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34–132—PDF 2006

S. HRG. 109–841

SAVING FOR THE 21ST CENTURY:

IS AMERICA SAVING ENOUGH TO BE

COMPETITIVE IN THE GLOBAL MARKETPLACE?

HEARING

BEFORE THE

SUBCOMMITTEE ON LONG-TERM GROWTH

AND DEBT REDUCTION

OF THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

APRIL 6, 2006

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

CHARLES E. GRASSLEY, Iowa, Chairman

ORRIN G. HATCH, Utah

TRENT LOTT, Mississippi

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

CRAIG THOMAS, Wyoming

RICK SANTORUM, Pennsylvania

BILL FRIST, Tennessee

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

MAX BAUCUS, Montana

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JAMES M. JEFFORDS (I), Vermont

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

KOLAN DAVIS, Staff Director and Chief Counsel

RUSSELL SULLIVAN, Democratic Staff Director

SUBCOMMITTEE ON LONG-TERM GROWTH AND DEBT REDUCTION

GORDON SMITH, Oregon, Chairman

CHARLES E. GRASSLEY, Iowa JOHN F. KERRY, Massachusetts

(II)

C O N T E N T S

OPENING STATEMENT

Page

Smith, Hon. Gordon, a U.S. Senator from Oregon, chairman, Subcommittee

on Long-Term Growth and Debt Reduction, Committee on Finance ............... 1

WITNESSES

McCool, Dr. Thomas J., Director, Center for Economics, Government Accountability Office, Washington, DC ........................................................................... 3

Timmer, Jurrien, director of market research, Fidelity Investments, Boston,

MA ......................................................................................................................... 7

Bosworth, Dr. Barry P., senior fellow, economic studies, Robert V. Rossa

Chair in International Economics, Brookings Institution, Washington, DC ... 9

Brainard, Dr. Lael, vice president and director, Global Economy Development

Center, New Century Chair in International Economics, Brookings Institution, Washington, DC ........................................................................................... 14

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Bosworth, Dr. Barry P.:

Testimony .......................................................................................................... 9

Prepared statement .......................................................................................... 27

Brainard, Dr. Lael:

Testimony .......................................................................................................... 14

Prepared statement .......................................................................................... 34

McCool, Dr. Thomas J.:

Testimony .......................................................................................................... 3

Prepared statement .......................................................................................... 38

Smith, Hon. Gordon:

Opening statement ........................................................................................... 1

Prepared statement .......................................................................................... 59

Timmer, Jurrien:

Testimony .......................................................................................................... 7

Prepared statement .......................................................................................... 62

COMMUNICATION

American Council of Life Insurers, et al. ............................................................... 85

(III)

(1)

SAVING FOR THE 21ST CENTURY: IS AMERICA

SAVING ENOUGH TO BE COMPETITIVE IN

THE GLOBAL MARKETPLACE?

THURSDAY, APRIL 6, 2006

U.S. SENATE,

SUBCOMMITTEE ON LONG-TERM

GROWTH AND DEBT REDUCTION,

COMMITTEE ON FINANCE,

Washington, DC.

The hearing was convened, pursuant to notice, at 2:30 p.m., in

room SD–215, Dirksen Senate Office Building, Hon. Gordon Smith

(chairman of the subcommittee) presiding.

Also present: Senator Kerry.

OPENING STATEMENT OF HON. GORDON SMITH, A U.S. SENATOR FROM OREGON, CHAIRMAN, SUBCOMMITTEE ON

LONG-TERM GROWTH AND DEBT REDUCTION, COMMITTEE

ON FINANCE

Senator SMITH. We will call this hearing to order. This is the

U.S. Subcommittee on Long-Term Growth and Debt Reduction of

the Finance Committee. I apologize to you that many of your colleagues got scrambled with the latest bomb scare. So perhaps you

were not in a building affected by that.

I know Senator Kerry is headed here, and we will certainly turn

to him when he arrives. But we thank you for being here to discuss

a topic of growing concern in America, simply our national savings.

The bottom line is, Americans simply are not saving enough.

This is true of both our government, and our citizens. Our national

savings rate is among the lowest of any other major industrialized

country. For the first time since the Great Depression, we have a

negative personal savings rate in this country.

These saving trends are especially troubling because of the dramatic demographic shift our country is unavoidably about to experience. By 2030, the segment of our population over age 65 will become twice as large as it was in the year 2000. This shift has been

described by some as an aging tsunami.

Americans are living longer than ever before and spending more

years in retirement. A person who reaches age 65 can expect to live

another 18 years, and most Americans retire before they reach the

age of 65.

If you boil it down, that is 18 years a person is consuming medical care, housing, food, and other resources while in retirement,

while not producing or contributing to the national economy in

2

terms of employment. Americans are simply consuming more in retirement than any previous generation as well.

You compound this problem with the new wave of baby boomers

going into retirement, and you have a demographic train wreck.

The first of the baby boomers will turn 60 this year. Therefore,

over the next few years as the boomers reach retirement age, a

huge wave of Americans will be leaving the workforce. This trend

will have significant impact on our economy.

Unless our immigration policies change, it will likely result in future labor shortages. This will hurt the competitiveness of American businesses, and our economy will stagnate. Because of the

sheer number of baby boomers, we must also be concerned with the

potential brain drain. Our workforce will be losing some of our

most experienced workers, many of whom have skills that are simply not replaceable, or not soon replaceable.

All of these trends—the aging of our population, our increased

life expectancy, and the impending retirement of baby boomers—

will place significant strains over the next several decades on our

senior entitlement programs of Social Security, Medicare and Medicaid. While these programs have improved many Americans’ lives,

the reality is that they simply cannot be sustained long-term in

their current forms.

Under current law, benefits will grow much more rapidly than

revenues because of the increases in the number of retirees versus

workers. In 1950, there were about 16 workers for every Social Security recipient.

Today, this ratio has fallen to about three workers per retiree.

By 2030, there will only be two workers for every retiree receiving

benefits. Federal spending on these programs will increase considerably.

In 2004, Social Security and Medicare spending accounted for 6

percent of GDP; by 2030, it is projected to increase to about 9 percent. Reforming our entitlement programs is necessary, but we

must do so in a thoughtful manner so as not to hurt those Americans who rely on these benefits the most. These reforms will require some difficult political decisions.

I think most of my Senate colleagues realize that we must take

action to ensure that the vital retirement and health programs are

around for the next generation—in addition, our entitlement programs. I have spent a great deal of time over the last year examining the issue of retirement savings.

As I noted earlier, most Americans are saving less than ever before, and many Americans are not saving at all. This is a very, very

disturbing thing. For that reason, Senator Conrad and I have introduced a bipartisan Retirement Savings Security bill.

One of the key savings proposals in our bill encourages employers to adopt automatic enrollment in 401(k) plans. It has other features as well, but all of it is designed to simply incentivize people

to save for their retirement.

I will put the balance of my statement in the record.

[The prepared statement of Senator Smith appears in the appendix.]

Senator SMITH. I want to welcome our witnesses today, who have

a wealth of experience on savings issues.

