It is an honor to be asked to appear before the Senate Budget Committee. At the
White House, I had the opportunity to work with members of both parties on this panel on substantial legislative achievements, and am glad to have this opportunity to talk with you again in my new life.
I. Recent Evidence on Fiscal Discipline and the Economy
It is my belief that this country must always be in search of pro-growth economic policies that foster innovation, entrepreneurship, and productive investment in our future. For our country to grow economically and grow together as a people we must devise policies that both ask all Americans to contribute to growth as well as share in its benefits.
During the last five years we have seen a remarkable record of growth. GDP has grown 4.0% annually over the last eight years, and when one focuses only on the private sector, growth has been an even more impressive 4.5% annually.
The dramatic shift in our fiscal situation has contributed to a remarkable virtuous cycle in which fiscal discipline has contributed to lower long-term interest rates that have spurred an investment-led recovery and expansion and, in turn, led to more revenue and greater surpluses.
Clearly both the perception and reality of the federal government’s commitment to shift from being a net drain on savings through large deficits to a net contributor to savings through running surpluses has been a vital force in this cycle. Indeed, we saw in the early part of 1993, that even the strong market perception of a new commitment to fiscal discipline led to an immediate drop in long-term interest rates. The 1993 Deficit Reduction Act, the 1997 Balanced Budget Agreement that Chairman Domenici played such a critical role in forging, and the commitment led by President Clinton to save the surpluses for debt reduction and Social Security has turned that perception into reality. The near doubling of our net national saving rate from 3.4 to 6.0 is primarily attributable to the change in fiscal policy.
One can see the critical impact this shift in our fiscal position has had on freeing up capital for private investment by looking at this fiscal year alone. In January 1993, the Congressional Budget Office (CBO) projected the unified deficit to be over $513 billion in 2001. Instead, we now expect unified surpluses to be $281 billion. Simply put, that means that shift in the federal government’s fiscal position has made $794 billion more in capital available for private sector business investment, mortgages and car and student loans in a single year—than was projected to be the case only eight years ago.
Clearly this shift has helped keep long-term rates low even in times of high growth and high demand for capital, helping to lead to an unprecedented eight consecutive years of double-digit growth in productive investment, with an average over the time period of approximately 13%.
Goldman Sachs estimated that the full turn-around from deficits to surpluses may mean over 200 basis points in lower interest rates. Indeed, the Goldman Sachs analysis was based on the smaller swing that existed in 1999. Goldman Sachs at the time estimated that “the swing in the federal budget position from a deficit of $290 billion to a surplus of $124 billion in 1999… has lowered equilibrium bond yields by a full 200 basis points.” (Goldman Sachs, U.S. Daily Financial Market Comment, April 14, 2000.)
This contribution of fiscal discipline to lower interest rates and a virtuous investment cycle has certainly worked, together with our advances in information technology, to create a favorable environment for productivity growth. It has further helped facilitate greater flexibility at the Federal Reserve. And during the Asian financial crisis, this strong fiscal stance certainly helped make the United States the bulwark of financial and fiscal stability during that critical moment in the world economy.
Finally, the virtuous cycle encouraged by fiscal discipline together with strong education and health investment and pro-work incentives, helped spur more private sector employers to reach out to the previously-perceived periphery of the labor force helping to lower not only the overall unemployment rate to 4.2%, but the black and Hispanic unemployment rates to record lows.
II. The Administration Tax Relief Proposal and the Risks of Fiscal Imbalance
Today, I’d like to discuss why I believe that the tax cut being proposed by the Administration puts at risk many of these hard won gains, and, just as important, could forgo vital future gains our country could reap by continuing its fidelity to the principles and policies that have served it well over the last several years.
One guiding principle that I fear this new tax cut is abandoning is the view that we should not allocate large amounts of our surplus until we have first put in place solutions to both pay down our external debt and extend solvency for Social Security and Medicare. There are many different partial or full solutions to this solvency dilemma, but they all share one common element: all solutions require us to consume less and save more now so that we don’t have to pass on the costs of this burden to the next generation in the form of higher taxes or less investment in education, health care, a clean environment or science.
Most solutions also share in common the need for substantial on-budget surpluses to help fund the transition from a pay-as-you-go system to a more prefunded system. Therefore, a tax cut proposal that drains the entire non-Medicare, non-Social Security surpluses could seriously harm any effort to find a bipartisan solution for Social Security or Medicare reform. If we waste this tremendous opportunity to use on-budget surpluses to help fund Social Security and Medicare reform, we will be forced into unnecessarily painful choices.
This becomes all the more apparent when we look at the projected 20 year costs of this tax cut. Even if one accepts that the true cost of the tax cut is $1.6 trillion with interest costs—a proposition that seems unlikely—the full 20 year drain on the surplus would be anywhere from $5.5 to $7.3 trillion.
Again, even assuming no additions, the tax cut alone would cost an estimated $4.79 trillion over 20 years—even before calculating lost interest savings. If we failed to pay off our national external debt during this period, the full cost with lost interest would be a staggering $7.35 trillion dollars. While adjusted for inflation, this number would be smaller, this is still a profound commitment of national resources to make before a long-term Social Security and Medicare solution is found.
The concern that we would pay off our debt too early and be faced with the problem of what to do with the government accumulating assets seems premature. First, the Administration’s purported goal for Social Security reform is to divert substantial amounts of the Social Security surpluses away from debt reduction to partially-privatized Social Security accounts, keeping the U.S. in debt for the foreseeable future. Indeed, even if the Administration were to now seek to preserve the Social Security surpluses for debt reduction—a far from certain prospect—there would still be $776 billion in external debt by 2011 according to analysis by Peter Orszag, our soon-to-be colleague at Brookings.
