of a moral society is the kind of world that it leaves to its children,'' and I think what we are doing to our kids is fundamentally immoral.
    I would like to respond to a comment that Congresswoman McCarthy made about why we cannot get together and solve this problem, because I don't know many people that want to consciously hurt their own children.
    I think we need a common understanding of what the problem is. And if I could make one suggestion, Mr. Chairman, I would love to have you have a hearing on the single issue of the trust fund, because I think that has done more to confuse the American people and to diminish the importance of this problem than almost anything that has happened.
    My father went to his grave saying, ''I don't know why you keep writing books about all these long-term liabilities and stuff. I have got an account, and that money has been set aside, and that's going to be there when I retire.'' I collected oxymorons because I was once called a powerful Secretary of Commerce, and anybody who has ever been here knows there has never been one in the history of the government. In a sense, the trust fund is kind of an oxymoron because it says fund. It's not funded; it's unfunded. It says trust, and I think it's extremely important, Mr. Chairman, that the American people have a common understanding of this problem because as long as they really believe there is a trust fund out there that has been funded and that's set aside for them, they aren't going to take this problem seriously. And it is the one thing I think we all agree on, that it is a real problem.
    Mr. INSLEE. If I ask Mr. Hassett, we know the arguments for a removal of the dividend tax, the potential of distorting impact, but in your view, given certain facts that I think we all agree on, namely, that people are getting older and medical care costs are going up, the baby boomers are starting to retire, the AMT tax will be fixed in some sentiment, defense costs will go up, Homeland Security increase will go up. All of these are bipartisan consensus items I have stated.
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    Given that fact and given the fact that deficits will increase as a result, would it not be preferable if you believe you want to remove that distorting impact of the dividend tax, to find some other means so that we don't end up with these giant deficits? For instance, closing the Bahamian-Bermuda Triangle tax dodge that some of our less patriotic corporations have chosen to take, for instance.
    Mr. HASSETT. Thank you for the question. I think that the dividend tax cut is likely an important enough policy that we should try to think what we can agree on to do in order to get it passed. I think that we also have to recognize, however, that, as in my testimony, the charts to my testimony, to the extent that we are doing this irresponsible or you said immoral thing to our children because we are setting them up to have this terrible bill that they are going to have to pay, well, the reason that we are doing it, first order, big reason is that the spending is soaring so out of control.
    Mr. Peterson mentioned that Margaret Thatcher indexed retirement benefits to inflation but not to growth. If we did something like that, it would go a long ways towards fixing the problem, and whether we do something like that or not, I don't think is going to be seriously impacted by $200 billion of tax policy this year.
    The CHAIRMAN. The gentleman's time has expired. Gentleman from Massachusetts to close.
    Mr. FRANK. Mr. Chairman, I want to apologize to our witnesses. Not for my personal shortcomings, but for the shortcomings of our political culture. This is a very useful discussion. I am enormously grateful to these four very busy, very thoughtful people for having a rational and civil discussion about some of the most important issues in society. I am sorry it's not sensational enough to attract the attention it ought to. I am comforted by the fact that C-SPAN is here and that people are interested in it and that the number is 10s and of more thousands, and I think it has been useful time.
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    I was struck by Mr. Hassett referring back to the Kennedy Administration, because that's when I was taking Economics 125 and Dr. Aaron was grading me. So I was going to say that's an irrelevant, so far time gone, but I can't do that. I was going to suggest to Mr. Peterson that maybe he wasn't governmentally powerful. I think Herbert Hoover used the Secretaryship of Commerce to at least some political advantage. He may have been the only powerful Secretary of Commerce.
    Question, first I am struck and I appreciate your honesty. It's been talked about, Mr. Hassett and Mr. Malpass, too, in some extent that each side suggests witnesses. Dr. Hassett, you were particularly explicit in denigrating the marriage-penalty relief and the child-tax credit. Would you expand on that?
    Mr. HASSETT. Sure, Mr. Frank. Thank you. I guess you are trying to get me in trouble but——
    Mr. FRANK. No, I am reading what you wrote. I am not bugging you.
    Mr. HASSETT. I will continue to dig. I think that tax policy needs to be based on sound economic principles, that we need to have broad bases.
    Mr. FRANK. We can stipulate to that. Why does that then lead you to be critical of marriage-penalty relief and a child-tax credit?