3

Our first witness will be Dr. Thomas McCool, who is the Director

of the Center for Economics with the Government Accountability

Office. Dr. McCool will discuss the impact of the national savings

on our economy.

He will be followed by Mr. Jurrien Timmer, who is the director

of market research for Fidelity Investments. Mr. Timmer’s testimony will focus primarily on personal savings and retirement.

Dr. Barry Bosworth is someone known to me through a television

set for many years. He is a senior fellow in economic studies at the

Brookings Institution. He will examine international saving trends

in human behavior.

Dr. Lael Brainard is also from the Brookings Institution. I pronounced your name wrong. How do you pronounce it?

Dr. BRAINARD. Lael.

Senator SMITH. Lael. Very nice. She is vice president and director of the Brookings Global Economy and Development Center. Dr.

Brainard will discuss the impact of national savings on international competitiveness.

We thank you all for being here. Dr. McCool, we will start with

you.

STATEMENT OF DR. THOMAS J. McCOOL, DIRECTOR, CENTER

FOR ECONOMICS, GOVERNMENT ACCOUNTABILITY OFFICE,

WASHINGTON, DC

Dr. MCCOOL. Thank you, Mr. Chairman. I appreciate the opportunity to talk with you today about national savings and the central role it plays for our Nation’s long-term economic growth and

future living standards. National savings is the sum of savings by

households, businesses, and all levels of government.

It represents resources available for investment to replace old

factories and equipment and to buy more and better capital goods.

Higher savings and investment in the Nation’s capital stock contributes to increased productivity and stronger economic growth

over the long run.

Comptroller General Walker has spoken frequently about the

fact that our Nation faces a number of deficits, including three that

are directly related to this hearing. These three interrelated deficits are our Nation’s budget deficit, savings deficit, and current account deficit.

Unfortunately, America has been heading in the wrong direction

on all three deficits in recent years. Nonetheless, we have a window of opportunity to turn things around, but we need to act, and

act soon, because the miracle of compounding is currently working

against us.

Today’s savings and investment decisions have profound implications for the level of well-being in the future. Increasing personal

saving is an important way to bolster retirement security for current workers, and increasing national saving will allow future

workers to more easily bear the cost of financing the Federal retirement and health programs, while maintaining their standard of

living.

In my testimony today I will describe these three deficits and

why they raise concerns about our Nation’s long-term growth and

its ability to finance the health and retirement needs of an aging

4

population. Finally, I will discuss the Federal Government’s role, or

potential role, in increasing national savings.

The first deficit we face is the Federal budget deficit. In 2005, the unified budget deficit was around $318 billion, or 2.6 percent

of GDP. This figure is an approximation of what the Federal Government absorbs from private saving.

Although a single year’s deficit is not a cause for concern, persistent deficits are. The U.S. faces the prospect of persistent, large

deficits in the near future and significantly larger deficits further

out in the future. Federal deficits reduce the amount of national

saving available for investment. They also lead to growing Federal

debt on which net interest must be paid by current and future generations.

More significantly, over the next few decades Federal spending

on retirement and health programs, Social Security, Medicare,

Medicaid, and other Federal pension, health, and disability programs will grow dramatically.

Absent policy changes on the spending and/or revenue sides of

the budget, a growing imbalance between expected Federal spending and tax revenues will mean escalating, and eventually unsustainable, Federal deficits and debt that could threaten our future

economy and standard of living.

The budget deficit represents dissaving by the government, but

the U.S. suffers from an even broader national savings deficit. National saving is the sum of personal saving, corporate saving, and

government saving.

Last year, the net national saving declined to less than 1 percent

of GDP, and the personal saving rate was slightly negative. A negative personal saving rate means that, in the aggregate, households

are spending more than their current income by drawing down past

savings, selling existing assets, or borrowing.

No one is sure why the personal saving rate has declined. One

possible explanation is increases in household wealth, which surged

in the late 1990s due to the stock market boom, and more recently

due to the run- up in housing prices.

If people feel wealthier, they may feel less need to save. Continued financial liberalization and innovation have also made it easier

for Americans to borrow, particularly against real estate wealth,

which may have led to greater consumption.

Now let me turn to the third deficit, our current account deficit.

The current account deficit is the difference between domestic investment and national saving. That is, it is the amount of domestic

investment financed by borrowing from abroad.

Over most of the past 25 years, the U.S. has run a current account deficit. But in 2005, the current account deficit hit an alltime record, $782 billion, or over 6 percent of GDP. That is twice

what it was only 6 years ago.

While current account deficits support domestic investment and

productivity growth, they also translate into a rising level of indebtedness to other countries. In our testimony, we have a figure

that shows that net foreign ownership of U.S. assets grew to more

than 20 percent of GDP in 2005. The fact that our net indebtedness

to other Nations is rising so rapidly raises concerns that the U.S.

current account balances are on an unsustainable path.

5

Because investors generally try to achieve some balance in the

allocation of their portfolios, and U.S. assets already represent a

growing and significant share of foreign portfolios, economists and

policy makers are concerned about what would happen to the stock

and bond markets if these foreign investors began to reallocate

their portfolios, lowered their rates of accumulation, or worse yet,

started to sell off their holdings. This could raise U.S. interest

rates, reduce investment and growth, unless offset by increased

U.S. savings.

Now let me turn to the Federal Government’s role in national

saving. From a macroeconomic perspective, it does not matter who

does the saving. Any mix of increased saving by households, businesses, and government would help to grow the economic pie.

In light of the virtual disappearance of personal saving and concerns about U.S. reliance on borrowing from abroad to finance domestic investment and the looming fiscal pressures of an aging

population, now is an opportune time for the Federal Government

to begin reducing Federal deficits.

And although there may be ways for the government to effect

private saving, the only sure way for the government to increase

national saving is to decrease government dissaving, that is, the

deficit.

Higher Federal saving, to the extent that the increased government saving is not offset by reduced private saving, would increase

national saving and tend to improve the Nation’s current account

balance, although typically not on a dollar-for-dollar basis.

As the Comptroller General has said, meeting our Nation’s large,

growing and structural fiscal imbalance will require a threepronged approach that includes restructuring existing entitlement

programs, reexamining the base of discretionary and other spending, and reviewing and revising the existing tax policy, including

tax expenditures which can operate like mandatory spending programs.

Let me turn to a particular subset of those expenditures: savings

incentives. The Federal Government has sought to encourage personal saving, both to enhance households’ financial security and to

boost national saving. Tax incentives may affect how people save

for retirement, but do not necessarily increase the overall level of

personal saving.

For example, although tax benefits seem to encourage individuals to contribute to these kinds of accounts, the amounts contributed are not always new saving. Some contributions may represent

saving that would have occurred even without the tax incentives

and may even be shifted from taxable assets or financed by borrowing.

As with other tax expenditures, it makes sense to see if these incentives are achieving their goals or could potentially be better targeted.

Then, lastly, I would just like to talk briefly about education with

respect to saving. A leading obstacle to expanding retirement saving has been that many Americans do not know how to save for

retirement, let alone how much to save.

6

The need to provide consumer financial literacy, their ability to

make informed judgments and effective decisions about the management of money and credit, has become increasingly important.

