[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
BEYOND THE TAX CUT:
UNLEASHING THE ECONOMY
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
DOMESTIC MONETARY POLICY, TECHNOLOGY,
AND ECONOMIC GROWTH
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
__________
MARCH 29, 2001
__________
Printed for the use of the Committee on Financial Services
Serial No. 107-8
U.S. GOVERNMENT PRINTING OFFICE
71-632 WASHINGTON : 2001
_______________________________________________________________________
For sale by the Superintendent of Documents, U.S. Government Printing
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Mail: Stop SSOP, Washington DC 20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice BARNEY FRANK, Massachusetts
Chair PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska MAXINE WATERS, California
RICHARD H. BAKER, Louisiana CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma KEN BENTSEN, Texas
ROBERT W. NEY, Ohio JAMES H. MALONEY, Connecticut
BOB BARR, Georgia DARLENE HOOLEY, Oregon
SUE W. KELLY, New York JULIA CARSON, Indiana
RON PAUL, Texas BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio MAX SANDLIN, Texas
CHRISTOPHER COX, California GREGORY W. MEEKS, New York
DAVE WELDON, Florida BARBARA LEE, California
JIM RYUN, Kansas FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina CHARLES A. GONZALEZ, Texas
DOUG OSE, California STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York JOSEPH CROWLEY, New York
GARY G. MILLER, California WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania
SHELLEY MOORE CAPITO, West Virginia BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio
Terry Haines, Chief Counsel and Staff Director
Subcommittee on Domestic Monetary Policy,
Technology and Economic Growth
PETER T. KING, New York, Chairman
JAMES A. LEACH, Iowa, Vice Chairman CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California BARNEY FRANK, Massachusetts
FRANK D. LUCAS, Oklahoma GREGORY W. MEEKS, New York
RON PAUL, Texas BERNARD SANDERS, Vermont
STEPHEN C. LaTOURETTE, Ohio JAMES H. MALONEY, Connecticut
DOUG OSE, California DARLENE HOOLEY, Oregon
MARK GREEN, Wisconsin MAX SANDLIN, Texas
CHRISTOPHER SHAYS, Connecticut CHARLES A. GONZALEZ, Texas
JOHN B. SHADEGG, Arizona MICHAEL E. CAPUANO, Massachusetts
VITO FOSSELLA, New York RUBEN HINOJOSA, Texas
FELIX J. GRUCCI, Jr., New York WILLIAM LACY CLAY, Missouri
MELISSA A. HART, Pennsylvania MIKE ROSS, Arizona
SHELLEY MOORE CAPITO, West Virginia
C O N T E N T S
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Page
Hearing held on:
March 29, 2001............................................... 1
Appendix
March 29, 2001............................................... 41
WITNESSES
Thursday, March 29, 2001
Armey, Hon. Richard, Majority Leader, U.S. House of
Representatives................................................ 2
Baily, Dr. Martin N., Senior Fellow, Institute for International
Economics, Washington, DC...................................... 15
Glassman, James K., Resident Fellow, American Enterprise
Institute...................................................... 12
Kudlow, Lawrence, Chief Executive Officer, Kudlow & Company, LLP. 18
Kvamme, E. Floyd, Co-Chairman of the President's Council of
Advisors for Science and Technology............................ 10
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 42
Maloney, Hon. Carolyn B...................................... 44
Baily, Dr. Martin N.......................................... 62
Glassman, James K............................................ 50
Kudlow, Lawrence (with attachment)........................... 68
Kvamme, E. Floyd............................................. 46
Additional Material Submitted for the Record
Glassman, James K.:
``The Joy of Debt,'' The Weekly Standard, March 26, 2001..... 58
BEYOND THE TAX CUT:
UNLEASHING THE ECONOMY
----------
THURSDAY, MARCH 29, 2001
U.S. House of Representatives,
Subcommittee on Domestic Monetary Policy,
Technology, and Economic Growth,
Committee on Financial Services,
Washington, DC.
The subcommittee met, pursuant to call, at 10:00 a.m., in
room 2128, Rayburn House Office Building, Hon. Peter T. King,
[chairman of the subcommittee], presiding.
Present: Chairman King; Representatives Oxley, LaFalce,
Shays, Grucci, Green, Ose, Paul, Fossella, Hart, C. Maloney of
New York, Clay, and J. Maloney of Connecticut.
Also present: Representative Toomey.
Chairman King. The hearing will come to order.
It is my personal pleasure to begin the first business of
this new subcommittee by examining one of the most vital issues
facing our country--the health of the economy.
Let me first say that I welcome the distinguished
Representative, Mr. Armey, and I thank all of you for setting
aside time in your schedule to share with us your economic
insights.
I would also like to congratulate Mr. Kvamme on his newly
appointed status as President Bush's Co-chair of the
President's Council of Advisors for Science and Technology. I
understand that Mr. Kvamme will have to leave early so he can
get down to the White House. They do have certain priorities,
so we will certainly respect that.
The importance of economic growth cannot be overstated,
particularly at this point in time. There is strong fear and
skepticism across the Nation as to where our economy is headed.
Today, it is my hope that we will discuss the many steps
necessary to put the economy back on track, starting with some
tax relief.
In the interest of time we would ask that the Members limit
their opening remarks today and to put them in the record. I
also realize that Mr. Armey is under very serious time
constraints this morning, and I agree with my distinguished
Ranking Member, Mrs. Maloney, to allow only these limited
remarks before Mr. Armey gives his remarks.
Again, I can't stress enough how important the subject
matter is that we are covering today. We're talking about jobs,
savings, education, and the list goes on.
I also want to commend President Bush for taking on this
problem head on. And, as to the subcommittee, I assure you we
will do all we can to ensure economic growth.
I will yield back my time and recognize the distinguished
Ranking Member, a good friend from New York, Mrs. Maloney.
Mrs. Maloney. Thank you very much, Mr. Chairman, and I will
withhold my full statement until after the Majority leader
testifies.
Given that this is the first hearing of the new Domestic
Monetary Policy, Technology, and Economic Growth Subcommittee,
let me first welcome the Chairman, Peter King, my fellow New
Yorker. I look forward to 2 interesting years of working
together and I look forward to today's hearing, and
particularly I am very eager to hear the Majority leader's
testimony.
I yield back the balance of my time. I will submit later my
opening statement.
[The prepared statement of Hon. Carolyn B. Maloney can be
found on page 44 in the appendix.]
Chairman King. I thank the Ranking Member.
And now it's my pleasure to introduce the Majority leader
of the Congress, my good friend from Texas, Mr. Armey.
STATEMENT OF HON. RICHARD ARMEY, MAJORITY LEADER, U.S. HOUSE OF
REPRESENTATIVES
Mr. Armey. Thank you, Mr. Chairman.
First of all, let me say, it's a pleasure to be invited,
particularly on this subject, a subject I've studied throughout
most of my adult life.
Let me begin, Mr. Chairman, by pointing out that I believe
in the separate authority of the Federal Reserve Board. I
believe that the proper role of the Federal Reserve is to be
obsessive with inflation and I believe that the current Federal
Reserve Board does their job quite well in that regard.
I do believe though that there should be a coincidence
between the Federal Reserve's monetary policy and the Federal
Government's fiscal policy. And that coincidence should be born
out of an accurate understanding of what's going on in the
economy.
The current news about the re-evaluation of our last
quarter's performance and the current indications of this
quarter's performance cannot be encouraging to the American
people; and they are, in fact, looking to us to do something
about it.
Let me just talk about what it is we can do. The clear
first fact that is what we can do must almost inevitably be and
almost perhaps solely be in the area of lowering taxes. The
incredible tax debate that we're having right now centers
around the President's tax plan. Everybody realizes and,
indeed, I believe they realize also at the White House that
that plan was written at another time under different economic
circumstances when the Nation was in a different mood about tax
reduction than what we are today.
Today, the Nation is concerned about the performance of the
economy and they are anxious to have a tax reduction and they
are becoming more critical with respect to the forum in which
the tax reduction takes place.
And while I applaud the President's plan, the component
parts of the President's plan do not, I think, find themselves
constructive in the most favorable way for economic growth and
to provide incentives to growth.
My recommendation is that we change the President's plan in
such a way as to do what the President has said he would do,
and that is the commendable part of the position he takes
today, he's trying to implement what he campaigned on.
But to go a little bit further, I believe that you can see
change happening now already. A few weeks ago, some of us were
talking about retroactivity, and now retroactivity of the
President's plan seems to have a growing following, and I
indeed expect more retroactivity in the final analysis than
what you've seen already in the rate reduction that we've seen.
But while it is beneficial and is certainly just to do
things like eliminate the marriage penalty and eliminate death
taxes, and while death taxes in particular may have some long-
term growth incentives in their elimination, there are things
that I think we ought to be doing in addition to the marginal
rate reduction that could speak more quickly to today's more
immediate concerns. And those would be in the areas of capital
gains tax reduction to provide further incentive for
investment. But one thing that is indisputable now by our
historical experience with reducing capital gains is that it
does, in fact, incentivize growth in the economy, investment is
the engine of economic growth.
And, in particular, Mr. Chairman, since we see the scope of
your jurisdiction in this subcommittee, relate that to high-
tech world in which we live today. We are going through, in the
world, driven, I think, very largely in the United States, by
what I would call the ``electronic revolution.'' We have the
agricultural revolution, we had the industrial revolution, now
we are in the electronic revolution and it is a magnificent
phenomena.
The high-tech sector of the economy obviously shows us a
change. When we had our recent concerns about the stock market,
it showed up in the NASDAQ with the high-tech instruments
there.
So when we look at what we can do on the investment side,
we ought to be sensitive to what we can do to sustain high
levels of investment in this dynamic sector of the economy,
this leading sector of the economy.
Capital gains tax reductions certainly would be good for
that sector of the economy as it would be for any other sector
of the economy.
I think we ought to look, in particular, at some things
that we might be able to do in the high-tech sector. And one of
the suggestions I might offer is expensing capital for software
and perhaps even consider it for hardware simply because its'
rate of obsolescence is so high. My way of putting it is, that
every time you have another college dropout, you have another
new major innovation in the high-tech computerized sector of
the economy. And that, of course, means that people who would
want to implement this for the increased productivity they can
have, have to recapture that cost quickly or they may not dare
to do so, because it could be obsolete next year.
The other thing that I think that we have available to us
is the Portmann-Cardin retirement security legislation. This
expands IRA opportunities for all Americans. And certainly one
of the things that it does that you can put under the item of
justice is give hard-working American, stay-at-home wives, the
same access to this opportunity for their retirement as wives
who work outside the home. That is something that just must be
done.
The affordability is very important given the nature of our
economy today, especially, again, in the high-tech sector.
Those folks move around like college professors and they need
to take their pensions with them. So I think that's an
important point.
One final thing I would like to touch on, there is, today,
what I'm calling the ``rebate debate.'' Because of the success
that we have had in holding down spending and generating a
surplus to the economy, we have in this current fiscal year a
substantial surplus of some $70 billion. That money can be
available for a tax rebate right now almost immediately. And
that is not a bad thing to do.
Any time you take people's money, that is received by the
Government, in a sense as a tax overcharge, you can give it
back, and that would be a good thing to do. And I would be all
willing to do that. But I do not think we should entertain any
thought of doing that instead of a larger, more comprehensive
tax reduction policy such as the President proposed leading
with a rate reduction and adding some of these other growth
factors.
Anybody that would suggest that, I would suggest doing what
I would call ``rebate and switch.'' And that would be a bad
effort for us to entertain.
So what I would suggest on that is we take advantage of
this surplus that is in this existing fiscal year to enhance
what we can achieve under the President's plan. That is,
perhaps, by the way to transfer some of that money to some of
the out years to make the plan work more smoothly in the out
years, or indeed to, in fact, increase the retroactivity for
this year out of this year's money through some mechanism or
indeed possibly the rebate itself.
But let us not let this opportunity for immediate rebate
born out of this fiscal year's surplus detract our attention
from the larger requirement of providing America with a set of
new opportunities and incentives to do more in their life.
Let me put it to you finally in this way, if I were to get
into a poker game with a thousand dollars and win with this
thousand dollars, I would certainly celebrate that thousand
dollars and I have no doubt I would spend it to stimulate the
economy. But I would make no life changing decisions on that. I
would like to point out, incidentally, that if I were to lose a
thousand dollars, my wife would make a life changing decision.
[Laughter.]