    Mr. HASSETT. That's a more complicated answer. I will be glad to get back to you with that, but there is a reason why. The concern of the marriage penalty is quite cyclical over time, and we get really upset about it for a while. Then we fix it, and the way we fix it, we get upset about that, and then we put it back.
    Mr. FRANK. You presumably aren't cyclical about it. Why do you think it's not very important?
    Mr. HASSETT. I think that the——
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    Mr. FRANK. From the economic standpoint.
    Mr. HASSETT. On the economics of it, on the marriage penalty, you have to decide whether you want every family who has an income of $100,000 to pay a tax, regardless of where the $100,000 comes from. Is it one person making $80 and one person making $20? Or is it two people making $50? Or do you want to tax everybody who makes $50,000 the same, whether they are married or not? You have to pick, and if you get upset about the way the tax code treats one set of people, then you will change the code.
    Mr. FRANK. Give me a factual statement now. You say it does little to strengthen the economy. Why do you say that?
    Mr. HASSETT. I think that using the tax code to attempt to shape families is—you are not going to have any use out of that. It is not going to be effective. So if you want to have more children, I don't think a child credit is going to make people have more children. In terms of lowering taxes, we try to stimulate activity——
    Mr. FRANK. Neither one of these, in your judgment, would be likely to increase efficiency or productivity or do those things ?
    Mr. HASSETT. Correct.
    Mr. FRANK. Let me say, I did want to comment, and I respect the integrity of the gentleman from Texas with whom I am often aligned on various matters of personal liberty, but I disagree very much, as Dr. Aaron did, with his formulation that it is the people's money.
    This notion that it is the people's money versus some entity called the government's money, I think, greatly misstates things. Of course it is the people's money, but thoughtful people understand that they have two sets of needs roughly. There are needs that we can all best deal with individually, by money that is individually available to us, but there are also needs that, all the people I know believe, that can only be dealt with collectively, cleaning the air, public safety to some extent, public transportation.
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    So this dichotomy between the people's needs and the government's needs is a mistaken one. There is a dichotomy between those needs which we can best fulfill individually and those which we can best fulfill working together. There are some questions about the inherent efficiency or inefficiency of when we work together. I tend to share Dr. Aaron's view on that but I think that's where we ought to formulate it.
    That leads me to this question. We get into debates. Well, first, one preliminary factual question, seriously, for both Dr. Hassett and Mr. Malpass. You are critical of the 10-year window, but to be honest, I wasn't sure whether you want a shorter or a longer time horizon or both of the above. Should we substitute for the 10-year window an indefinite, as far as the eye can see, or should it be 2 or 3 years? I think, frankly, in your criticisms of the 10-year window, sometimes it was too long and sometimes it was too short. Could you expand on that?
    Mr. HASSETT. I think it's too short in the sense that you need to look at the total effect of every policy. So I agree that Mr. Malpass and I were saying different things but we were——
    Mr. FRANK. Okay. Mr. Malpass, you seem to be saying sort of both. By the way, let me just stipulate to one thing. Passing a tax cut to say 2010 was extremely stupid. I understand. I didn't vote for it. None of us did, and so I am glad you told them that, but should we lengthen or shorten the window?
    Mr. MALPASS. I think we should have both. First, an indefinite window, meaning in its fully-mature state. If you develop an entitlement program and you figure out what it is going to cost down the line, that is a relevant number. By having a 10-year window, it is encouraging you to minimize the cost in the first part of that window. You don't get charged for the long-term, and that's an artificiality that is distorting your——
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    Mr. FRANK. So both of you say it should go on.
    Let me put it this way. When we do a budget, should we then do it as binding for 1 year, and then the projection is infinite? We have this 1-year, 5-year. How would you change your procedures in what terms?
    Mr. MALPASS. As I mentioned, I think spending restraints on the size of programs might be useful. The budgeting process that you use now doesn't help make good decisions.
    Mr. FRANK. I understand. What would you do instead?
    Mr. MALPASS. I think you could look at last year's budget deficit, not a projection of budget deficit, and then have your rules be based on whether you are meeting your goals.
    One kind of goal is the debt to GDP ratio. We are right now at 35 percent. So you could put in some kind of concept that when you are above that, then it takes more votes, a super majority to pass new entitlements.