In the recent Comptroller General Forum Report, we discussed

the Federal Government’s role in improving financial literacy.

Among other things, forum participants suggested that the Federal

Government serve as a leader, using its influence and authority to

make financial literacy a national priority.

Now, I would just like to conclude by saying, increasing the Nation’s economic capacity is a long-term process. Acting sooner rather than later could allow the miracle of compounding to turn from

enemy to ally.

This is why the Comptroller General has called for reimposing

budget controls, reforming Social Security, Medicare and Medicaid,

and reexamining the base of all major spending programs and tax

policies to reflect 21st-century challenges.

As I said before, every generation is responsible for the economy

it passes on to the next. Our current saving decisions have profound implications for the Nation’s future well-being.

Mr. Chairman, this completes my prepared statement. I would be

happy to respond to any questions.

[The prepared statement of Dr. McCool appears in the appendix.]

Senator SMITH. Dr. McCool, we have heard some people in high

places say that deficits do not matter. Are there some deficits that

matter more than others?

Dr. MCCOOL. Well, I think that, again, the point is not that deficits do or do not matter. They matter much more in certain contexts than others. In particular, the concern we have is with persistent, large deficits, and even more so the fact that, looking out

10, 15, or 20 years to the baby boom retirement, again, under the

assumption that health care costs are rising at a much more rapid

rate than the rest of the economy, that the deficits become huge—

not just large, but huge—and in fact they could take up a substantial part of the economy, up to the 20- to 25-percent range. Again,

those are projections. They are not likely to happen, but that is the

thing I think we can all agree, those deficits would clearly matter.

Senator SMITH. It seems to me that, between now and 2030, the

consequences of at least our entitlement deficits are going to so

crowd out all other government spending that it is going to help

align the need for policy change with the political requirement that

we change. Do you have a sense when that day might arrive?

Dr. MCCOOL. Well, again, there may come a day when the deficits become so large we have to do something. I guess the concern

we have is, it would be, to some extent, easier and less costly if we

started sooner rather than later.

Senator SMITH. If we do it now.

Dr. MCCOOL. The longer you wait, the more expensive it becomes.

Senator SMITH. But to make those kinds of hard choices, it seems

like there has to be a political imperative, and that just does not

exist right now in this country.

Dr. MCCOOL. Right.

Senator SMITH. How do you see this playing out? I mean, what

cannot go on forever will not go on forever. It just will not.

7

Dr. MCCOOL. Right. That is what Herb Stein said.

Senator SMITH. So, how long do you think it will be before the

politics and the policy can align?

Dr. MCCOOL. Well, if I knew the answer to that I would be on

Wall Street. If I could predict the future that well, I would be in

a different business, I think.

Senator SMITH. And as you speak of deficits, whether individual,

government spending, or current accounts, how is America relative

to other western countries? Are we worse off? Are we any better

off?

Dr. MCCOOL. In terms of saving? I think Dr. Bosworth has a lot

of data on that. But I think, certainly with respect to the G–7 and

the OECD countries, the U.S. is pretty close to the bottom on the

personal saving and the national saving fronts.

Senator SMITH. And in terms of entitlement obligations, where

are we?

Dr. MCCOOL. I do not know the answer to that.

Senator SMITH. All right. That is all right.

Dr. MCCOOL. I mean, I think lots of other countries certainly

have aging populations and certainly have requirements.

Senator SMITH. And they have higher, more generous benefits,

older population, and smaller birth rates than we do.

Dr. MCCOOL. Smaller birth rates. Right.

Senator SMITH. So I was just wondering where we stand in that

regard to the competition.

Anyway, Mr. Timmer, thank you for being here.

STATEMENT OF JURRIEN TIMMER, DIRECTOR OF MARKET

RESEARCH, FIDELITY INVESTMENTS, BOSTON, MA

Mr. TIMMER. Thank you for the opportunity to speak to you

today. It is an honor to have been invited.

In my opening remarks, I will refer to the charts on pages 5

through 8 in your handout. I have also included some supplemental

charts, which I would be happy to address during the question and

answer period.

Retirement security is, and will remain, a dominant issue for a

very long time. America is growing older and living longer and is

not saving enough. The chart on page 5 illustrates what is perhaps

the most profound demographic trend of our time, that is, the baby

boom tidal wave that is under way.

In 1985, by far the largest segment of the population consisted

of 25- to 29-year-olds. Currently, the largest segment consists of 40-

to 44-year-olds. By 2025, this same group will be reaching retirement.

At the same time, Americans are living longer, with the average

life expectancy increasing from 66 years 5 decades ago to an expected 80 years 5 decades from now. This prompts the question,

are American households saving enough? The answer is no, although by some measures the news is not as bad as it appears.

The chart on page 6 addresses household savings. The savings

rate in the U.S. is negative and has been declining for years. However, things may not be as bad as they seem. There are flaws in

the way the savings rate is calculated, in that it includes the taxes

on capital gains, but not the capital gains themselves. If we adjust

8

the savings rate by including capital gains, it improves to 5.75 percent.

The other shortcoming is that the savings rate does not account

for accumulated household wealth. When considering household

balance sheets, the picture brightens considerably. Household net

worth stands at $52 trillion, which is 5.6 times disposable income

above the average of the past 50 years. Assets are 6.9 times income, and liabilities are 1.3 times income.

This lack of income savings and the much better state of household balance sheets is probably no coincidence. It is likely that

American households simply have not felt the need to save out of

their paycheck, given that their assets have appreciated in value.

This is especially true in recent years, given how low interest

rates have been and how fast home prices have risen. However, the

result is that Americans are increasingly relying on their home as

their nest egg.

The charts on pages 7 and 8 address retirement security. Over

the past 30 years, defined contribution plans have taken over from

defined benefit plans as the primary workplace savings program.

Senator SMITH. Can I stop you right there? Because I want to

understand what you just said.

Mr. TIMMER. Yes, sir.

Senator SMITH. The savings rate is not as bad because of the way

it is calculated, because the savings are in our real estate?

Mr. TIMMER. It does not account for wealth and it does not handle the capital gains versus capital gains taxes, in my opinion, very

efficiently. The capital gains are reported with a several-year lag,

and they are only reported annually, so it is hard to construct the

savings rate.

So by some measures it is quite a bit higher than where it is.

I mean, it has been declining over the years, but by some measures

it is not nearly as bad as it seems.

Senator SMITH. But for somebody to have a nest egg, they have

to sell their assets to go to a nursing home or whatever.

Mr. TIMMER. Household wealth is the much better picture, but

that is homes and financial assets.

Senator SMITH. All right. I am sorry to interrupt you, but I wanted to understand that.

Mr. TIMMER. That is all right.

Let me just start at this paragraph. The charts on pages 7 and

8 address retirement security. Over the past 30 years, defined contribution plans have taken over from defined benefit plans as the

primary workplace savings program for American workers.

Since 1975, the number of workers covered by a DB plan has

fallen from 29 million to 21 million, while at the same time the

number of employees covered by their company’s 401(k) or similar

plan has grown from 11 million to 64 million.