And that is analogous to the region, certainly we will have
used it productively on behalf of our families. But it provides
no incentives for us to make change. As opposed to a tax plan
that says, for now and into the future you will receive a
greater take-home pay for your larger efforts. You will receive
a greater return on your investments to reduce capital gains
tax. You will be able to take a date to put into technology
that might be obsolete in a year, because you can afford it at
this time by expensing. Those are things that really provide
people the opportunity to take the risks, the innovate, be
creative, and improve technology.
We must never underestimate the impact of computerized
electronic technology in our economy and the impact is
precisely this. It give us growth to increase productivity and
that is the only way we can have growth without carrying with
it the current inflation. And that is the miracle of modern
electronics in terms of economics and we ought to foster
investment.
Thank you.
Chairman King. Thank you for your testimony.
I realize that your schedule is very tight this morning, so
I am going to yield my time to the Chairman of the full
committee, Mr. Oxley.
Mr. Oxley. Thank you, Mr. Chairman. And welcome, Mr.
Majority Leader, to your first appearance, and hope not the
last, before the new Financial Services Committee. Let me
commend you for your vision in helping us create this new
committee. And I think the ability to consolidate all of the
financial services jurisdiction under one committee was a wise
decision. And we appreciate your ideas and leadership on this.
I was driving in this morning and heard the Oakridge Boys
on----
Chairman King. Imus.
Mr. Oxley. Imus; very good.
[Laughter.]
You probably heard the same thing. And I thought
immediately of my friend from Texas and was pleased to have him
here today. I'm not going to ask questions and I'm going to
make my opening statement part of the record.
[The prepared statement of Hon. Michael G. Oxley can be
found on page 42 in the appendix.]
I just wanted to indicate our appreciation for your
appearance and your leadership on these economic issues.
Everybody knows you are an economics professor, and I think
once an economics professor, always an economics professor.
I remember a long time ago we were down in Oklahoma and we
were saying that you became an economist, but your mother
wanted you to be an accountant but you didn't have the
personality----
[Laughter.]
I've always remembered that for a long time. But we do--I
know your time is short and we do appreciate your appearance
here and look forward to working with you on a lot of these
economic issues that are so important to our country's future.
Mr. Chairman, I yield back.
Chairman King. Thank you, Mr. Chairman.
If I might just comment. I too listened to the Oakridge
Boys this morning and thought about Chairman Tauzin, who in
reflection about the construction of this committee in singing
their song, ``it takes a lot of river to wash these tears
away.''
[Laughter.]
We will pass it on to the gentleman from Louisiana.
[Laughter.]
I now recognize the Ranking Member, Mrs. Maloney.
Mrs. Maloney. And I thank the Chairman for being here and
for his ideas. You have often come up with ideas that stimulate
the economy. And I think everybody owes a debt to you for
coming up with the idea of the base closing commission.
Congress was stranded and couldn't move, and you came forward
and solved that problem and moved it forward.
I want to ask a question about the alternative minimum tax.
Under current law, the Joint Committee on Taxation estimates
that over 20 million Americans will fall into the AMT by 2011.
They also state that the Bush tax cut increases this number to
35 million--benefits of the Bush plan. The impact is especially
hard on States that have State income taxes like New York, the
State that the Chairman and I represent.
Just today, in the delegation meeting that we were at
earlier, the Chairman of the Ways and Means for the Democrat--
the Ranking Democrat Member, Mr. Rangel, circulated a letter in
which he merely stated that the program merely had changed the
name of tax they paid, not the size, talking about the AMT, the
tax cut moving more people into it. And I just wondered what
your comments were on it. Do you acknowledge this problem and
do you have any plans as to how to solve it?
Mr. Armey. Let me first of all thank you for raising that
question. This gives us another opportunity, I think, to
appreciate the President's openness. Because as we begin to
look at constructing the President's plan in the tax law,
Chairman Thomas immediately spotted this problem. And as you
can see, looking at what was done on the rate reduction bill
that passed the House a couple of weeks ago to address the
alternative minimum tax to mitigate against that that you will
see also in the bill that we have on the floor today where we
put a hold harmless provision in the bill that prevents
additional people from being afflicted by the alternative
minimum tax.
I think the healthy indicator that you see in both these
actions by the Chairman as the mark ups come out of his
committee and to the floor and the applause that he's received,
the encouragement from the White House is that, yes, we are
very much aware of that and we are very committed and mitigate
any impact on that, even to have a renewed look at the
alternative minimum tax in its total as to whether or not it's
something that should be continued in tax law.
So the one, I think, very healthy thing that has come out
of the President's proposal and our efforts to right it is a
very--let's say, thorough-going reexamination of the minimum
tax, how we can mitigate against that and, indeed, its very
legitimacy. So I think Chairman--or the Ranking Member Rangel
forgot to raise these issues. I think the committee is
sensitive to this and I know the Administration is encouraging
in that effort.
Mrs. Maloney. Can it aid him to fix the--within the $1.6
trillion that we're considering in that?
Mr. Armey. It seems to me that one of the things we would
have to do--I kind of laughed, I said, my mother always figured
I'd be in a straightjacket some day, but I never thought it
would be a $1.6 trillion straightjacket.
[Laughter.]
And one of the things that I'm encouraging everybody is, as
we re-examine our opportunities, let's see the extent to which
we need that extreme. We might be able to get around that, and,
indeed, the alternative minimum tax provides, I think, a need
that's sufficient enough so that any reasonable person that
wanted it accomplished, the other thing that we can do with
that tax cut--or maybe going to $1.7 or $1.8 is worth it in
terms of the good things we can do. So I think we just need--
outside the $1.6 million.
Mrs. Maloney. You mentioned in here an interesting idea, I
had really never heard of it before, of expensing capital for
hardware, acknowledging the great impact that technology has on
growing our economy. And would you expand that to parents to
deduct the cost of buying computers?
When I was growing up, we had to have a pencil when we were
in school. Now the kids have to have a computer.
I know that in New York a lot of our high schools and
middle schools are not even wired for computers. They don't
even have computers. How in the world can they get a job in
this new world economy without computers? I think it's an
important point that you raised about the impact of the new
technology of growing our economy and the importance of
recognizing it in business. I think we've got to recognize it
in education. And I wonder if you have any further comments on
it?
Mr. Armey. Well, one has to, I think, always be very
careful in terms of differentiating in electronics and
computers where it is, in fact, a business application and
where it is a recreational application. Because recreational
opportunities of the modern computerized technology are, of
course, enormous; so enormous that my wife no longer calls my
office ``my office'' she calls it ``my play room'' since I put
a computer in there. So as parents examine that, I think we
have so many efforts to try to get computers in the hands of
our young people through the schools and then other efforts. I
do think we need to differentiate.
If you're talking about expensing capital, whether it's in
the form of what kind software or hardware, I think you need to
keep that notion applied to where it is currently applied in
business applications.
Mrs. Maloney. Thank you very much.
Chairman King. Thank you for your testimony. We realize you
are to be at another meeting at 10:30. So we want to thank you.
I just would like to say that the more I hear about your
mother, the more I really admire her insights.
[Laughter.]
Thank you very much for your testimony today and any final
statement you want to make.
Mr. Armey. I just want to thank you again for letting me be
here. And I want to thank you all, in particular, for sparing
me the tough questions that might have come from Mr. Shays.
[Laughter.]
Chairman King. Thank you, Mr. Armey.
If the next panel will step forward.
Mr. Shays, would you like to make an opening statement?
Mr. Shays. No, Mr. Chairman.
Mr. Grucci.
Mr. Grucci. No, Mr. Chairman.
Chairman King. Mr. Ose.
Mr. Ose. No.
Chairman King. I recognize the Ranking Member.
Mrs. Maloney. OK. This morning the subcommittee considers
the topic, After the Tax Cut: Unleashing Economic Growth. While
I plan to raise a number of issues, I must comment on tax cut
stuff--actually on the floor that the Majority is proposing.
They constitute some of the greatest challenges to sustaining
economic growth by threatening a return to large deficits and
higher interest rates.
One of the Majority's tax cuts is so large based on
economic assumptions that it varied so greatly that we risk
deficits if our numbers are only slightly off.
CBO, whose rosy projections are the voices for the tax
cuts, indicated that its average error margin in projecting
budget surpluses or deficits for fiscal year in progress has
historically been about .5 percent of gross domestic product--
GDP. In the current economy this would be $54 billion in 1
year. As projecting 5 years out, CBO's average error has been
3.1 percent of GEP, a sixfold increase--to borrow a Bush catch
phrase this is truly ``faith-based budgeting.''
Second, despite the tax surplus the Federal Government is
enjoying, danger lies just over the horizon. The uncertainty of
the next 10 years, trumped by the uncertainty of the second ten
starting in the later half of this decade as the baby boomers
will begin to retire, drastically increasing our retirement
commitments. Should we find ourselves facing deficits in 2008
we will truly be in a dire predicament.
Third, as we all know, the economy is slowing and the
President's supposedly $1.6 trillion tax cut, which is actually
closer to $2.2 trillion with interest not paid on the debt and
the necessary fixes are included, is not conceived as economic
stimulus, it was a campaign package that was constructed 2
years ago to appeal to Republican primary voters.
It will have little immediate impact, and in fact, 75
percent of the promised tax cuts comes in the second 5 years.
The Majority may claim to want to end the marriage penalty, but
as some of my Democratic colleagues have pointed out on the
floor, their plan is like a tenth anniversary present.
These concerns are reflected today in an editorial that is
in The Washington Post entitled ``Tax Fraud.'' While I could go
on about this ill-conceived tax package, let me simply say that
the Democrats support tax cuts and we could easily have
bipartisan consensus for an historically larger, fair, and
immediate tax cut that would be supported on bipartisan basis
and passed in days. Looking beyond the Majority's flawed tax
cut there is a great deal Congress could do to spur economic
growth. The Federal Government plays a critical role in
encouraging research and development in the private sector.
This is especially important to technology companies that have
been the engines of economic growth, as the leader just pointed
out, in the last decade.
We must also increase our commitment to the education of
all of our children, especially those in public schools. I do
not believe that this is accomplished through any program that
we merely subsidize other schools by taking money out of the
public school system.
Finally, I strongly favor, as part of a responsible tax cut
plan, increasing IRAs and 401(k) contribution limits and
allowing for pension catch-up contributions. These provisions
increase savings and catch-up contributions can be especially
beneficial to women rejoining the workplace later in life.
I believe the Congress can make major positive
contributions to economic growth. My only fear that the
Majority's plan commits almost all of our expected future
surplus to a long-term tax cut that would do nothing for
economy now and it would take away our flexibility to deal with
future economic needs as they arise.
Let me just close by saying, even the economies only
projected a 5-year plan and that a 10-year plan really might
cause problems if there is.
I thank the Chairman.
Chairman King. Thank you, madam.
Mr. Shays.
Mr. Shays. I would love to make a statement.
The economy has had a 5-year plan, but then our economy
went down because it was an economy that was directed by the
Federal Government. My big fear is that if we don't return some
of the taxes back to the American people, we are going to start
to see an economy that is more directed by the Federal
Government.
I served on the Budget Committee for 10 years and during
that time I became more and more convinced of the value of tax
cuts. We had a President, President Kennedy, who wanted a tax
cut when we had no surpluses. We had another President who
wanted a tax cut when we had deficits. We have a President now
who is saying we should have tax cuts when we have a surplus,
and the surpluses are quite large.
In listening to the budget debate for the last 2 days, I
was struck by the fact that, contrary to what my colleagues on
the other side of the aisle were arguing, you know, no tax cuts
pay down the debt, practically everything that came forward was
just more spending. So the issue is, why would you want to
continue to spend more money if we could just spend the
surplus? That is where the difference is. And I would suggest
with all due respect to my colleagues, the Ranking Member whom
I agree with, much more than I disagree, cutting taxes a
quarter of the projected surplus makes eminent sense. Trying to
speed that up, I agree, would make eminent sense. But we phase
it in, and if in the future we decide we do not want part of
that phasing to go in, there is nothing to prevent a future
Congress from saying, let's not do it.
I am eager to hear what our colleagues have to say. I'm not
sure we will agree on everything, but I just learned a lot from
what all four have said over the past years and I think our
economy has been better for our listening to them.
So I am eager to begin this hearing and I thank you, Mr.
Chairman, for conducting this hearing.
Chairman King. Thank you Mr. Shays. I will now introduce
our panel.
First, Mr. Floyd Kvamme, who we mentioned before, was
appointed by the White House to the President's Council of
Advisers for Science and Technology; Mr. James Glassman from
American Enterprise Institute; and Dr. Martin Baily, Senior
Fellow, International Institute for Economics. We are expected
to have Larry Kudlow, who we presume is on the way.