Even if we had the very high-class problem of paying down the debt on too rapid a schedule, there are several options without even dealing with the issue of how independent Social Security Trust Fund investments could be. Money could be given into savings accounts or pro-savings tax cuts. Some like myself would like to see such accounts done outside of Social Security, such as was proposed by President Clinton with USA Accounts and Vice President Gore with his Retirement Saving Plus Account proposal. Others support making private individual accounts part of Social Security itself. None of these proposals threaten to overstimulate the economy. Or even more simply, if we found ourselves on too quick a pace of debt reduction, additional tax cuts could be passed in 2004 or 2005. Certainly, this type of prudence would be wiser than a tax cut in February of 2001 that drains all of the on-budget surpluses for a decade to come.
Another principle of our fiscal discipline that seems likely to be contravened by the Administration’s tax cut is what seemed to be a bipartisan commitment to protecting Social Security and Medicare surpluses for debt reduction. Recent accounts in the press would lead one to believe that the only fiscal threat to saving the Social Security and Medicare surpluses are new, not-yet-proposed corporate and special interest tax cuts or new unforeseen spending by Congress. Instead, it should be understood that with the Administration’s tax proposal, even President Bush’s own campaign spending commitments along with a portion of the individual tax cuts passed by Congress last year could take us back into deficits.
Consider the following four aspects.
First, it is hard to believe that we will pass such a large tax cut and then deny all or large chunks of it to over 25 million taxpayers by not adjusting the Alternative Minimum Tax. Therefore, the likely costs of the Bush tax cut would be $1.8 trillion or closer to $2.2 trillion when counting lost interest savings.
Second, if the tax cut is made retroactive this could easily add another $200-400 billion to the total costs, bringing the total cost to anywhere from $2.4 trillion to $2.6 trillion.
Third, consider what President Bush has committed to during his Presidential campaign. By the campaign’s own September 5, 2000, document, they detailed $474.6 billion in new spending initiatives—an amount that with lost interest savings—would drain another $600 billion from the on-budget surplus.
As listed by then Governor Bush on September 5, 2000, in his own campaign document, this amount goes as follows:
Fourth, also competing for surplus funds were tax cuts passed or strongly supported by Congress last year. For example, while President Bush has supported a marriage-penalty tax provision that has been scored at only $87.7 billion. And when President Clinton vetoed a $293 billion marriage-penalty provision, then Governor Bush stated that he would have signed it (Governor Bush statement on “Clinton-Gore Veto of Marriage Penalty Relief,” August 5, 2000.) If so, this alone could add another $150-200 billion to the likely tax cut costs.
Other provisions that fall into the same category include:
All told, the cost of tax cuts sponsored at least substantially by the Congressional majority not included in the Administration tax proposal, would draw at least $556 billion from the surplus when lost interest savings are included.
Others, such as Secretary Robert Rubin and the Center of Budget and Policy Priorities have expressed concern that the likely surplus may be several hundred billions of dollars smaller than traditional baseline projections because they do not include population increases in the discretionary baseline, emergencies and likely tax extenders. (Center on Budget and Policy Priorities, “What the New CBO Projections Mean,” January 31, 2001; Robert E. Rubin, “A Prosperity Easy to Destroy,” New York Times, February 11, 2001.) Yet, even without counting these budgetary considerations, we can see that even if only the Bush spending commitments, adjustments to the AMT, and Congressionally-passed tax cuts are included with the Bush tax cuts, the costs could be $3.52 trillion—$800 billion beyond what is available from the surplus once excesses from Social Security and Medicare payroll taxes are set aside for debt reduction.
Therefore, even with no new special interest or corporate tax provisions or new spending initiatives not considered on the campaign, a realistic forecast could foresee having to drain from $800 billion to $1.3 trillion of the Social Security and Medicare surpluses. Considering that marginal tax cuts may be more costly due to the higher revenue estimates forecast by the Congressional Budget Office, even this estimate may be conservative.
III. Notes on Progressivity
Finally, let me make two points on the issue of progressivity. Some have argued that the large amounts going to the top 1% can be justified by the fact that they pay most of the taxes and therefore should get a proportional amount of the tax cut. Yet, when one looks at the full tax burden including payroll taxes, the top 1% make 15% of the country’s income, pay 20% of the total taxes (US Treasury, Distributional Anaylsis Methodology, OTA Paper 85, September 1999) and yet would get 35-43% of the tax cut—over twice their proportion of the full tax burden.
Lastly, Governor Bush and his advisors had previously suggested that they were concerned about the work incentives of working poor families in the $13,000 to $25,000 range. Yet, his tax cut would provide absolutely zero for the vast majority of those millions of families. I strongly suggest that Congress consider some combination of the following incentives: an EITC provision to help larger families and lower their reduction of benefits with higher earnings; a refundable expansion of the child tax credit or a rebate on payroll taxes.
The Administration’s proposal currently does provide the child tax credit to some children currently not covered—those in families making between $110,000 and $200,000. Yet, 16 million children in the lowest income families—1 in 4 children—would still get nothing from the child tax credit. How can we justify telling the family making $180,000 that they now get $1000 each for their two children, while we tell the family making $18,000 that their children will not benefit one penny from the expanded child tax credit?
A refundable child tax credit would be a true bipartisan achievement. President Bush could claim credit for his proposal to double the child tax credit. Yet, by making it refundable, we could ensure that the hardest-pressed families—including those whose tax burden comes from payroll, state, and sales taxes—also received tax relief while being part of an affordable passage that will pay down the debt and save families thousands through lower interest rates and a stronger economy.