Page 8 illustrates that, while the rise in DC plans is a very positive trend, more needs to be done. Of the 122 million working

Americans today, 58 million are not covered at all, and of the 64

million who are covered, 22 million choose not to participate for one

reason or another.

Senator SMITH. Can I ask you another question? Why is one

going down and the other going up, defined benefit versus defined

9

contributions? For the same reasons as Social Security, in terms of

promises and the number of people working underneath?

Mr. TIMMER. Company pension plans have been in decline. At

the same time, DC plans, where people can take some control over

their own destiny, have risen quite a bit. It is somewhat of a

generational thing. It is certainly our generation where we have

seen that.

Making matters worse, many workers do not properly manage

their 401(k) plan. To a large degree, this is understandable. Creating a retirement savings plan when you are in your 20s, picking

the right investments, maximizing your deferral rate, and then rebalancing your portfolio on a regular basis over the subsequent 4

decades, and all this without consistent guidance, is something that

even some professional investors have trouble with.

How can we better prepare America for retirement? The continuing stresses on defined benefit pensions make it even more urgent that we do everything we can to strengthen the DC system.

Trends already under way to automatic enrollment, automatic savings escalation, and to the use of life-cycle strategies all promise to

do exactly that.

In addition, initiatives such as a national small business 401(k)

plan and reforms to the IRA system will help to ensure that all

Americans have the opportunity to save for their retirement.

By their very nature, the demographic and retirement savings

trends I have discussed are long-term, but they are also incredibly

powerful, and they will impact us all in just a few years, not decades. The sooner we act to meet these challenges, the better.

Again, thank you very much for listening. I would be pleased to

take any questions you may have.

Senator SMITH. I will likely have some more.

[The prepared statement of Mr. Timmer appears in the appendix.]

Senator SMITH. Dr. Bosworth, it is great to have you here.

STATEMENT OF DR. BARRY P. BOSWORTH, SENIOR FELLOW,

ECONOMIC STUDIES, ROBERT V. ROSSA CHAIR IN INTERNATIONAL ECONOMICS, BROOKINGS INSTITUTION, WASHINGTON, DC

Dr. BOSWORTH. Thank you. I had some prepared remarks which

I submitted, so I am just going to try to summarize quickly some

of the points I wanted to make.

Senator SMITH. We will actually include your prepared remarks

as if read in the record. So, we appreciate your summary.

[The prepared statement of Dr. Bosworth appears in the appendix.]

Dr. BOSWORTH. I was asked to focus on two things. One, the

international implications of the decline in U.S. saving, and second,

a comparison of U.S. saving and investment behavior with that in

a variety of other countries.

I want to do this in a very simple framework in which a nation’s

saving, minus its investment that it undertakes domestically, is

just equal to the current account investment that it can make

abroad.

10

Within that framework, you can sort of illustrate it in the handout I gave for U.S. savings investment by just noting that in the

U.S., national savings, up until about 1980, ran at a very constant

rate of between 10 and 12 percent of GDP.

Since 1980, it has just engaged in steady decline. Much of the decline, or a push, I should say, has been these fluctuations in publicsector saving. In the 1980s, we had a very large public-sector deficit, went back to a surplus for a couple of years in the 1990s, and

now we are back in a large deficit again.

But probably more striking is that the private-sector savings rate

just steadily has gone down over these last 25 years at a pretty

much constant rate, and it has now reached the point that the

household savings rate, as you mentioned, is negative by a small

amount.

The only type of savings that has held up very well in the United

States, and is doing very well today, is corporate saving, and that

mainly reflects the fact that there has been a boom of corporate

profits since the 2002 recession, and corporations have hung on to

and reinvested a large portion of those profits.

So we have, today, an incredibly low national savings rate. It

was 11 percent historically. We are now down to 1 percent of our

national income, meaning that as a country we consume 99 percent

of all our income in any given year, both in the public sector and

the private sector.

Senator SMITH. Well, how would we compare to Japan, for example?

Dr. BOSWORTH. Japan, actually, today, in the national savings, is

fairly low as well. I will discuss that a little bit more.

Senator SMITH. That is a fairly recent development.

Dr. BOSWORTH. Yes, it is. Japan was historically noted as a very

high-saving country. It is low because it has had so many problems

in the 1990s, that the government of Japan now has a very large

budget deficit, trying to use deficit spending as a way to sustain

its economy.

Senator SMITH. They are encouraging spending, are they not?

Dr. BOSWORTH. Right. It has a high private savings rate, but a

very negative public savings rate, about the size of ours.

Senator SMITH. Yes.

Dr. BOSWORTH. So there is not as big a difference as there used

to be.

But the other striking thing, I think, about the United States is

not just the saving, but if you turn over to the investment side, unlike saving, the United States has great investment opportunities.

So we are a country where we do not save anything, but we have

a lot of investment opportunities. So the result of that in the

United States is we tend to borrow the money abroad. It turns out

we now have a current account deficit with the rest of the world.

How much do we borrow? Seven percent of our income every

year. This is truly an unprecedented situation. There has never

been a time in which a country the size of the United States ran

current account deficits with the rest of the world like this.

The debt has now accumulated to between $2.5 and $3 trillion

with the rest of the world. We are the world’s most indebted country by a huge magnitude, despite the fact, at the same time, we are

11

the world’s richest country. It really is a strange situation that we

live in today.

Senator SMITH. Can you tell me what it means? What does it

mean in the lives of people, eventually, in America? How is this

going to translate into our experience as Americans?

Dr. BOSWORTH. You can make an analogy of people and compare

it to the Rockefeller family. The first Rockefeller earned an incredible amount of wealth, and his family has been living off his wealth

now for over 100 years. So far, they have not run out. They have

been selling it off, but there is still some wealth left.

Americans, the current generation, are living off the wealth of

past generations, in effect. What we are doing is no longer adding

positive savings. We are, instead, consuming the wealth of the

past. That is not, in the long run, probably, a sustainable situation.

But we are an incredibly rich country, so we can do this probably

for quite a period of time.

What I think has been remarkable about all this is the ease with

which we have been able to do this financing. The rest of the world,

in effect, agrees with us: the United States is a great place to invest. So they have not minded having this capital inflow into the

United States of about $800 billion a year. It is very sustainable

from that respect.

Will there not come a day when they will doubt whether we intend to repay? At that point, yes, you begin to get a crisis when

they worry that they are not going to get their money back, say in

Argentina, would be an extreme example. But we are a long ways

from being Argentineans.

Senator SMITH. And where are we relative to our European allies

in this regard?

Dr. BOSWORTH. European countries, on balance, have zero net

debt with the rest of the world. They no longer have a large foreign

asset position. A couple do, but most do not. They do not have a

large foreign debt, either. They have tended, over long periods of

time, to have basically a zero balance in their external affairs.

Senator SMITH. And they do that through protectionism?

Dr. BOSWORTH. No. I think they do it by, one, in the case of Europe, savings has stayed higher than it is in the United States.

Number two, they do not have good investment opportunities in

Europe, so they are not faced with the same pressures that we are.