Mr. Kvamme, we realize that you are going to have to leave
early and we would just ask you to go on and give your
testimony.
STATEMENT OF E. FLOYD KVAMME, CO-CHAIRMAN, PRESIDENT'S COUNCIL
OF ADVISORS FOR SCIENCE AND TECHNOLOGY
Mr. Kvamme. Thank you.
Mr. Chairman, I am pleased and honored to have the
opportunity to testify before the subcommittee on issues of tax
policy in capital formation and to submit written statements.
These hearings could not come at a more propitious time;
weakening economic performance and a greatly divided stock
market have significantly inhibited and will even erode the
ability of our capital markets to allocate the necessary
resources to fund growth in our economy and maintain our
international competitiveness.
I am a general partner at Kleiner Perkins Caufield and
Byers in Menlo Park, California; we are a high-technology
venture capital firm, and in that capacity, I serve on the
boards of directors of some seven high-technology companies. I
also serve as Chairman of Empower America, a Washington-based
issue advocacy organization; on the board of the Washington-
based National Venture Capital Association and on the Executive
Committee of the Technology Network, a network of about 280
high-tech firms with headquarters in California, but with
members from across the country.
My testimony today, while influenced by each of these
associations, represents, however, my personal view on steps
that could unleash the economy.
For more detailed explanation of my testimony here, please
review the written testimony I have submitted to the
subcommittee.
Mr. Chairman, as you know, the venture capital industry has
been a catalyst for much of our economy's remarkable and
consistent growth in the past decade. What used to be a
relatively small community of investors has expanded into a
nationwide industry. The skills of talented entrepreneurs and
managers backed by venture professionals has translated into
successful investments that have greatly increased interest
among the investing community in this asset class, and has
provided significant returns to the pension funds, foundations,
university endowments and other organizations that are our
limited partners.
These investments are helping to introduce and integrate
critical technological innovations that are being applied
throughout the economy. According to the Federal Reserve Board,
industry's application of information technology over the past
decade has vastly increased labor productivity.
Today, however, we are presented with the challenging
question of how to keep this level all productivity and
economic growth growing.
An important first step to economic growth is already being
taken. President Bush's tax relief proposal which is advancing
through Congress is critically important to both the short-term
and long-term growth. Reductions in marginal tax rates and the
elimination of both the estate and marriage penalties will
release much needed capital into the economy and lead to still
greater productivity. I applaud the steps you and your
colleagues have taken to enact the President's tax package.
But I urge you to consider more comprehensive tax and
regulatory relief efforts focused on sustained economic growth
in security. Below, I offer some specific ideas.
The number one priority of emerging growth companies is,
and always has been, sufficient and efficient access to
capital. Congress has taken important steps in the recent past
to help in this area, most recently in 1997 when it lowered the
capital gains tax rate. But our industry believes that further
efforts to lower the tax rate are necessary. The U.S. investors
face capital gains tax rates on both short- and long-term
gains, which are among the highest in the industrial world. The
U.S. long-term rate of 20 percent compares to an average of
14.8 percent overseas while top short-term rates in the U.S.
compared to an average of 18.4 percent international average.
Closing these differentials will significantly enhance the
incentives within our country to buy, hold, and sell equity
instruments for individuals and corporations.
Interestingly, if the past is any predictor of the future,
every time the capital gains rate has been reduced, revenues
from taxation of capital gains have increased. Thus, capital
gains reductions will broaden the President's tax cut proposals
while raising the after-tax return on capital, making it more
attractive for people to invest in startup companies.
In contrast to this focus on capital formation, the idea of
a $60 billion cash tax rebate check unconnected to more
comprehensive reform aimed at temporarily bolstering consumer
spending is circulated.
But as Larry Kudlow will probably point out, consumption
expenditures are the strongest part of today's economy. In the
current quarter, real consumer spending could, in fact,
increase by 3.25 percent.
In stark contrast stands investment spending, in the form
of diminished stock market purchases and business equipment
expenditures, which has declined, significantly pulling down
the entire economy. As a result, we should focus on increasing
capital investments as a means of restoring our economy to
health. Far preferable to any kind of stand-alone rebate would
be for Congress to provide a front-loaded acceleration of
January 1, of the across-the-board marginal tax rate reductions
proposed by the President.
On a smaller but more immediate scale, small business
access to capital can also be enhanced through the specific
regulatory clarification that will fully implement legislation
Congress passed several years ago such as Section 1045 of the
IRS code as governing partnerships. For a more thorough
explanation, please see my written testimony.
In addition, Congress and the President should act to
encourage savings by increasing limits, as the Ranking Member
just mentioned, of lifting the caps on IRAs, Roth IRAs and
401(K) plans. On regulations Congress should remain ever
vigilant to guard against the growing morass that is
encroaching on the high-tech and biotech industries such as
rules on communications technology and export licenses.
Excessive regulation of any particular industry increases
investment risks and thereby lowers the industry's access to
adequate capital.
Remember that the American high-tech industry leads the
world in virtually every area of competence and produces nearly
half of its revenue from export sales to further benefit of the
American economy. To my knowledge, there's no such thing as a
high-growth regulated industry. Continued leadership for
American companies could be threatened if regulations restrict
the freedom of action that the industry has enjoyed to date.
Thus, policies that promote free trade, efficient stock
markets, effective patent and copyright protection, tax
treatment allows the expensive software immediately, makes
permanent the R&D tax credit and removes obstacles to broadband
deployment and workforce development through strong support of
improving our education system, an area that we look forward to
working very closely with the President and Congress would all
be helpful.
The President's plan, along with these pro-growth tax
initiatives and a cooperative monetary policy will help
stimulate the economy. Then the Administration and Congress
should forge ahead to reform Social Security into a payroll-
tax-financed worker investment and personal retirement account
program by allowing workers to invest a portion of their
payroll taxes into personal accounts.
Again, I am honored and pleased to be before your
subcommittee to discuss these vitally important issues.
Although there's much work still to be gone to implement the
President's tax relief package, I commend you for your
leadership in beginning the discussion of the next steps to be
taken in order to enhance our economy's growth and efficiency.
Thank you.
[The prepared statement of E. Floyd Kvamme can be found on
page 46 in the appendix.]
Chairman King. Thank you Mr. Kvamme.
I also want to welcome the other Members who took all the
trouble to make it down here. I appreciate the effort they went
through to get here. And we have votes coming up.
What I would like to do is we will probably be leaving here
in about 7 or 8 minutes and then come back.
Mr. Glassman, if you want to begin your testimony, we will
perhaps finish your testimony before we leave to vote. Then we
will come back.
STATEMENT OF JAMES K. GLASSMAN, RESIDENT FELLOW, AMERICAN
ENTERPRISE INSTITUTE
Mr. Glassman. Thank you, Mr. Chairman.
Mr. Chairman, Representative Maloney, Members of the
subcommittee, the message I bring you today is that the U.S.
economy has slowed and that tax cuts and monetary easing are
necessary, but not sufficient to restore the rate of growth we
experienced in the late 1990s. What is critical is that changes
are made in regulatory policy to encourage what I call the
liberation of supply, the resurgence of output. I will give
brief recommendations on how this could be accomplished.
First, however, I want to congratulate my friend, Floyd
Kvamme, and say that it is an honor to be invited to testify
here on this important matter especially in the company of such
a distinguished group of economists including the Majority
leader who just left.
You know, it was Ronald Reagan who said that economists are
people who see something work in practice and wonder if the
would work in theory. And what has worked in practice over the
last two decades is the U.S. economy. We have far exceeded the
record for the longest expansion in U.S. history. Since World
War II we have had nine recessions, but only one since 1982,
and that, by historic standards, was shallow and brief, but it
still hurt. Recessions, even slowdowns, are extremely painful
to real people.
Today, we may have already entered into the tenth post-war
recession; at the very least, the economy has slowed
significantly.
Let me just briefly review the causes of the slowdown, the
reasons for the economic boom that we have seen, and some
recommendations on unleashing the economy once again. Here are
the major culprits as far as the slowdown is concerned:
Number one, Fed rate hikes. The Federal Reserve began to
raise interest rates in June of 1999 with little sign of
inflation. As far as I'm concerned, I believe it was a mistake.
Second, the tripling of oil prices. Eight of the nine post-
war recessions, including the last four, have been preceded by
an oil shock. It is the rising price of oil plus tighter Fed
policy that tends to cause recessions, and this double whammy
is present today, as well.
Third, the drag of high taxes and a gigantic surplus.
Federal tax revenues as a percentage of gross domestic product
last year were 20.6 percent--a level exceeded only twice in
U.S. history, and that during World War II.
The surplus itself is a reflection of these high revenues
flowing into Washington. Cash that could have been used for
consumption or new private investments is instead being used to
retire the bonds of investors who typically use the proceeds to
buy more bonds. Retiring debt--especially with debt at such low
levels as a percentage of GDP is no way to spur the economy.
And I respectfully refer the subcommittee to my article, ``The
Joy of Debt'' in the March 26 issue of The Weekly Standard.
Fourth, the end of the high-tech enterprise zone. The past
year, especially, has seen increased Government intervention in
the economy, especially in the high-tech sector as well as
Federal and State mismanagement of the planned deregulation of
telecommunications. A year ago, I argued that this change in
political approach to high tech threatened a ``regulatory
recession.'' We may be in it.
It is no coincidence that high-tech stock prices began
their 60 percent slide at almost the exact moment that the
Justice Department asked a Federal court to break up Microsoft
Corporation, the software company that is credited with
igniting the computer revolution in the early 1980s.
But before getting to the question of what should be done
to reverse the slowdown, let me just examine very quickly why
the economy has boomed up to now. Business cycles work in
fairly predictable ways. Prosperity causes demand to rise, it
bumps up against supply, constraints of production and labor,
prices rise, the Fed comes in and whacks down this inflation
with higher interest rates, the economy slows, and frequently
goes into recession and then we have the same thing all over
again.
But for most of the 1980s and 1990s, that did not happen.
We had strong growth--at times, twice the average with really
very low inflation.
Why?
The reason is that the U.S. has been undergoing what I call
a ``liberation of supply.'' When demand rose, it did not bump
up against supply constraints.
Why?
Let me just briefly cite four reasons:
One, the spread of free trade, both in goods and in people
through immigration.
Second, lower tax rates and better regulatory policies that
really began in the Carter and the Reagan years.
Third, better monetary policy.
And, fourth, Mr. Kvamme referred to this, the high-tech
revolution. The advent of inexpensive, powerful network
computers, has boosted productivity to about twice the historic
average. Very simply, productivity means more output for the
same input--that is, more supply.
But lately this liberation of supply has stalled, new
bottlenecks and shortages have developed and steps need to be
taken. Two of them, obvious ones, are already being taken.
First, the Federal Reserve has cut interest rates and will
continue to do so. Second, Congress has begun action on
President Bush's plan to cut taxes a total of $1.6 trillion
over 10 years. And while the hearing is titled ``Beyond The Tax
Cut,'' I heard a lot of talk about taxes and I'm going to put
in my two cents' worth. I want to emphasize the importance of
significant tax relief, rather than a quickie short-term cut
that will do nothing to stimulate the economy, in fact, it will
probably be counterproductive.
I would also just like to associate myself with the
comments of the Majority leader about expensing software and
hardware. The single step that would give the economy the
biggest boost would be to accelerate depreciation or allow
expensing of capital investment. You get an immediate boost and
a very big one. But we need more, specifically these few
things:
Number one, the U.S. must formulate a clear energy policy
that concentrates on encouraging supply. Currently, supply is
being severely restricted by excessive environmental barriers
to increase exploration for energy and by policies such as
``new source review,'' that discourage the renovation of old
refineries and utility plants and the building of new ones.
This is especially hurting the high-tech economy in California.
Second, the antitrust policy of later years of the Clinton
Administration should be changed to take into account the
realities of high technology.
Third, the bottlenecks that are restricting the spread of
broadband technology must be forced open. The main problem is
the lack of enforcement of the main piece of regulatory
legislation, the Telecommunications Act of 1996.
And finally, wireless, too, is being hurt by lack of
supply. Regulators should get out of the business of allocating
bandwidth to the politically powerful and instead let market
forces determine who gets space on the spectrum.
The U.S. economy has shown that, when supply is liberated,
growth rates of 4 or 5 percent--roughly double the post-World
War II average are possible without inflation. With tax cuts,
interest rate cuts, and a supply oriented energy policy and
sensible regulations, we can revive a prosperity that will
improve the lives of even more Americans than the boom of the
1980s and 1990s.
Thank you, Mr. Chairman.
[The prepared statement of James K. Glassman can be found
on page 50 in the appendix.]