    Mr. FRANK. I appreciate that. Is that relevant, because that's one of the questions, the ratio of debt to GDP? The argument has been, well, that's really not all that relevant and if it's relevant why? Does it have effect on interest rates or you don't think it crowds out savings? Why should I care what the ratio to debt to GDP is based on your analysis?
    Mr. MALPASS. I think a debt to GDP analysis is a relevant way to look at a government's fiscal situation.
    Mr. FRANK. What harm does a high one do, is my question to you?
    Mr. MALPASS. Right now, the U.S. is at 35 percent of GDP. In Europe, many of the countries are at 60 or 80.
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    Mr. FRANK. What harm does it do if we get too high?
    Mr. MALPASS. As you get too high, you are going to have trouble funding that size of a deficit. So it's like a credit limit. If you think of a person with a given income and then they say, ''Well, I am borrowing $50,000,'' and the bank says, ''Okay, that amount you can handle,'' and then the person says, ''Well, I want to borrow $100,000,'' and they have a health problem, that's going to create a problem.
    Mr. FRANK. Meaning people would charge me more for it?
    Mr. MALPASS. I don't think the interest rate——
    Mr. FRANK. But how is it going to be a problem? I want to borrow more. It sounds like you are now acknowledging that there is some negative to the higher deficits, and I wasn't sure of what they are.
    Mr. MALPASS. I really think that the U.S. debt to GDP ratio is low enough that more borrowing won't affect interest rates.
    Mr. FRANK. That is not what I am asking, Mr. Malpass. We have been very civil here. I am asking you, in your theoretical terms, what—and we also know it's not either/or, these things are all cumulative. You have ranges. At exactly what point I am not asking now. What is the damage that comes if the ratio gets too high? How does that damage manifest itself?
    Mr. MALPASS. I think if you get to a high debt to GDP ratio beyond your creditworthiness, the investment in your country dries up. People don't want to put money in because they see a debt crisis coming. The good news is that the U.S. Isn't anywhere close to that, and I think a better model for thinking about extra debt now is more in terms of quantity discounts. There are a lot of corporations where, if they borrow more money, they get a lower rate.
    Mr. FRANK. More debt would be a good thing for us right now?
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    Mr. MALPASS. No.
    Mr. FRANK. That's what you are telling me. I understand that, but I am trying to follow the policy implications.
    Mr. MALPASS. I disagree with the argument that a budget deficit——
    Mr. FRANK. I understand that, Mr. Malpass, but isn't the implication of what you say, your quantity discount, that more debt could be a good thing?
    Mr. MALPASS. I think a tax cut would be very good for the economy now.
    Mr. FRANK. I know, but I didn't ask you that. Leaving aside of how we incurred the more debt, what was that reference to quantity discount? It sounded like there could be some value to having some more debt, or is that just a throw in that I shouldn't pay attention to?
    Mr. MALPASS. No, no. Very practically, for corporations and for foreign countries, they think about placing debt on the yield curve in order to lower their borrowing rate. It's a very practical concept. You know that there is the concept of a prime rate in the U.S. Who gets prime rate? Is it somebody that doesn't borrow very much money. No. It's always somebody that borrows a lot of money. They get a lower rate because they——
    Mr. FRANK. You think that has relevance to the U.S. Government?
    Mr. MALPASS. At our current debt to GDP ratio, yes.
    Mr. FRANK. Let me take Mr. Aaron's last comment.
    Mr. AARON. Just two specific points.
    The CHAIRMAN. You can tell what kind of grade you gave.
    Mr. FRANK. A minus, so I owe him.
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    Mr. AARON. A high ratio of debt to GDP means a high ratio of interest to total budget expenditures, and that is a threat to the capacity of the government to meet its obligations in the future. That's point one.
    Point two, the more debt that exists, in all likelihood, the larger the holdings abroad of U.S. Debt and hence the greater vulnerability of the U.S. Dollar to shifts in sentiment on the part of foreign debt holders.
    The CHAIRMAN. The gentleman's time has expired. All time has expired. We are most in your debt to coin a phrase.
    Mr. FRANK. And that's a good thing.
    The CHAIRMAN. We appreciate your patience and your participation. It was most enjoyable and the committee now stands adjourned.
    [Whereupon, at 1:35 p.m., the hearing was adjourned.]