We are a very contrasting situation. No savings, very good investment opportunities. Everybody wants to invest in the United

States. Europe, reasonably good savings, very limited investment

opportunities. It tends to see the money go abroad.

Senator SMITH. And why is that, their policies or receptivity?

Dr. BOSWORTH. I think it is due to other economic policies. You

are seeing a demonstration in France at the present time, a public

dispute over economic policy in France. So, France is a slowly

growing economy with a great deal of difficulty finding jobs for its

citizens. That tends to not make it a very good place to have a very

high level of investment.

Senator SMITH. Yes.

Dr. BOSWORTH. So in some ways, our current account deficit is

both good news and bad news. Good news, because of the strength

of the U.S. economy and the great investment opportunities that

12

exist here, and our rapid economic growth. The bad news is, we are

not willing to finance any of it ourselves. We are, instead, just engaged in consumption of our own income.

Senator SMITH. Isn’t that why some in high places say deficits do

not matter?

Dr. BOSWORTH. That is right. In the short run, deficits do not

seem to matter.

Senator SMITH. But eventually they will.

Dr. BOSWORTH. I think, eventually in the long run, all these

things catch up to you. But the United States still has a very good

economic system where rules of the game, so to speak, in the

United States are probably better than anyplace else in the world.

People trust our institutions. Maybe Americans will not do very

well living here because we are not going to be saving and accumulating a lot of wealth, but our economy can continue to do well. It

is just that the economy will come to be owned, more and more,

by foreigners.

There are two separate issues here: how well Americans are

doing as citizens living in this country—and there have been disputes about the distribution of income, for example, and issues like

that, and good job opportunities—and the performance of the economy. The economy is performing very well. You are probably going

to hear more in future decades, are American citizens participating

in that benefit very much? That is a legitimate concern.

Senator SMITH. All right.

Dr. BOSWORTH. The last point I would just end with, you can do

this saving and investment comparison for lots of countries around

the world. What strikes you about the whole thing, I think, is there

is just an enormous disparity of savings rates across countries and

across regions.

China is currently saving in excess of 40 percent of their national

income. At the same time, I said the United States was down. To

be on a comparable basis, we are doing about 12 percent, because

it is a gross savings rate.

So there are enormous variations in savings, but it is, at the

same time, large variations across countries and investment. If you

are growing rapidly, you need lots of investment, you need lots of

saving. So countries like China tend to absorb all their own saving,

even though it is very high. They just re-invest it in their own

country. They do not have much of a current account surplus or

deficit.

The United States, in this comparison, stands out in this extreme

imbalance between our investment opportunities and our savings

behavior. That is not comparable with any other country in the

world.

Senator SMITH. What do you think of Mr. Timmer’s point, that

our calculation of the savings rate is not entirely accurate because

so much is in our homes?

Dr. BOSWORTH. That is true. Although, actually, if you made the

adjustment for homes, it does not change the calculation very

much. More accurately, the wealth figure he cited, that is a lot of

investment in equities, the stock market.

That is the biggest part. If the market continues to be strong and

there are continued capital gains, it looks very good. The trouble

13

with capital gains is that they can quickly turn into losses, as you

saw in 2002.

Housing. Nowadays, the same issue has come up. Some people

are afraid. Housing prices have gone up, and that sounds very good

to me, maybe when I retire. But who am I going to sell my home

to in the future? It is going to have to be my children’s generation

that buys it.

I think housing is an example of, the gain of one generation is

the loss of another generation. It is inside the United States, so to

speak. If housing has a big capital gain for me, it implies a big capital loss for my children if they do not yet own a house, because

they will have to pay that.

There is a concern that it is a bubble, that as we go out in future

generations there is no way our children are going to be able to pay

us for these inflated values of housing. So I agree that, right now,

the story on wealth is more positive than implied by savings. It has

been a remarkable 20-year run of capital gains.

The stock market has been going up since 1982, on average, with

some fluctuation. Home values have continuously increased. So

capital gains have offset the weak savings performance of most

Americans, and they continue to have fairly good wealth holdings.

Senator SMITH. I have always assumed, Doctor, that part of the

reason Wall Street has done so well, and some real estate investment so well, is to your point that we are a good investment society, good investment opportunities, and that is bringing in all of

the capital. So you have capital from all over the world competing

for these limited American assets. Obviously that means inflation

in the value of those assets.

Am I right in that assumption?

Dr. BOSWORTH. I think you are absolutely right. The U.S., for the

100 years that we have data for, has been a low-saving society. But

we use our saving very efficiently in this country, in part because

we have a very vigorous financial institution and financial markets, probably better financial markets than any other country.

So we allocate and utilize our saving very efficiently compared to

countries like Japan, which has not had that same sort of strong

financial system, and they wasted a lot of their saving.

Senator SMITH. You made a statement I find very interesting,

and I would like to pick your brain on it a little bit. You talk about,

on the one hand, the great investment opportunities in this country

that attract capital from all over the world.

Then you talk about the political question that will likely be debated in future campaigns, are Americans participating in it? It

seems to me the answer to that is, maybe not enough.

If the answer is, maybe not enough, what will be the policies

coming out of those election results that might transform us, perhaps, into acceding to policies such as you have in France that

might produce more savings, but destroy our investment environment? Do you see what I am saying?

Dr. BOSWORTH. That is exactly what will happen if you get too

much social discontent. In a democracy, you depend on the assumption by a wide majority of your population that ‘‘I am going to gain

from this system.’’ That has been a very strong American belief for

a long time.

14

But if it turns out that all the benefits begin to accrue to a few

and the average, typical American feels they are not participating

in the benefits, then you will see a lot of social disruption like you

are now being faced with in France, which is exactly the problem.

Senator SMITH. But if that is the conclusion, then the election results manifest themselves in policies such as our European friends

have adopted, and what happens? We have destroyed the investment climate and this American dynamo comes to hit the brakes,

it seems to me.

Dr. BOSWORTH. I think I would agree with that. It is a dangerous

situation. But just because the economic situation deteriorates does

not mean that you will respond in a positive fashion. You can do

what is happening in Europe. They are responding in a negative

fashion, and they are making their own situation worse.

Senator SMITH. Very interesting. Thank you.

Dr. Brainard?

STATEMENT OF DR. LAEL BRAINARD, VICE PRESIDENT AND

DIRECTOR, GLOBAL ECONOMY DEVELOPMENT CENTER,

NEW CENTURY CHAIR IN INTERNATIONAL ECONOMICS,

BROOKINGS INSTITUTION, WASHINGTON, DC

Dr. BRAINARD. Thank you, Mr. Chairman and Senator Kerry.

Thank you very much for the opportunity to address this topic. I

think this topic is one of the most vital long-term challenges facing

the Nation, and one of the least addressed.

America is not saving nearly enough to be competitive or secure,

in what is an accelerating global economy. The base, I think, of the

concern is really the eye-popping fiscal turnaround that we have

seen in the last 5 years, going from historical surpluses to deficits

really into the indefinite future.

What is interesting is that so far we have been able to be relatively complacent about the situation. After all, we are kind of

having our cake and eating it too. We have had low interest rate

mortgages, we have had low inflation, we have had cheap borrowing all around.