Chairman King. Thank you, Mr. Glassman. We have to recess
to vote. Probably we will resume at about 11:15.
Mr. Kvamme, I realize you're going to have to leave. There
is no sense holding you around until the vote. I know Members
have questions for you. If it is OK with you, we will ask them
to submit those questions to you in writing and perhaps you can
give us the answers.
Mr. Kvamme. Again, I apologize for that. But I would be
very happy to, Mr. Chairman.
Chairman King. Thank you, sir.
And also, Mr. Glassman, your article, ``The Joy of Debt,''
without objection, I will have this inserted into the record.
Mr. Glassman. Thank you, Mr. Chairman.
[The article referred to can be found on page 58 in the
appendix.]
Chairman King. We will resume about 11:15.
[Recess]
Chairman King. The hearing will come to order.
I appreciate your patience and tolerance. Hopefully that
was the last vote for a while and we will be able to continue
with the hearing.
Our next witness was already introduced, and we look
forward to his testimony, Dr. Martin Baily.
STATEMENT OF DR. MARTIN N. BAILY, SENIOR FELLOW, INSTITUTE FOR
INTERNATIONAL ECONOMICS, WASHINGTON, DC
Dr. Baily. Thank you. Chairman King, Ranking Member
Maloney, and Members of the subcommittee, I appreciate this
opportunity to be able to talk to you about the economy and
some of the policies that might be affected in helping this
economy move forward.
Let me just note, as speakers have mentioned, that we
really have had an extraordinary period in our recent economic
history. This has been perhaps the longest and strongest
expansion of U.S. economic history. And a point that Jim
Glassman made, let us not be too theoretical here, let's look
at what worked in practice. The policies that were in place in
the 1990s have contributed to and helped us achieve this
extraordinary and unusual expansion.
One of the particularly striking things about this period
is what happened to productivity growth. Productivity growth
was very rapid after World War II for about 20 years,
unfortunately, then it began to slow down in 1973. The time
period is fairly short, but it does now seem, starting in 1995
and going through 2000, that the rate of productivity growth in
the U.S. economy doubled or slightly more than doubled.
That is a transformation. It affects living standards, it
affects family incomes, it keeps inflation down, it is a key to
strong economic performance. We need to make sure that whatever
we do we do not undermine that strong productivity performance.
Much of this performance was driven by new technologies,
but those don't raise productivity unless you have the right
environment.
Clearly, the economy started to slow in 2000. In part this
was a response to actions by policymakers, and the Fed in
particular, that the economy was running too fast and with a
very tight labor market, that it needed to slow down. The
resulting slowdown has been more abrupt than we wanted, and
there are certainly areas of economic weakness that are evident
here. But let us remember that even now the strong fundamentals
remain, we have low unemployment and moderate inflation once
the energy problem is under control. There is a good chance,
not a certainty, but a very good chance that we will avoid a
recession, but there will be pretty slow growth through much of
a this year. After that, we're going to get a resumption of
normal solid growth, even if we make no changes in tax policy
at this point.
In terms of dealing with the current weakness, the evidence
of history is pretty clear that monetary policy is the most
effective way to avoid a recession or if we actually go into a
recession to come back out of recession. And indeed the Fed has
acted quickly to lower interest rates and to try get us back on
track. Monetary policy takes a while to work and it may be
uncomfortable while we go through this current period of
slowdown, but let's give that, the right medicine, a chance to
work first.
With respect to a tax stimulus package, past history
suggests that manipulating taxes in order to save our economy
is relatively ineffective and can be counterproductive. I'm
certainly not the only one who thinks that. John Taylor, who is
a distinguished economist, who is either now a member of this
Bush Administration or will be soon, wrote a piece last year
evaluating the role of fiscal stabilization policy and
concluded that it generally is not very effective. And there
are a number of reasons for that included in my testimony.
More importantly though, we need to keep in place the
policies that have contributed to the outstanding economic
performance of recent years. The policy of fiscal discipline as
we shifted from deficits to surpluses has paid off quite
handsomely in the performance that I mentioned. And in order to
keep that fiscal discipline, we need to have realistic
estimates on what discretionary spending is going to be. We
need to be realistic, based on past actions, as to how much
discretionary policy we're going to have and how much Americans
want in terms of the programs that they are looking for.
The next aspect of fiscal discipline is that it creates
surpluses that give us the opportunity to start dealing with
the challenges of Social Security and Medicare. The long run
fiscal position that the United States faces as we look into
the century is not nearly as rosy as the current fiscal
position. One way, for example, to deal with Social Security
over the long run would be gradually to shift to a fully funded
system so that as people paid in they built up an investment
account and then they receive their retirement part back as
they retire. We do not have that currently. We have a pay-as-
you-go system.
In order to get from where we are now to where perhaps we
would like to be, we're going to need a substantial amount of
transition funding. And the surpluses, the ones over and above
the Social Security surplus, give us that opportunity to do
something about meaningful Social Security and potentially
Medicare reform.
I would also like to draw attention to the international
part of this. The U.S. is running a very large trade and
current account deficit. We are borrowing nearly $500 billion a
year. We have accumulated $2 trillion of net indebtedness.
The U.S. has have benefitted greatly from our ability to
tap into global capital markets. That has helped us with our
investment, it has helped our productivity, it has helped to
strengthen this economy.
One of the concerns of this hearing is access to capital.
We need to realize that we cannot keep borrowing at such a rate
from overseas. There are natural forces as the debt builds up,
a reduced willingness of foreigners to lend to us, that will
make it difficult for continued very high borrowing.
In order to reduce the current account deficit, we need to
increase national saving in our economy. Private saving is
likely to rise moving forward. It's been so low in part because
the stock market has been so strong. People haven't felt the
need to save as long as their houses and stock portfolios have
gone up so much. But as we have now had a flattening or decline
in the stock market, we probably won't get the same
astronomical gains going forward as we have had in the past. So
I would expect private savings to rise.
But we need to reinforce that by making sure we also have
budget surpluses which are a contribution to national saving in
order to turn around that situation.
Rapid economic growth over the long run requires investing
in the future. This helps productivity, which increases wages
and family incomes. It also helps the budget surplus, which can
get into a virtuous cycle as stronger economic growth improves
the situation.
I am opposed to any large or long-term tax cut which would
undermine the surplus. The surplus is needed to increase
national saving and as a way to deal with the demographic
challenge. The Social Security trust fund is scheduled to be
depleted in 2038. There are not going to be Social Security
surpluses going forward.
The tax stimulus package currently proposed would have only
a modest effect on the current short-term weakness. Any tax cut
that is designed as a stimulus should come into effect quickly
and should be targeted to lower income families that need help
in a softer economy. But whatever the pros and cons of a
moderate tax cut or rebate to stimulate the economy, a large
long-term tax cut that phases in gradually over the coming
years is the wrong approach to deal with a temporary economic
slowdown.
Something which came up in today's discussion has to do
with falling investment. There has been a sharp fall in
investment, but the main reason is that investment got ahead of
itself in 2000. The economic growth was so strong, the
telephone companies were out there investing, building more
capacity than was really needed. There was perhaps more
investment in high-tech than was justified by the fundamentals.
That's the reason for slowing investment. Investment should
resume as economic growth picks up.
Finally, the latest jump in consumer confidence is welcome,
but I think a lot of American families are still pretty
nervous. And one of the reasons they are nervous is they are
worried about what is going to happen to them if they lose
their jobs. They're afraid that they can't pay their bills,
they might end up potentially in bankruptcy. They're afraid
that their health insurance is going to evaporate.
So, this would be an appropriate time to review some of the
Federal programs like unemployment insurance, and programs that
help people without health insurance. If we strengthened some
of those programs, it would help improve consumer confidence.
Thank you very much.
[The prepared statement of Dr. Martin N. Baily can be found
on page 62 in the appendix.]
Chairman King. Thank you, Dr. Baily.
Our next witness is a man who feels so strongly about this
issue he braved the choppy skies and risked lightening and wind
to come down here this morning, Larry Kudlow, an old friend.
Mr. Kudlow.
STATEMENT OF LAWRENCE KUDLOW, CHIEF EXECUTIVE OFFICER, KUDLOW &
COMPANY, LLP
Mr. Kudlow. Thank you, Mr. Chairman and greetings to the
panel. My own Congresswoman, Mrs. Maloney, greetings, Mr.
Shays.
I just want to make a few points that I hope have not been
made by my other fellow panelists. First of all, the Federal
Reserve cannot do it alone. We have had a pretty significant
reduction of the Fed's policy rates, the Fed funds rate, and
the discount rate so far this year. They have knocked the funds
rate down by one 150 basis points, as you know, and similarly
the discount rate.
But the reality is, the stock market and the economy are
still very much in the doldrums. And I want to put on the table
the possible point for future discussion and that is, what
really matters in the current economic setting with respect to
the monetary policy, is not the level of the Federal funds
rate, it is the volume of high-powered liquidity that the
Central Bank injects into the economy. You know, this cycle was
never plagued by the problem of rising inflation and rising
interest rates.
Interest rate movements have been remarkably benign. I know
they went up a little bit in 1998 and the first part of 1999,
but, you know, as someone who cut his teeth in the profession
in the 1970s, this is nothing. And I'm glad the Fed fund rate
jumped from 6.5 to 5. And I believe personally when this cycle
is over it will probably get to around 3.5 or so.
But, more important than the level of raise is the volume
of high-powered cash that ejects to fund the economy. And there
are two ways to measure that. One is the measure known as the
monetary base, the other one is a subset of that measure which
is adjusted bank reserves. And neither one has shown much
stimulus in the economy so far. I just want to note that.
So we are in this strange position where the Fed is
bringing down its policy rate, but there has been only the
slightest improvement in general liquidity conditions. And this
is a subject that is unfortunately quite technical and quite
complex, but I can't begin to tell you how important it is.
I'm in agreement with Martin Baily, you can't do it alone,
but I surely agree the Fed is going to be a major player. I
don't think tax cuts will do it alone either. I think we need a
shift in macro-policies toward lower tax rates and easier
money, frankly.
So far we've gotten neither. And, therefore, it is not
surprising that the stock market continues to decline. I
characterize this--promises, promises, but what have you done
for me lately? The answer is, virtually nothing.
Just to add another point to this Fed story, there was some
increase in the monetary base in the month of January when the
Fed first began to cut rates. You may recall the stock market
did have a temporary rebound. But since then, the base has
actually leveled off--a level base. And actually declined in
its growth rate.
So, for the past 2 months the base growth has only been 1.6
percent; at an annual rate, that's a very meager rate. And
another measure which takes the currency component out of the
base is called adjusted bank reserves, which for the Fed--is
the old term ``non-borrowed reserves'' essentially. Non-
borrowed reserves have been essentially falling right now.
They're falling. They're not rising.
So, my point is from the standpoint of the monetary side, a
drop in interest rates is merely a reflection of the decline of
economic activity. It does not include any particular monetary
stimulus. And I speak here hopefully empirically and in a non-
partisan way for those people who believe that the Fed should
get the economy moving and I personally believe there's a good
deal of truth in that point. The fact is, they are not getting
the economy moving. They need to take a much more aggressive
posture with respect to controlling the high-powered cash flows
that they control. So that's point number one.
In the fiscal area, I found myself much more in agreement
with Mr. Glassman than with Mr. Baily. And I want to make a
couple of points on how I see the problem right now. Because
we've had a very deep stock market plunge, which I believe
today is more important than main street kitchens, than GEP,
since there's over 100 million Americans who are invested in
the market, the vast majority for long-term retirement
purposes.
The stock market plunge has caused a significant increase
in the cost of capital. There are many ways to show that, but
let me just choose what I think is a fairly obvious one in the
parlance of the--using the S&P 500 as broad as the most
representative index of stocks. About a year ago, in March of
2000, at the S&P was pretty close to its peak, the price
earnings multiple was roughly 33. The prices were roughly 33
times expected earnings.
Now, translating that into capital costs is very simple,
just invert the measure and you get earnings divided by price,
which gives you a bond yield. And at 33 times earnings, the
bond equivalent is 3 percent. Take one over the PE multiple and
divide. This is not a Republican point, this is not a
Democratic point, this is really a corporate finance point.
Now today, with the stock market down about, in rough
terms, 25 percent the S&P, the price earnings multiple has
fallen to something around 22 times earnings. And those are 22
times last year's earnings.
So the earnings yield has increased to 4.5 percent. I hope
I haven't lost you already. But the point I want to make is,
the earnings yield is one important measurement cost of equity
capital. The increase from 3 percent a year ago to 4.5 percent
currently is a roughly 50 percent rise. That's a very
significant increase in the cost of equity money. And that is
one of the most difficult consequences of the plunge in the
stock market. It is now much more expensive for everyone to
finance through equity fund. And I think we would all agree, we
would rather American companies, both large and small, use more
equity than debt.