So what has enabled this fiscal binge? Well, I think it is pretty

clear: it is the very large and growing reliance on foreign borrowers. As Barry said, about 7 percent of our income was actually

borrowed from foreigners last year. If you look at current trends,

we will pass the half-way mark in terms of foreign ownership of

Treasury securities by the end of this year. That is a pretty important marker.

It is also true that America has borrowed a lot from foreigners

in earlier periods. If you look back into the 1980s, there was a concern then as well. But during that period we were net creditors to

the rest of the world. We have now swung into the net indebtedness position, and it is growing very rapidly.

If you look only at the last 5 years, our ratio of indebtedness to

foreigners to GDP has gone from 14 to 25 percent of GDP. Now,

that may not seem like a large number, but if you look at Brazil

and Argentina, on the eve of their financial crises in 2001, we are

nicely situated right between their debt-to-GDP ratios.

The other thing that is quite anomalous about it is, historically

super powers have been suppliers of capital to the rest of the

15

world, not a net drain. Other rich countries have borrowed a similar share of GDP historically, but we are talking about places like

Australia and New Zealand, not countries that account for about

one-third of the world economy.

So are there risks? The current course suggests that, no, there

are no risks. The rest of the world is all too eager to finance our

borrowing and, hence, the relatively low interest rates that we

have seen to this point. I think that is a fair observation, but it is

also a bit misleading. You were talking earlier about, what are the

risks of having increased foreign ownership.

Well, there is another risk. If you look inside the aggregates, it

masks a big shift away from private investors from Europe and

other places in the world, investing mainly in private securities in

the United States, to foreign, official lenders, central banks, mainly

in Asia, buying Treasury securities.

So we have a different kind of lender lending for different purposes, and they are lending different kinds of securities. They are

financing, increasingly, our fiscal deficit.

I think that the projected levels of foreign borrowing do pose

risks to our economic competitiveness and our economic security.

Of course, the hard-landing scenario is the one that we hear the

most about, that is, a sudden rush to the exit, some kind of sudden

change in investor perceptions where people dump dollar assets

and the Fed has to precipitously raise interest rates. That is, as

many people will tell you, a low-probability event. It is not a very

pleasant event to live through.

But here is the bad news. The other scenario is hardly reassuring. Even with smooth adjustment, time is simply not our

friend. If we delay adjustment, if foreign central banks continue to

indulge this consumption binge, it is going to get more and more

painful to fix it.

The cost of servicing that debt to foreigners will eat up a larger

share of our export earnings and will require a greater turnaround

in our trade balance and more compression in domestic growth to

stabilize it.

If you look at some of the projections out there, in only 2 years

or 3 years, because of the compounding effect, we will be at 50 percent of GDP in terms of indebtedness.

Senator SMITH. Can I ask you this?

Dr. BRAINARD. Yes.

Senator SMITH. How would you fix that? Just put up protectionist barriers to stop Americans from buying abroad?

Dr. BRAINARD. In fact, that would be the last thing in my tool

kit.

Senator SMITH. All right. How do you fix it?

Dr. BRAINARD. Yes. This is not actually a difficult conundrum to

get out of if we start working on it now. We have seen historical

episodes, like the 1980s, where we have been in a similar situation

and gotten out of it, but it requires, first and foremost, taking

tough action here at home on the fiscal side, looking out into the

future and our needs in terms of the fiscal, and trying to get our

hands around that right now.

If we do that, we are in a very strong position internationally to

put a lot more pressure on our foreign partners to do their piece

16

of the puzzle, whether it be adjusting the exchange rates in Asia

or whether it be stimulating growth and getting rid of some of the

structural barriers in Europe and Japan.

If you put those three pieces together, you get a pretty positive

scenario in a relatively quick period of time. But, of course, the

first piece of that is extremely, extremely difficult to do.

Senator SMITH. Just to follow up: if we go fix our fiscal house,

do you see the problem in the discretionary spending or in the entitlement spending?

Dr. BRAINARD. Well, you are asking a really tough question. But

if you look at non-defense discretionary, it is an increasingly tiny

percentage of the budget.

Senator SMITH. Exactly.

Dr. BRAINARD. The reality is, looking out, we have big problems

that we are going to have to get our hands around. The fixes are

going to take looking at all the pieces, looking at the entitlements,

looking at the tax side. Brookings has a lot of work, I think, as you

may be aware, on this subject.

Senator SMITH. And has Brookings figured out sort of a point between now and 2030 when we are going to hit the wall and have

no choice but to fix it?

Dr. BRAINARD. No. I should say that Brookings has a whole series of different paths; some of them rely much more heavily on

taxes, some of them rely more heavily on entitlements, so it is sort

of a menu of options. But all of them say, the sooner you start, the

less harsh the out years are.

Senator SMITH. I just want Senator Kerry to know that I have

been asking each of them when the politics are going to line up

with the policy imperatives.

Dr. BRAINARD. Let me just wrap up. I do not want to go over

here.

On this connection, connecting the dots between our deficit and

competitiveness, I think we are at a moment when, like it or not,

the competitive landscape is shifting at a breathtaking pace. We

are seeing the entry of hundreds of millions of workers from lowwage countries into the global labor force.

We are seeing for the first time higher-skilled services jobs being

now in the global marketplace. And, of course, we now have a very

serious challenge on the energy security front.

There is no doubt that America can deal with all those challenges and be the most competitive economy in the world, but it

requires very proactive policies to invest in skills for the 21st century, to invest in the game-changing technologies of the 21st century, sustainable energy supplies, and, of course, the health care

system, which is our biggest competitive disadvantage.

You cannot do all of that with our current fiscal strait jacket.

You cannot do all of that by borrowing from foreigners. At the end

of the day, if we want to be competitive, we need to invest. If we

want to invest, we are going to have to save. Thank you.

[The prepared statement of Dr. Brainard appears in the appendix.]

Senator SMITH. I just have one other question, and then I will

turn the mic over to Senator Kerry for his statement or questions.

17

These all have been fabulous witnesses, and you have heard two

of them.

It seems to me that most of the people who work here on the Hill

are involved in the Federal pension program. I do not know about

others, but I take the maximum all the time. I know that I have

given a menu of things to direct these dollars into. They are securities, investments, bonds in some cases. Is that savings or is that

investment? How are you calculating that in all of this?

Dr. BOSWORTH. It is savings.

Senator SMITH. It is savings.

Dr. BRAINARD. Well, it enters on both sides.

Senator SMITH. It is both.

Dr. BRAINARD. It is savings that enables investment. So if, as

some of the gentlemen were suggesting earlier, we put some automatic options on the table in terms of 401(k)s and we actually increase net savings—and there is a question mark there—it provides greater capital for investments, here and abroad.

Senator SMITH. I ask that question because recently a friend of

mine in Oregon said that his housekeeper wanted to buy his car,

and they agreed on a price of $20,000. She gave him a roll of

money, of $20,000. How much of that is going on in the country

that is not accounted for in this? Is that just in the immigrant community? Is there any way to gauge that?

Dr. BOSWORTH. There is a series of studies that have been done,

none of them very convincing, about, how big is the so-called ‘‘underground economy’’ in the United States. I think the best summary of them is, this goes on, you are absolutely right.

It is relatively low in the United States, somewhere between 5

and 10 percent of the national income. The evidence that it has

been growing over time is pretty limited. It has stayed in that

range. It was a common phenomenon back in the 1950s.

Senator SMITH. And after the recession, I assume, when people

had no confidence in banks.

Dr. BOSWORTH. Right. Right. It is true here. There are people

who circumvent the financial system, for example, with their saving and their incomes. But if you use the IRS measures, which I

think have done the best job of trying to judge the magnitude of

this economy—I am not talking about the illegal, I am only talking

about activities that are not being reported in the statistics—I

would say it is between 5 and 10 percent of GDP, with no evidence

it is growing over time.

Senator SMITH. Would anyone disagree with the bill that Senator

Conrad and I have to encourage savings that involves extending

the Saver’s Credit, and obviously it relates to 401(k) programs, an

automatic program? You can opt out, but you automatically enroll.

Does anybody disagree with that policy?

Second, can you give us any other ideas to turn this around, the

savings?

Mr. TIMMER. I would illustrate how effective automatic enrollment would be. There is a page in here somewhere that shows the

system in Europe for organ donor programs, and in some countries

it is an opt-in program, and in some countries it is an automatic

enrollment, and you can opt out through negative election.

18

For instance, in Germany, the participation rate is 12 percent. In

Austria, which is in many ways very similar as a country to Germany, it is 99.98 percent. So the power of automatic enrollment is

quite compelling.

Dr. BRAINARD. I would only add to that that the research suggests that it would be more powerful for low-income people, so

there is a double benefit there.

Senator SMITH. Thank you all so very much.

Senator Kerry?

Senator KERRY. Thank you, Mr. Chairman. I apologize for being

late and not being able to hear everybody’s testimony, but I have

done my best to try to get the essence of what each of you have

said here, and I appreciate it.

Mr. Timmer, it is good to welcome you here from our State. Dr.

Brainard, thanks for being here and for the work that we are doing

on some other things.

The debt clock in New York is going to run out of digits in about

10 years if we keep going the way we are going. I guess we are

at $8.4 trillion now. Fifty-one percent of our debt is owned by foreigners. I do not know if you have commented on that.

But how much does that matter? Japan being the biggest owner

of debt at $600-some billion, and China next, $258 billion. What is

the significance of that on America’s financial well-being and future?

Mr. TIMMER. I take a slightly different take on this than my colleagues here. The last page of this handout basically, in my opinion, sums up what is going on in the world, and it is essentially

globalization.

It is called the ‘‘S’’ curve. It is essentially a growth curve that

you can apply to almost any product or technology. The U.S., as

well as western Europe and Japan, are in the upper far-right corner. That means we are very wealthy and mature nations. Our

GDP is high, but not growing that fast.

The vertical part of this curve shows the emerging markets, including China and India, which, of course, with 2.4 billion people

combined, is a major development. To me, this sums up this whole

current account imbalance situation and who owns our debt. We

are basically the consumers. We are the wealthy consumers and

China and India are the producers of cheap labor and goods.

So every day, every month, our dollars go abroad to purchase

things, and that means these dollars end up in their reserve system. With those extra reserves, they buy our Treasuries. That was

especially the case with Japan a few years ago when its economy

was very much suffering, and basically China was eating its lunch

in terms of their export business to us.

So what Japan did, what the Bank of Japan did, is every month

they would buy tens of billions of dollars’ worth of U.S. dollars in

the currency market as a foreign exchange intervention, because

they needed to get the yen down to compete with the Chinese economy for our business.

I think at one point, on an annual basis, they were buying something like $300 billion worth of our Treasuries and Agencies. To

me, that is a mechanical activity. It is not that somebody there deVerDate 11-MAY-2000 09:48 Mar 30, 2007 Jkt 095484 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 34132.000 SFIN1 PsN: SFIN1
19

cided, well, U.S. bonds are a great investment, I am going to buy

$300 billion of them. It was basically a liquidity operation.

So I do not quite share the concern that these foreign investors

are all going to dump our bonds and teach us a lesson and the dollar is going to implode and interest rates are going to skyrocket.

I think actually it is the result of the lower dollar that causes

this buying of our Treasuries, and therefore our interest rates have

remained low, which in turn is a stimulus to our American consumer. So, I do not take quite as dire a view on what is happening.

Senator KERRY. But when you say a stimulus to the American

consumer, the American consumer is about as laden with personal

debt as at any time in our history, and the American consumer has

used those low interest rates to take huge equity loans out of their

homes. So they are already taking their retirement equity and they

are spending it today.

Mr. TIMMER. Well, homeowners’ equity has been pretty stable,

around 56 percent, for the last 5 years or so. What I mean is that

interest rates remain low. It is a stimulus to the consumer. Debt,

in absolute terms, is at an all-time high, but relative to——

Senator KERRY. But the interest rates being low are a stimulus

to the consumer how? Where is the average consumer taking that

stimulus?

Mr. TIMMER. They have taken it to refinance their mortgage in

recent years.

Senator KERRY. Correct. And once they have refinanced their

mortgage, many of them are spending the equity either on a home

improvement, in some cases, but not enough. Most of them are buying RVs and second homes, cars, paying for college education. It is

cash out the door. Then when they retire, with their pensions disappearing, and they will not have, most of them, 401(k)s, and so

forth, where are we going to be? Because I know in your chart you

have here that demographic——

Mr. TIMMER. Yes. I mentioned in my opening——

Senator KERRY. I mean, that cannot be considered to be sound.

Some of the top people in the country have talked about, this is an

unsustainable path we are on. Do you agree?

Mr. TIMMER. I think it is unsustainable if it continues at the rate

that it has in the past 5 years, but I think that was probably somewhat anomalous because we had very low interest rates, rapidly

growing home prices, so a lot of people did refinance and they did

take out more equity.

But I look at consumer debt in relation to the entire balance

sheet, not just on its own. Consumer debt has risen, but consumer

assets have risen more. As a result, consumer household net worth

is at an all-time high of $52 trillion. So, there are problems.

I just think the problems are somewhat overstated. I think the

biggest issue is that people are not saving through their workplace

savings program the way they should be, they are not maxing out

their deferral rates. A lot of Americans do not even have coverage

in a defined contribution plan. I think that is the more pressing

issue.

Senator KERRY. Well, the primary consideration of this hearing

is obviously, what is the impact, is there a danger or is there not,

in the low U.S. savings rate? And as I think you point out, Dr.

20

Bosworth, in your testimony, we have long had a pretty low savings rate in the country and we have fairly strong growth, so you

are fairly confident of that sustaining us. At least that is the way

I read your testimony.

Dr. BOSWORTH. Not indefinitely, no.

Senator KERRY. But not indefinitely.

Dr. BOSWORTH. I would share your concerns.

Senator KERRY. I beg your pardon?