So, with that in mind, I am concerned that fiscal policy,
particularly tax policy, must help relieve the cost of capital
increase which has occurred. And traditionally one can look at
this as the interest rate cost of capital and the tax cost of
capital. Although I want to underscore what Jim Glassman
mentioned, essentially the regulatory cost of capital, which is
an important point, but I'm going to leave that to his
expertise.
Traditional corporate finance is on the interest cost of
capital and the tax cost of capital. They're both very
important. And so the kind of tax changes that I would
recommend, the kinds of tax reforms I recommend would go to
reducing the cost of capital. And that leads me to two very
simple proposals:
One is the reduction in income tax rates, and, in
particular, as unfashionable as my sentence is going the be, it
is in this sense more important to reduce the top rates than
the bottom rates. My view is, all rates should be reduced. But
in strictly economic terms, with respect to the tax cost of
capital, the upper income rates are really tax rates on
capital, because that's the group that does the saving in our
economy, and we save to invest.
Investment required saving. Once you get into the middle
and lower brackets, there is virtually no saving and in the
lowest brackets there is substantially negative saving.
So if one wants to promote economic growth, which is, I
think, in many ways a different issue than various social-
related issues; if one wants to reduce the tax cost of capital,
then one would go to lowering the tax rate.
The other tax that, of course, comes to mind, and I'm not
shocky with people know my--capital gains tax rate. Capital
gains is the even more direct tax on capital. And so my
recommendation, Mr. Chairman, to deal with this economic slump
is to have immediate and retroactive reduction in marginal tax
rates on income and capital gains. Those are not the only tax
reforms that would be helpful. But, in an immediate sense, I
believe they would--and I use this word advisably--``provide
some shock therapy'' to the stock market plunge; which, in some
respects is feeding on itself right now.
You know, we are long past the point where normal
discounted earnings follows a future market value. Make any
sense? If earnings could fall by 10 percent in 2001, but if you
discount those earnings by a 4 percent treasury bill rate, then
the S&P 500 is at least 25 to 30 percent on the value right
now, that's all very interesting, but the market keeps
falling--forecasting, notwithstanding the market keeps falling.
So I have concluded that we need some shock therapy to jar the
quiescent animal spirit or investor spirits and create a better
atmosphere. And I think reduction in tax rates on capital would
be the best short-run policy.
I'm going to make two or three other quick points. In
addition to the rising cost of capital, the market plunge has
also generated significant increases of risk premiums on
capital. Now that, in some respects, is very much related to
capital costs.
One can see these risk premiums by the widening credit
quality spread between lower-rated corporate bonds and higher-
rated corporate bonds, and, of course, Treasuries, which are
risk free.
As Mr. Kvamme has indicated in his testimony, there has
been a general drying up of venture capital flows and there has
been a general pull back in the initial public offerings marked
``VIP'' only. Those are all additional pieces of evidence that
risk capital premiums have significantly increased. So I think
we need to take some tax measures and some monetary measures to
jolt the market attitude and to, if you will, create some shock
therapy.
As far as the economic outlook goes, I really believe for
those people who want an immediate tax cut on consumption, I
mean, I'm obviously sympathetic to the idea of an immediate tax
cut, but I must tell you, consumption is not the problem right
now. Consumption is not as healthy. Personal spending, personal
consumption expenditures, which is the largest category in the
national income accounts, are not as strongly growing as they
were a year ago. But, really, they are still positive. Up about
close to 4 percent in the fourth quarter, and I guess they'll
be up 3 percent or so in the first quarter.
Retail sales are rising, albeit more slowly. Automobile
sales are still at a high level. The analysts have pointed out,
I think Mr. Greenspan has pointed this out, incomes are still
growing however the slowdown and so forth.
Where the real weakness is occurring in the actual data is
on the investment side of the income potential accounts. In
particular, industrial production has fallen 5 straight months.
A sixth month of that could qualify as a recession indicator.
And factory orders and shipments continue to decline. We got
more bad news on that yesterday. There is an overhang of
inventories across the board. And gross domestic investment
declined in the fourth quarter and is set, in my judgment, to
fall again in the first quarter.
So we have an investment side recession. We have a capital
cost problem. We have an investment risk premium problem. And I
would argue that to generate long-run health of the economy we
should be looking at the supply or investment or capital sides
of the calculation, not the consumption side.
And, yes, I am a Wall Streeter and, yes, there is,
therefore, some preoccupation with the stock market. But I must
tell you, what has happened in the stock market is not
something to be just sloughed off, oh, it will recover, it will
recover. I remain an optimist in the long run, but I can tell
you, the stock market plunge is taking its toll on the economy,
on sinking investment spirits, and on the risk-taker. And to
expand the productivity revolution that Martin Baily discussed,
a point with which I completely agree with him--completely--we
need more capital. It is in many ways our most valuable
resource. It is capital that makes labor productive.
Thank you.
[The prepared statement of Lawrence Kudlow can be found on
page 68 in the appendix.]
Chairman King. Thank you, Mr. Kudlow.
Over the next several weeks and months we are going the
have very intensive debate in Congress about the President's
tax policy and whether or not it should be expanded, whether or
not it should be restricted. And my concern has been that there
appears to be a distortion of certain basic facts. For instance
there almost seems to be a--taken as gospel--that the Reagan
tax cuts of the 1980s did not work; it hurt the economy,
interest rates went up. My understanding of the Reagan tax cuts
is that interest rates--dramatically cut, 18 million jobs were
created, inflation were dramatically cut, 4 million Americans
came out of poverty during that time. It was the longest
peacetime expansion we had.
We have, over the last 19 years, had one brief recession.
And yet, both the media and among certainly many members in the
opposition party there's talk that these tax cuts did not work.
You can go back to the Kennedy tax cuts. There was no surplus
either. Those tax cuts worked.
So I would like to ask, what we can learn from the Reagan
tax cuts and how they are applicable to today, and how real are
the fears that if the economy does take a bit of a downturn, or
if there is a brief deficit that somehow this is going to ruin
our economy for years to come. So I would just ask the three of
you, I guess in order, Mr. Glassman, Mr. Baily, Mr. Kudlow, the
order in which you testified.
Mr. Glassman. Well, Mr. Chairman, I agree with what you
said. The Reagan tax cut certainly worked. Imagine today if we
confronted top rates of 70 percent on so-called ``unearned
income.'' This was the disdain with which policymakers viewed
investing. They called it ``unearned income.'' The top rate on
earned income was 50 percent. The Reagan cuts essentially
``liberated''--a term I used in my testimony--investment and to
some extent worked. And, indeed, while deficits rose, although
they did not rise because of these tax cuts, interest rates
fell. The economy boomed. The contrast between the 1980s and
the 1970s could not be more stark.
So, yes, marginal tax rate cuts work. Unfortunately, they
did go back up over the last 10 or 20 years. Well, we still had
rates considerably low. So I think that the Bush tax cuts,
which concentrate on marginal rate reductions are a good idea
and they are certainly a step in the right direction.
Chairman King. Mr. Baily.
Dr. Baily. Just briefly. The late 1970s and the early 1980s
was a very difficult period. There was very high inflation,
double-digit inflation. There was then a very deep recession in
1982. Following that, there was certainly strong economic
growth as the economy came out of that very deep recession.
Much of that growth was recovery from the recession and then
there was some reasonably solid growth after that, in part,
because a lot of people were coming into the labor force. My
concern about the Reagan tax cuts--by the way, I think 70
percent margin tax rates are too high--was they were too large,
they were based on an unrealistic view of how much expenditure
was going to be cut and so there were very large deficits.
Those did increase interest rates relative to what would have
occurred otherwise.
They disrupted financial markets, the international
exchange markets and we ended up with a big trade deficit, so
we actually were borrowing overseas to cover those deficits,
which is not what we are doing now. We are borrowing overseas
today to cover private investment. Then we were borrowing to
cover Federal deficits.
And the other thing to keep in mind is that productivity is
really a key to whether you can keep expansions going or
whether limits are going to arise. Productivity slowed after
1973 and it really did not accelerate in the 1980s. It stayed
at a very mediocre pace. The idea that large tax cuts would
liberate higher productivity. That did not happen.
Chairman King. Mr. Kudlow.
Mr. Kudlow. I'll just sign on to what Mr. Glassman
mentioned in aggregate terms. I will make a wee bit of a
follow-up to my friend, Martin Baily, that in my view, and I
guess I was there in OMB counting numbers, some days were
better than others in those days. The single biggest source of
the cyclical budget deficit was the rapid deceleration of
inflation, which we did not build into our numbers, because
when Jerry Jordan and Craig Roberts and--Jerry and I said, if
the Fed could get inflation down in a year or two, no one in
Washington agreed with us.
People hauled out their Phillips curves and told us this
will take 8 or 10 years. You probably could never get inflation
down. It was rising upward to 12 to 15 percent on the CBI. And,
Mr. Voelcker, who was a very heroic Fed chairman, if unpopular,
he was heroic, took the inflation rate down from the 12 to 15
percent peak to 2 to 3 percent inside of about 18 to 24 months.
And anyone who knows how the budget works knows that
revenues are estimated from the rate of rise in nominal GDP,
which is representative of national income. And the rate of
rise in nominal GDP was collapsed in the early 1980s. So the
inflation sponsored revenue increases that we had lived on for
the prior 10 or 12 years evaporated and they did so in an 18-
to 24-month period. That was the single biggest source of the
deficit.
I actually, with all respect in looking at the numbers,
would note that although the Congress may have spent too much,
``aggregate spending,'' totals from the Congress in the 1980s
were not significantly different from the aggregate spending
totals provided by the Reagan Administration.
The priorities were different. But the aggregates were
remarkably similar. And so I have never taken the view that
deficits were caused by too much spending. Indeed, the Federal
share of GDP began to fall in the 1980s and it intensified in
the 1990s, a good thing. But my point is, it was rapid, rapid
disinflation. And it wasn't--we had to do it, whatever, that's
what happened.
The second point is, we had trade deficits for 20 years.
The best way to cure a trade deficit is a recession. The only
time we went close to trade surplus was 1990-91, which was our
last recession. And I don't agree with Martin, foreign capital
has been flowing into the United States for 20 years, because
we've had the highest investment rate of return. And that's one
of the reasons our productivity rates are so high.
And I'll just add, Mr. Chairman, I have never seen
empirical evidence, I have never seen empirical evidence
whether it's regression analysis or any other statistical means
that proves a relationship between deficits and interest rates
or debt and interest rates for the U.S. economy. For other
economies, particularly in Latin America and Asia, yes. For the
U.S. economy I've never seen it. And I gave a paper to this
effect at the American Enterprises 2 or 3 weeks ago.
Chairman King. Mrs. Maloney.
Mrs. Maloney. Thank you, Mr. Chairman and I would like to
welcome all of our panelists, particularly Mr. Larry Kudlow who
is from the great State of New York and actually a neighbor on
93rd Street.
Mr. Kudlow. In your district.
Mrs. Maloney. Absolutely. And, Mr. Glassman, it's so
wonderful to meet you in person and not your website or one of
your many TV appearances.
And I would particularly like to welcome Dr. Martin Baily
from the Institute for International Economics. Dr. Baily
served as Chairman of President Clinton's Council of Economic
Advisors. I truly believe that one of the reasons that we had
the economic successes during the Clinton Administration, 8
years of sustained economic growth, was the high level of
people who served, particularly in the financial services area
with Rubin, Summers and Dr. Baily at CEA. So I welcome you and
I thank you for coming. I do appreciate it.
I would first of all like to ask Dr. Baily to respond to
Mr. Kudlow's remarks about the so-called ``tax cost of
capital'' that we need shock therapy to reduce rates and
capital gains in the economy. And also his comment that
deficits are not caused by spending, but by other factors and
that the way to cure a trade deficit is through a recession. I
would just like to hear your counterpoints on that.
Dr. Baily. Cost of capital, the second one was?
Mrs. Maloney. His statement that deficits are not caused by
too much spending.
Mr. Kudlow. Deficits in the 1980s.
Dr. Baily. Well, the price-earnings ratio in the stock
market is one element in the cost of capital. What I would do
is put this somewhat more into a historical perspective. We had
had a tremendous run up in the stock market. If you look back
historically the price-earnings ratio might have been around 12
and then it got up to 33 and now it is back down a little bit.
You may recall that Chairman Greenspan talked about
``irrational exuberance'' in the stock market. I think the Dow
was around 6000 at that time. So we just had an enormous
increase in the stock market which went beyond any good
estimates of what earnings growth was likely to be to sustain
it. So there has been a correction. I'm not going to forecast
where the market is going to go in the future, but I think we
have seen a correction, a necessary correction to get a little
bit more realism into the market. And the market is still very
strong in terms of its overall level. I would not regard it as
providing a significant barrier to investment.
The problem with investment right now is the overinvestment
that took place in the boom. Companies now need to get back on
track as we restore growth; which I think we can do.
As to the deficits in the 1980s, it's a matter of
arithmetic. A deficit is the difference between what we take in
and what we spend. So it can be affected by both sides of that
equation.
What happened in the 1980s was that we promised that there
were going to be bigger cuts in spending or that spending was
going to be controlled, in a way that did not happen. For good
reason. A lot of programs people want to have in place.
Another thing I mentioned about the 1980s is that although
there were significant cuts in income tax rates, there were
increases in payroll tax rates, so that a lot of people at that
time did not experience a tax cut. And looking forward, as I
mentioned in my testimony, the share of discretionary spending
in GDP has been going down. It went down significantly from FY
1992 to FY 2000. Given the need for a strong defense, given the
kind of investment programs in technology that are helpful to
growth into the private sector, you have to take a realistic
look at how much further squeeze there is likely to be on
spending. Then think of the tax cut in that context and what we
can sustain and still keep the surpluses going.
I don't know what to say about this recession reducing the
trade deficit. Technically it does. If everyone stopped
spending then they would stop buying from overseas. But I don't
think Larry Kudlow believes we should induce recessions to cure
the trade deficit. What we need to do is to find a way to make
sure that we sustain the level of national savings. We can do
this by increasing private saving and maintaining public
saving. This would bring more of a match between what we
produce and what we spend. That's the way to reduce the trade
and foreign account deficit.
Chairman King. The gentleman's time has expired.
The Chairman of the full committee, Mr. Oxley.
Mr. Oxley. Thank you. Mr. Chairman, let me welcome our
distinguished witnesses whom I've followed for a number of
years and appreciate their contribution to the debate. Let me
begin.
Mr. Kudlow, you mentioned that consumer spending tends to
or continues to be relatively robust, if I don't misquote you
or misstate it, and yet most economists tell us that two-thirds
of our economic growth is consumer spending. If that is the
case and we still have this robust consumer spending, then why
are you telling us that the economy continues to falter?
Mr. Kudlow. Well, because consumer spending is almost
always roughly two-third of GDP, whether the economy is rising
or falling. That's just the way the arithmetic works. At the
margin, however, it is highly unusual for consumer spending to
lead a downturn. It is almost always--the downturns are almost
always found in the investment side of the accounts, either
inventories or production or gross domestic investment. That's
what causes swings in business cycles.
Now, we have had periods, particularly in the late 1970s,
early 1980s, when the inflation rate was so high that almost
definitionally, logically, real consumer spending fell and it
had as much to do with the gigantic boost of inflation as it
did the actual drop in the volume of sales. And, actually,
right now there's a little risk here depending on how one
measures it.
In recent months, the last 3 months, the increase in retail
sales, which is a smaller component of consumer expenditures,
that increase is just barely keeping up with the inflation
rates--CPI. It's mostly energy and natural gas-related. But,
yeah, that's the reason. PCE just, you know, is always whether
the economy is up or down. It very seldom turns negative. When
it does we are in a heap of trouble.
Mr. Oxley. Let me ask Mr. Glassman if he agrees with that
general viewpoint?
Mr. Glassman. I do Mr. Chairman.
Mr. Oxley. And, Dr. Baily?
Dr. Baily. You made a valid point, which is that
consumption is a big part of the economy and since it's
continuing to grow, that's an optimistic sign that we should be
able to get through this period without recession, even though
there is a risk of recession.
Mr. Oxley. I've heard many people opine on the question of
whether, in fact, the stock market is really the economy and
I've heard a number of people say, that indeed the stock market
is not the economy. Let me ask you Mr. Kudlow, that is the old
adage that the market is predicted viable the last three
recessions, don't you concur that the stock market is totally
separated from the economy?
Mr. Kudlow. No.
Mr. Oxley. Well, let me ask Mr. Glassman, do you agree with
that?
Mr. Glassman. That the stock market is separated from the
economy?
Mr. Oxley. Yeah.
Mr. Glassman. No, not at all. In fact, the stock market
frequently tells us what the economy is going to do next But
there are major feedbacks, and I think this is what Larry was
saying, that when people feel that their wealth has declined as
a result of a sharp decline in the stock market, even if they
don't plan to use their 401K plan for another 20 years, they
cut back and it's not good for the economy. There are
definitely feedbacks.
Mr. Oxley. Well so far as though we haven't seen that.
Mr. Kudlow. Oh, yes, we have, we've seen it. We've seen a
slowdown, it's just not a feedback on consumption. It's a very
nominal fee. I never bought into the consumption wealth, stock
market wealth view that Mr. Greenspan has.
Mr. Oxley. You never bought into the wealth effect concept?
Mr. Kudlow. Which Mr. Greenspan himself has recently
abandoned. My point is the accepted point, different point. In
corporate finance terms movements in the stock market affect
the cost of capital and the returns to capital, and that runs
right through entire investment process.
In other words, the market is integrated to the economy,
because people in business, men and women in business, have to
make basic capital decisions, to invest or not to invest and
I--buying stock in their own companies. And they do that, in
large measure, based on capital cost which can be looked at in
terms of interest rates as well as taxes. There's a tax cost of
capital and an interest cost of capital.
What we've had in the last 12 months is a plunge in the
market, an increase in capital costs and we've had a
significant slowdown of investment spending in the economy. So
there's your link, it runs on the investment sides, not just
the consumption or down side.
Mr. Oxley. Thank you. My time has expired. Thank you, Mr.
Chairman.
Chairman King. Thank you Mr. Chairman.
The gentlemen from California, Mr. Ose.
Mr. Ose. Thank you, Mr. Chairman.
Dr. Baily, I want to explore something. Looking at your
written testimony under the summary.
Dr. Baily. Yes.
Mr. Ose. Down at the bottom you talk about a tax stimulus
package for a very large, long-term tax cut. The first point is
that the tax package is likely to have a modest effect on
current short-term weakness, and then your second point is that
a very large long-term tax cut that phases in gradually over
the coming years is the wrong approach to deal with a temporary
economic slowdown.
My question is, if we reversed the hypothesis--that is that
a tax increase package is likely to have only a modest effect
on the current short-term accounting, how long of a lag do you
envision in that impact? Is it 6 months, is it alleviated in 18
months?
Dr. Baily. We're talking about a short-term, immediate
package?
Mr. Ose. That's my first question, yes. If a tax stimulus
package is only going to have a modest effect, how long before
we get to that effect?
Dr. Baily. If it went into affect immediately, I would
expect its' impact to be fairly quick. Of course, people have
to feel it in their after-tax incomes, so you have to get it
through Congress and signed. If it were a tax rebate then
people would get it right away. If it's a reduction in rates,
then it would take a while before people would actually feel it
in their household after-tax income. But the impact would
certainly be 6 months or so.
Mr. Ose. Would that be the same in your comment about the
very long, large, long-term tax cut is the wrong approach to
deal with temporary economic explosion. Is it your point that a
very large, long-term tax cut should be oriented toward a very
long-term economic prosperity?
Dr. Baily. That's correct. And that long-term tax policy
should be geared toward maintaining economic prosperity. We
obviously have disagreement here. Many of the witnesses or
Members of the subcommittee believe that the tax cuts are a way
to get prosperity.
The argument that I am making in this testimony is that
running surpluses and maintaining fiscal discipline is the best
way to continue the prosperity. Either way, leaving aside that
difference, the setting of long-term tax rates should be based
on the goal of long-term prosperity.
Mr. Ose. So your point is that, it takes almost a
triangulated approach between fiscal policy, monetary policy
and tax policy to make the economy right?
Dr. Baily. Yes.
Mr. Ose. Well, we passed a tax cut here in the House and
the Senate last August and the President vetoed it. Can you
give me some indication as to why he said that we don't need it
and now 6 months later we're clearly in an economic downturn?
Dr. Baily. Well, it was a large tax package, it was long
term and the President believed--and his economic advisors
believed--that this would undermine the fiscal discipline which
we felt had brought us the very strong prosperity or
contributed to it. The private sector obviously is the prime
mover there. That was the reason that the tax package was
rejected by the President.
He also had some concerns about the distributional effects
of that tax cut. He felt that if you were going to have a tax
cut it should be that more of the tax relief should go to
lower-income families.
Mr. Ose. If I might follow up on that. I know by that time
Mr. Rubin had left the cabinet. I'm curious. Did the President
or anybody ever visit with Mr. Rubin about his perspective on
that proposal?
Dr. Baily. Well, I was not party to private meetings, but I
know he respects Mr. Rubin's opinion and I imagine he continued
to consult with Mr. Rubin. But I have no personal knowledge of
that.
Mr. Ose. Thank you, Mr. Chairman.
Chairman King. The gentlemen from Connecticut, Mr. Shays.
Mr. Shays. Thank you. I appreciate you holding this
hearing. This is fascinating stuff. It's fun to be on the
Budget Committee and look at these issues a little differently.
But let me first tell you from my budget experience, I thought
that one of the reasons we eliminated rapid--was that we wanted
Government to get off the spending at least during the 1970s
and the 1960s, so to say that the 1980s wasn't any different to
me, it was, that's the shame of it, it was supposed to be
different. And I just make that observation.
But my first question is this, there must be different
types of investment spending, because I have trouble Larry, Mr.
Kudlow, with the concept that inventory has been down, you
know, that's the area of focus, excuse me, inventory has been
up, spending of inventory has been down. The reason why
spending of inventory went down was that there was no consumer
spending eating up that inventory.
Mr. Kudlow. Actually, most of the weakness on that side is
from business, decline in business spending of the inventory.
Mr. Shays. No, this is not----
Mr. Kudlow. And when I refer to investment, Chris, or Mr.
Shays, I'm talking about investment in structures and
equipment. Yes, we're having an inventory correction, but I
kind of pushed that aside. We get inventory pressures from time
to time, so I'm not----
Mr. Shays. Mr. Glassman, your article is fascinating. One
of the interesting things about that, I got excited when we
coupled Social Security--the debt reduction, because it was
based on just spending. And also, we only had three options,
basically, we condition spend it, or we can provide a tax cut,
or we can pay down debt. Those are the three basic areas that I
see my ability in Government. And so I guess the question I am
asking is, has it been a healthy way for us to cut down
spending, by suggesting some of this surplus go to get out of
debt, and so isn't it a question of how much debt we could
have?
Mr. Glassman. Well, I think the objective is defensively to
stop spending. The best way to do is by stopping the flow of
tax revenues into Washington through a tax cut. I think that's
a much better way to do it than retiring the debt.
Mr. Shays. But we all are trying to be somewhat practical
here, I mean, its my choice then that we go this way, do you
agree that having a tax cut, may be even larger. Once we got to
that point the choices in the last 3 days and in debate was
spending more on a tax cut and there is a lot of interest in
spending. I mean, we're right about the caps----
Mr. Glassman. I agree. And spending more, first of all, I
want to say I think Martin and I were--and certainly Larry,
more than I--were among the few who saw these surpluses
developing 4 or 5 years ago. And my great fear was exactly
what's happened over the last couple of years, which is, it has
spurred Congress to bigger spending increases in the last few
years than we've had since the 1970s. How to stop that?
I think really the only way to do that is through a tax
cut.
Think about this: the Congressional Budget Office, in the
January 31 report, says that by 2006 we are going to have paid
off all the debt that we can pay off. It will all be gone, and
then we are going to start what the CBO calls ``uncommitted
funds.'' They had to actually invent a term for this, which is
money flowing into Washington that can't go to pay off the
debt, because it's already paid off.
Mr. Shays. It's going to be spent at this moment, my
concern is----
Mr. Glassman. Exactly. It is going to be spent and so we
need to reduce that flow and, by the way, it would also help
the economy to reduce that flow through a tax cut.
Mr. Kudlow. I mean, if debt retirement were going to stop
spending----
Mr. Shays. You need to get closer to the mike. But make it
short, if you could.
Mr. Kudlow. If debt retirement was the path to lower
spending, then it would have been the path to lower spending.
But it hasn't been. We've been retiring debt--spending more.
Mr. Shays. Let me just say, if we were not retiring debt we
would be spending more. I mean that is the challenge.
Mr. Kudlow. Maybe, I mean maybe. All I'm saying is----
Mr. Shays. Well in my 13 years here, you know, I just see
it's too darned easy. And my Republican colleagues are willing
to spend as much my Democrat colleagues.
Mr. Kudlow. Well, all I'm saying is that we have been
retiring debt in the last couple of fiscal years and as an
experiment we have not, this is not spending increases. That's
all I'm saying.
We're not spending all of it. We are retiring debt at a
rate of $1 billion per businesses day. It's quite amazing. But
if we were not getting that money flowing into Washington, then
there would not be any conditional spending and there would not
be as much debt retirement.
Mr. Shays. We're going to have a few more rounds, yes?
Thank you.
Chairman King. Mr. Grucci.
Mr. Grucci. Thank you, Mr. Chairman.
First let me acknowledge some of the students that are here
from the eastern end of the first congressional district.
Welcome and I hope you're find this enlightening, because I
certainly am.
Mr. Kudlow, you have testified that capital gains reduction
is helpful to the economy. And if you do believe that and I
happen to agree with that same philosophy, if you do agree with
that and you have stated that you do believe that it does work,
to what level should it be lowered or should it be eliminated
completely? And if it is eliminated or lowered, to what impact
do you see that having on the economy, the projections, the
surpluses that are materializing or for us to keep on course
through our current tax plan, budget that was outlined so far?
Mr. Kudlow. You know, there are two Presidents who have
resided over significant reductions in capital gains. One is
Ronald Reagan and the other is Bill Clinton, and they both
enjoyed tremendous economic success through the process. And
both times the revenues generated from capital gains went up. I
have a chart in my testimony on the Clinton capital gain
effect. So I think we have a lot of evidence, it's a good
thing.
Now, you asked what the right rate is, I'm not sure I have
all that listed. We're talking about a general tax reform and
simplification plan, which is something I devoutly desire. It
might be possible to eliminate cap gains or perhaps drop it to
something around 5 or 10 percent. It is currently, as you know,
20.
I don't know, I think right now dropping it from 20 to 15
would be an enormous help to the deteriorating investor
spirits. It would aid the return on capital, it would help
offset the higher cost of capital. All of which I think are the
biggest issues right now from the economics spectrum.
Mr. Grucci. Thank you. If I have time left, Mr. Chairman,
I'd appreciate the other panelists' position on that same
question.
Mr. Glassman. Well, let me just add another perspective to
this, and that is that one of the problems with a high capital
gains tax rate, that's what we have right now, is that it
misallocates capital. People tend to hold onto their
investments, even when they are not good investments, because
they do not want to take--they don't want to be hit by the
capital gains taxes. And I think that's one of the problems we
ran into in what a lot of people consider a tech bubble. People
have built up gigantic gains in stocks that they probably had
come to realize were not necessarily very solid companies. And
without really being able to get out of those stocks without
being penalized by a high capital gains rate, moving that money
into probably better uses for that capital. So that's one of
the big problems that capital gains, high capital rates cost
us.
Mr. Grucci. Thank you.
Dr. Baily.
Dr. Baily. A moderate tax on capital gains is appropriate.
It's fairly easy, well, not fairly easy, it's certainly
possible for many people to shift whether they receive income
as general income that's subject to the ordinary income tax, or
whether they receive it as capital gains. If there is no
capital gains tax at all, there's a danger that this becomes a
way of avoiding taxes altogether. I would suggest that we have
a reasonable capital gains tax rate.
The rate that's in place now--during this period there has
been a tremendous investment boom. There has been almost too
much money floating out to people with fairly vague business
plans. The capital gains tax that we had in place in this
period has certainly not been associated with a particular
shortage of capital.
Mr. Kudlow. But the only--if I could just----
Mr. Grucci. Sure.
Mr. Kudlow. As a tax reform as someone that has long
advocated flat tax type reform, my criteria is that income be
taxed only once. And when you get into capital gains and other
forms of saving and investment taxation, there is multiple
taxation and that renders the system a lot.
Mr. Grucci. I must say, I share your opinion on taxes--for
the American people.
Thank you, Mr. Chairman, I yield back the remainder of my
time.
Chairman King. Thank you, Mr. Grucci.
Ms. Hart--I'm sorry, Dr. Paul.
Dr. Paul. Thank you, Mr. Chairman. I want to direct my
questions and comments to Mr. Glassman and Mr. Kudlow. But
basically I think I'm in agreement with much of what you say,
because I'm a strong proponent that we ought to get taxes down,
the sooner the better, the more the better. I also think that
we ought to cut spending and cut regulations all to help the
economy. And the more the better. I wanted to make just a
comment about the surplus, where I have some slight
disagreement. I don't really want to dwell on that as I do
think that we should be concerned about the obligation of the
Federal Government and that has not been shrinking.
The only thing that shrinks is the marketable debt. So we
have a tremendous obligation, whether it's considered debt or
whether it's considered the national debt, the official
national debt actually hasn't shrunk. And those numbers may
well change in a recession, because at the peak of the market
our assumptions are wrong, but we have more revenues than we
think. At the bottom it's the opposite, we have a lot less than
we assume. So I think that is a future problem.
But I want to talk more about and get you to comment on
monetary policy and interest rates. Because you seem to accept
the definition that most everybody here accepts as the
definition of inflation. That is, if you look at CBI and the
CBI doesn't go up, there's no inflation. And I disagree with
that. Because from the Austrian viewpoint, you look at the
money supply. And the money supply is increasing significantly.
If you look at MZM right now, which is the best measurement
of the money that's available for spending, it is currently
going up at a 28 percent rate. So there's a lot of money there,
and that to me is inflation. And even to argue that we have no
inflation by the CPI and the PPI, we can look to--which you
admit we have rising prices, services are going up rather
quickly, medical fees are going up, education costs are going
up, the cost of housing is going up and something nobody wants
to put into the cost of living are taxes. So these are all
going up.
So I think there's tremendous inflation and an Austrian
economist would also include the inflated prices in the stock
market. And when you have excess credit floating out there,
people do dumb things. They develop overcapacity and
malinvestment, and they ``over-speculate.''
So instead of arguing that we lack capital, and lack money,
I would say the opposite is true. We've had way too much.
Greenspan expressed a concern in 1996 about the stock
market, and since that time he increased the money supply by 50
percent and M3 went up over $2 trillion. And, again, the attack
on the Fed for not addressing this quickly enough and
forcefully enough, we failed to remember that raising interest
rates aren't always that harmful immediately.
In 1994 to 1995 he raised interest rates 7 times. We didn't
have a recession. Nobody was hollering and screaming. But right
now he raised them and the market is ready to correct from all
the inflation. So I would say that it's a serious mistake not
to recognize that it's the mischief of the Fed that's causing
it--which you might agree with--but you're saying, ``Well, what
we need is more money.'' Under capitalism, capital comes from
savings. But we have no savings. We say, ``Oh, no, the stock
market is up and that's life savings.'' Well, does that mean
that we lost $4 trillion worth of savings in the last year?
It's because we have no savings.
And I don't see how you can solve the problem of inflation
with more inflation. It seems like the only debate that goes on
here is how wide the spigot should be. Should it be coming
faster or slower? And when you come up with the inevitable
slump that always comes from the inflated monetary system, the
money supply, then the only answer is, well, you didn't inflate
fast enough, or you turned it off too soon.
I would ask you to comment on those remarks.
Mr. Kudlow. Well, you covered a lot of ground, Congressman.
Let's see, I'll try to--I used to be a fairly devout reader
of--and, as I recall, he measured the value of money based on
commodity indexes and gold, both of which have been generally
falling in the last 20 years. I think that's about right. We've
been in a disinflationary environment bordering on deflation.
So that's my basic comment.
Technically I think you're confusing money supply with
money demand. People are front loading their money into
institutional and retail money market funds. That's a classic
signal of the lack of confidence in the market and the economy.
So as a result, MZM is rising rapidly. But that's a function of
the increased demand for cash and typically in an atmosphere of
declining interest rates, the opportunity--cash has come down
quite a bit. It is not a healthy economic sign. The only money
the Fed controls is the money they create, which is bank
reserves and that continues to decline, and that's a
deflationary signal. And I would hope that this subcommittee
would explore these issues, because I believe Federal Reserve
policy needs to come under much greater scrutiny.
Dr. Paul. My time has expired.
Chairman King. Thank you, Dr. Paul, for your questions and
for being an honorary panelist.
Ms. Hart.
Ms. Hart. Thank you, Mr. Chairman. I actually don't have
any questions for the panel, but I do want to thank them for
coming here and discussing this issue as we continue to debate
these issues as the actual full Congress.
Chairman King. I thank the gentlelady.
Do you have time for one more round? There are some more
questions that I would like to ask.
I would just to ask on question. Addressing the whole, what
I call ``class warfare'' about how too much money--that the tax
cut plan cuts too much for the top level. My understanding is
that when Reagan came in, in 1970, the top rate was 70 percent,
now it's 39. It went down further at one time. Still it's gone
from 70 to 39, and yet the people at that top rate in 1980 were
paying 18 percent of total revenues, now they're paying 30
percent of total revenues, which seems to indicate that as we
reduce the rate at the higher level they actually end up paying
more.
Now, maybe I have that backward, and I really would ask
that you clarify that, or is that accurate?
Mr. Glassman. Mr. Chairman, that is exactly accurate. The
thing I would just add about the top bracket, it's very
important to understand is that the majority of businesses in
American are sole proprietorships or partnerships. So they are
taxed, most of the ones that are doing half decently, at that
top rate. So we are not just talking about rich individuals, we
are talking about most half-decent sized American businesses.
Chairman King. Now, these are Sub-chapter S companies?
Mr. Glassman. Right. So we are talking about Sub-chapter S
corporations, partnerships and sole proprietorship, and LLPs.
So that is the majority of American business. That's the rate
that they're being taxed at, 39.6.
If you take the rate down a little bit, you'll have a big
impact on those folks who tend to be very entrepreneurial, it
will increase the flow of capital to those businesses and it
will increase investment and work. So its very important.
But your original point is very well taken. It is also, of
course, one of the political difficulties of cutting marginal
rates. The top 1 percent of earners pays 34 percent of the
Federal income taxes.
So any time you're going to have anything that's close to
an across-the-board tax cut, obviously people who pay most of
the taxes are going to get the biggest benefit in terms of
absolute dollars. Not in terms of percentage. In fact, the Bush
tax cut gives the biggest percentage cuts to people in the
lower brackets.
Mr. Kudlow. I just think that--I'm sorry.
Chairman King. Go on, Mr. Kudlow.
Mr. Kudlow. I just want to make an--you know, I think--the
bottom rate is consumption and the top rate is capital. I mean,
that's really how our system works.
Mr. Shays. Say that again?
Mr. Kudlow. he bottom rate is consumption and the top rate
is capital. That's really how it works. And, you know, I think
you've got some political forces who want to ease the tax rate
on the consumption and others want to ease the tax rate on
capital or investment. You know, you can do both. That's what
the beauty of across-the-board rate reduction is. It just
occurs to me. I mean, Martin Baily was talking about, you know,
if you pass a tax cut it will take effect on the economy pretty
quickly. And it just strikes me that two things happened here
and they merged together as some of the arguments.
Number one, if you lower tax rates across the board, the
IRS will make the adjustment to the polling rates, and in this
case it's a downward adjustment. Well, that includes cash flow.
So in that sense it's consumption oriented. But it also changes
the incentive system, because the extra dollar will be taxed at
a lower rate, which provides for greater reward for work effort
and investment capital decisions. So both work together. You
also get the benefit of dropping investment costs. But my point
is, supply siders argue the rate reduction, because it affects
behavior through a better reward system. Well, I think we need
that after the Fed has eviscerated the stock market. You know,
it's time for some rewards. But, also, if people are
concerned--fine, because their cash flows as Jim Glassman
indicated, their cash flows will benefit. It's win/win. But if
we choose one or the other, I think you're leaving the realm of
economic policy and you're going to the realm of social policy.
That's what I think. And, you know, I think right now we need
economic recovery policy, not social policy.
Chairman King. Dr. Baily.
Dr. Baily. If I could just make a quick comment. We want
people to be successful and those who are successful make
money. That's great for America. And, as we said, many of them
are in small businesses, some of them are large businesses. The
reason the proportion of tax revenue paid by people in the top
brackets has risen is that the economy has done so well. There
are more people moving up into higher brackets. Also, there has
been some widening of the income distribution. Certainly as you
look at taxable income, the distribution has widened. Many of
the benefits of this very strong expansion have gone to people
in the upper income brackets and they have then paid the tax
rates that apply to that group.
We were just talking about the availability of capital.
Most of the capital that is generated in our economy comes from
retained earnings of corporations. Corporations do pay taxes,
although the proportion of revenue coming from corporate taxes
has gone down. The availability of capital for investment is
largely generated by internal funds from companies or may be
subject to the capital gains tax rate which is lower.
Chairman King. Thank you.
Mrs. Maloney.
Mrs. Maloney. Dr. Baily and the rest of the panel, many of
my colleagues are comparing the Bush tax cut plan to the
Kennedy-Johnson tax cut of 1964. The Kennedy-Johnson plan cut
the highest tax rates from 91 percent to 70 percent, thereby
tripling the benefit of each dollar an individual earned. The
highest bracket decrease proposed by the Majority would go from
39.6 percent to 33 percent. While this overwhelmingly skews the
benefits of the overall package to the wealthiest taxpayers, at
the same time there's only an 11 percent less tax burden for
those taxpayers. Is this plan truly comparable to the Kennedy-
Johnson tax cut, would you say, or--and would you add, would a
reduction in the estate tax be an effective economic stimulus?
Dr. Baily and then Mr. Glassman and Mr. Kudlow, your comments.
Dr. Baily. One can exaggerate the similarities with the
Kennedy tax cut. I agree with the point that you made that 91
percent is a pretty absurd rate of tax. It was actually
appropriate to cut that rate; 70 percent was still pretty high.
Once you get up to 91 percent, you're going to get some
distortions. Bringing that rate down is a very appropriate
thing to do.
The parallel being made is that tax revenues rose after the
tax cuts were enacted. This was because the economy had been in
a recession in the early 1960s--there was a double-dip
recession--and as it recovered, there was high growth in the
economy. It may well be also, going from 91 to 70 percent, that
there were effects on the incentive side. Most of what happened
was the cyclical strength, which then went too far as
expenditures on the Vietnam War increased and the economy
became overheated.
The tax rate reductions that are being proposed now, to the
extent they have incentive effects, those would be
substantially smaller. But on the overall point: We should set
our tax rates with an eye to what's the reasonable burden that
people should pay relative to what the level of spending that
has to be financed. The incentive effects, most careful
analysis suggests, are fairly small to making moderate
adjustments in tax rates.
Mr. Glassman. I'm not sure if the implication of your
question is that the Bush tax cuts are too small. I would
probably agree with that. Certainly the Kennedy----
Mrs. Maloney. I think he answered it pretty clearly. Would
you say a reduction in the estate tax, do you feel that would
be an effective economic stimulus?
Mr. Glassman. It's not on the top of my list. In other
words, I don't think the estate tax has a big economic effect.
It has some. The main effect is a lot of money flowing to
lawyers and accountants so that people can set up a system
where they don't end up paying the tax. It's very inefficient--
one of the many inefficiencies in the tax code.
Mr. Kudlow. It's in the second tier of my wish list.
Mrs. Maloney. What effect do you think cutting the estate
tax would have on the economy? Do you think it would be an
economic stimulus?
Mr. Kudlow. Yes. I think it's pro capital formation,
absolutely. I think the measuring those effects, however, are
not easy, because so many people today don't pay because of
what Jim said, you've got the diversion of accounting and legal
financial planning industry, which is there precisely to set
up, I might add, highly successful avoidance schemes.
I just wanted to mention on the question you asked Dr.
Baily, you and I have gone back and forth on this for many
years, lower marginal tax rates are lower marginal tax rates.
And what President Kennedy proposed is, in terms of structure,
identical to what President Reagan later did and what President
Bush is doing. And I might add what President Clinton did in
the mid-1990s. Income distributions are different, inflation
rates are different, tax brackets and so forth are all
different. But lower marginal rates are lower marginal rates.
And Coolidge, Kennedy, and Reagan and Clinton did it in the
20th Century. Every time economic growth followed.
Mrs. Maloney. But after the Reagan tax cuts, Mr. Dole came
forward and had to increase taxes, because the deficit was
going up and was reacting to cuts that were too much.
Mr. Kudlow. The deficit went down.
Mrs. Maloney. And possibly we would have Republicans having
to raise taxes if this $1.6 or $2.2 trillion goes through.
Mr. Kudlow. Well, you and I might disagree about the
history of the 1980s.
Mrs. Maloney. Did Mr. Dole raise taxes roughly $300 million
after the Reagan tax cuts?
Mr. Kudlow. We did not change income tax rates. That's the
important point. Income tax rates were lowered in the 1981
bill, implemented over a 3-year period and they were never
raised. No.
Mrs. Maloney. Well, where did the Dole tax increase come
from?
Mr. Kudlow. The Dole program, and I don't want to single
out Senator Dole, he didn't have that much power in those days,
no Senator does. But the fact is, payroll taxes were raised and
some shifting about in the original corporate tax cut is
changed. In other words, the safe--releasing was repealed and
certain depreciation reform was repealed. The individual income
tax rates, which were brought down, were never raised. And I
might add, from the full implementation, which was January 1st,
1983, each and every year individual income tax receipts rose.
The non-payroll individual income tax receipts rose every year.
Mrs. Maloney. My time is up.
Chairman King. Mr. Shays.
Mr. Shays. Mr. Greenspan said that he supported a trigger
for surprising--tax cut and I don't want to--he said what about
spending? He said, well, he would support a trigger on
entitlements.
Is there logic to actually--I don't support a trigger, but
if you had one, couldn't I do the inverse and basically say,
you've got a great surplus that we need to accelerate the tax
cut? And if I did that, what would be the negative?
Mr. Kudlow. Well, I mean, that's an interesting model,
actually. I had considered that. There probably is merit to
that. Because I think the lower tax rates, if we're going to
get better here on the probe and that's actually going to throw
up higher surpluses which permit a greater tax reform in the
next decade.
Mr. Shays. Mr. Glassman.
Mr. Glassman. I agree with what Larry said. I mean, I'm not
for a trigger, that's for sure. I think it limits your
flexibility among many other things, but, if you had one,
that's not a bad idea.
Mr. Shays. Dr. Baily.
Dr. Baily. I'm not too enthusiastic about triggers. The
concern about a trigger would be that if the economy were
perhaps beginning to overheat at some future point, it might at
that point be throwing off larger surpluses. That's part of the
automatic stabilizer mechanism that helps to prevent that
overheating. So if you were to trigger greater tax cuts, this
would be the wrong policy. Similarly, if the economy would go
into a deep recession, the surpluses would disappear. I don't
think that would be a good time to increase taxes.
Mr. Shays. I realize this isn't the Ways and Means
Committee, but if I asked, in terms of the most important as it
relates to taxes, stimulus, fairness, inefficiency or--to get
it off the table, get the money off the table.
Mr. Kudlow. Stimulus.
Mr. Glassman. I think I would go for number four first. I
would say get the money off the table, and then I guess I would
say stimulus and then efficiency and fairness is a five.
Mr. Shays. Fairness is the easiest one for us to argue for
our constituents, so I'm sorry.
[Laughter.]
Mr. Shays. Dr. Baily.
Dr. Baily. I would think efficiency and fairness would be
the two I like.
Mr. Shays. I will yield back. Thank you.
Chairman King. Dr. Paul.
Dr. Paul. Thank you.
I think a good marginal tax rate ought to be about 10
percent. Any person who has to pay more than that--10 percent,
let's give them 10 percent and then let's work on it. But, of
course, that involves a spending problem. I want to get back to
money policy and deflation. I was looking at Mr. Kudlow's chart
that he gave us, and it shows that the monetary base, the
reserves monetary base was rising at a 17 percent rate a year
ago and it evened out and now is at 4 percent. So I would not
call that deflation. And the rapid rise a year ago, so we have
a lot of cash floating out there.
To me, deflation is what happened in the 1930s. The supply
shrinks, the purchasing power of a dollar goes up. By all
measurements the supply is going up, the purchasing power of
our dollar is going down. And commenting again on the panacea
that everybody looks to that all we have to do is get the lower
rates and we're going to solve our problem. Just like the seven
increases in rates in 1994-95 did not give us a recession,
sometimes the lowering of the rates won't do what they did the
last time.
For instance, interest rates are 0 percent in Japan because
we're not getting a stimulus. As a matter of fact, after the
depression got going we took interest rates very, very low and
it was the old story about pushing on a string, it doesn't
always work. So I do think that this concept of money and
market policy is still very, very important, because I believe
it's the mistakes made previously that gives us this mandatory
correction, to me that just makes the bubble that much bigger.
But I do want to follow up on a comment Mr. Kudlow made on
the indicator of the gold price. And I think that the gold
price could give us a good indication of what was happening,
except that the gold price is not controlled by the
marketplace. In the 1960s, we maintained the gold price at $35
an ounce by dumping gold. Therefore, the gold price was no
indication at all about what was to come in the 1970s. Finally
they quit dumping the gold on the market.
Today, gold is being dumped on the market in a different
way. Central banks are loaning that gold, that gets dumped on
the market. And some of those funds are used to buy Treasury
bills, it props up the dollar at the same time it drives the
price of gold down. Britain and other countries have literally
sold hundreds of tons of gold into the market. So I would ask
whether or not you think this is really a good number to
follow, a good price to follow, indicating what the market is
telling us.
Mr. Kudlow. Well, I wouldn't bet the ranch on any one
indicator. But gold holds up pretty well over time. As I
mentioned, in the last 20 years, the weight of the direction of
gold trends has been deflationary, not inflationary.
I agree with your other point on interest rates. I
mentioned that in my opening remarks, interest rates don't tell
you much about monetary policy.
However, if you examine that chart I'm glad I got somebody
to take note of that monetary based chart. Going from 16
percent growth over a 12-month change to minus 2.5 is one of
the biggest swings in post-war monetary history. And, by the
way, going on the other side, going from 5 to 6 percent of 16
was an inflationary swing in 1998 and 1999. But going from 16.5
to minus 2.5 in 12 months ended in December 2000. That's
exactly what we're paying for in this economy. And to say that
base growth now has jumped a little bit back to 3, 4 percent, I
don't think the Fed's job is nearly done. And I think somebody
with a higher paid rate in mind need to evaluate how this all
developed, because when the monetary authorities come before
Congress, they do not talk about this.
Dr. Paul. I think this makes my case that no Fed official,
bureaucrat nor politician knows how to manage the money
supply--they're incapable of doing it. And I think these swings
indicates it. And we have probably too much faith in an
individual knowing, well, what is the proper interest rate,
what is the proper money supply believing that they know how to
turn the spigot on and off. I contend that it's something not
known and that this has to be decided by the marketplace, but
we have given up on the market for one half of our economy, and
that's the money system. And that dictates everything. So we
are central planners through the control of money supply and
interest rates, so we are much more into central planning and
Greenspan is the biggest central planner. So when things go
well, he's a saint and when they go badly, you know, he's the
devil.
Mr. Kudlow. Well, I have made some of the same points,
Congressman. But I will say this, since we have a Fed and the
Fed is vested with the authority of open market operations, we
need to look at what they're doing.
For some reason, and I'm a keen student of the testimonies
of central bankers before Congress, for some reason, no one
goes down this road; no one looks at these issues. Members talk
about taxes, the budgets, and deficits, and debts and triggers
and all the rest of it, but there's never any discussion about
money, which is after all what the Fed controls. And, as you
know, there's only one interest rate the Fed controls. Well,
I'm sorry, two. They control the discount rate and then they
mostly control every other interest rate in the economy is not
controlled by the Fed. But what they do control is the creation
of bank reserves. And I wish you would look at that.
Mrs. Maloney. That's subject matter for another hearing.
Dr. Baily. Can I make a quick comment on that? Let me first
of all correct an impression that I may have given in thinking
that the Fed does it all. That's not my view. The Fed leans
against the wind. There are natural forces in the economy that
give rise to ups and downs. Recovery begins as inventories are
reduced.
And the other comment is on the change in the financial
system. The changes taking place in the financial system, and
the deregulation of the banking system, have made the money
supply a much less useful measure and that's why most people
look primarily to the effect of interest rates.
Chairman King. I would like to thank the entire panel for
their testimony. Again, as the debate goes forward, I would
hope that everyone would look at the your comments today, your
testimony which added immeasurably to the debate. And so I just
want to thank you for your time and being here.
I just want to note some Members may have additional
questions for the panel that they may submit in writing.
Without objection the hearing record will remain open for 30
days for Members to submit questions to the witnesses and place
the responses in the record.
The hearing is adjourned.
[Whereupon, at 12:45 p.m., the hearing was adjourned.]
A P P E N D I X
March 29, 2001
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