Dr. BOSWORTH. I would share your concerns. But I am not going

to give you a date. I do not think we know enough to forecast the

date of disaster, but continuing to run current account deficits of

this magnitude with the rest of the world is not sustainable. We

are running down our wealth. I think there comes a point where

people will ask questions about your government, about, how high

can the government debt be and still think that you are going to

raise taxes to pay for it. They will begin to question you. So, no.

I do not think either one of these trends is sustainable, but I do

not believe they are a crisis tomorrow. That is the problem, in fact.

If we had a crisis, Americans respond very well to crises. The

whole difficulty today is, there is no crisis, so people say, deficits

do not matter. If you can get a crisis, you can get a solution. That

is a funny way of looking at it.

Senator KERRY. The question is, is it not a crisis today, except

it is not being felt? Let me press you on that a little bit.

You, in the last paragraph of your testimony, say, ‘‘In the long

run, the lack of export markets will prove to be very damaging to

the job opportunities of American workers. Third, the situation is

likely to worsen in future years as more baby boomers move into

retirement.’’

Well, we know that is going to happen. We know we are moving,

because some of you referred in your testimony, from defined benefit to defined contribution, and that is lowering people’s benefits

and quality of life available.

Then you say, ‘‘From a demographic perspective, the current U.S.

private savings should be at an all-time peak. The international

comparison suggests that demographics do have some influence on

saving. It appears to be small and easily overwhelmed by other factors.’’

As I look at the trend line here and the overwhelming factor, you

would all agree, I assume, that the fiscal choices we are making

play into this very significantly.

[All witnesses nod in the affirmative.]

Senator KERRY. All heads are nodding yes.

I assume, given the fact that in the year 2000 that clock I referred to was stopped, stopped dead, if it had been recording, it

would have been going backwards. But it could not record backwards, so it just stopped for 2 years. Now we are at $8.4 trillion,

and if we continue the way we are going, it will be $10 trillion, and

the clock cannot record any more.

So we have that staring us in the face. We have the disappearance of pensions staring us in the face. You have the disappearance

of high value-added paying jobs, and the traditional manufacturing

job base disappearing.

21

You have rising health care costs and rising numbers of people

who do not have health care. You have all these people who are

burdened with personal debt and have taken the equity out of their

homes and will not have additional equity on which to pay their

medical bills or their retirement, as they are the aging baby

boomers.

But as you start adding up these trends, is there not a profound

question that Congress ought to be asking itself, which is, why are

we going through another big tax cut round? Dr. McCool? I mean,

is that not irresponsible, in fact?

Dr. MCCOOL. That is not for me to say.

Senator KERRY. Why? You are an American citizen. You are a

person who judges our economy. Why is it not for you to say? I

mean, as an American citizen. Do you have kids?

Dr. MCCOOL. No, I do not.

Senator KERRY. Do you have a family?

Dr. MCCOOL. Yes.

Senator KERRY. Some wealth you hope to leave to somebody?

Dr. MCCOOL. I do.

Senator KERRY. Are you concerned about what is going to happen

in terms of the choices that are going to be left behind? Is this a

responsible set of choices that are being pursued in Washington?

Dr. MCCOOL. Well, I think that there are a lot of levels of responsibility, or lack of responsibility. That is, I guess, part of the issue.

Senator KERRY. Blame it on all of us, Congress. I am not trying

to be partisan here.

Dr. MCCOOL. I understand.

Senator KERRY. I am just trying to get to the root of it. Does it

make sense to be having a great big tax cut when we have all these

issues staring us in the face, and we are adding to the debt, we

are not solving the problem of retirement accounts, we are not providing added incentives for savings, we are not doing what we

ought to be doing for the next workforce to come along. We are cutting after-school programs. NIH will be level-funded. R&D. I mean,

just run down the list of long-term investment needs in the Nation.

I am just asking you, as a citizen, do you think it is responsible?

Dr. MCCOOL. Well, again, I think, as we stated in our testimony,

I think that there is a need to take action on the fiscal side and

all the sides and pieces need to be considered, revenues, entitlements, and discretionary spending.

Senator KERRY. I am for cutting spending. We just never talk

about the other. How can you cut spending, particularly make the

choice to cut kids’ after-school programs, and cut Perkins loans

which give kids, underprivileged kids, the opportunity to go, hopefully, create the jobs of the future?

We are going to cut those, but we are going to give people earning more than $1 million a year $32 billion worth of tax cuts. I do

not get it. It is a pretty simple question. It really is the pregnant

question of this city. I am willing to cut whole departments, incidentally.

But I am also unwilling to give away some of the revenue we

have today that, it seems to me, would go against the deficit, even,

if not against some of these other priorities. But we do not hear

22

enough public opinion leaders screaming about this. I am just asking you.

Mr. Timmer, what do you think?

Mr. TIMMER. I think, if you are referring to the capital gains and

dividend tax cuts, the extension of the tax cuts, the only thing I

will say about that is that those are probably the two taxes that

most directly affect the stock market. Of course, the stock market

is ultimately what most 401(k) programs are invested in, at least

at earlier ages.

Senator KERRY. You do not think 20 percent is low enough?

Mr. TIMMER. Excuse me?

Senator KERRY. You do not think 20 percent is low enough?

What is it, 15 now? What do we have? Fifteen?

Mr. TIMMER. Fifteen.

Senator KERRY. Yes. I mean, that is not low enough?

Mr. TIMMER. No. But I think they are talking about——

Senator KERRY. Compared to 39 percent.

Mr. TIMMER. Are they not talking about extending the current

rate?

Senator KERRY. Yes. Some people are.

Mr. TIMMER. My point is that stock investment is essentially the

net present value of future cash flows. So if you tax those future

cash flows at 15 percent or 30 percent, that has an immediate impact on the net present value.

So if you go from 28 to 15 and then back to 28, or whatever it

is when they sunset, that will have an immediate impact on the

stock market’s capitalization, which will have an impact on almost

everybody’s 401(k) plan.

Senator KERRY. Well, you know what Warren Buffett and some

very rich people tell me? They know how to make money and they

certainly know how to play the market, whether it is 20 percent

or whatever. Incidentally, I thought 20 percent was just fine, and

I voted to put it at 20 percent.

I just do not know why this is sort of a priority after priority,

again and again and again. I mean, 20 percent is better than 39,

28, or 33, which are the brackets a lot of other people are paying.

If you have a better bracket there, that is pretty good incentive.

But what I am getting at is this. Would it not be better for you,

for the savings rate of America, and for these long-term problems,

if we grew the 401(k) capacity of workers? Or since we are shifting

to defined contribution benefits, made it easier for that contribution

to go into a vested, portable 401(k) so people begin to grow their

own retirement capacity?

Mr. TIMMER. Yes.

Senator KERRY. Would you not do just as well versus that difference in the market?

Mr. TIMMER. I do not know what the numbers would be, but certainly automatic enrollment, automatic escalation, the use of life

cycle strategies—I mean, we have studies that show that a lot of

people do not have a plan. A lot of other people have a plan but

do not participate. Then there are a lot more people who do not

maximize the benefits.

So if we can make it easier for them to do that, through especially automatic enrollment, life cycle funds, automatic escalation,

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maybe increasing the deferral rates, I think that would go a very

long way to improving our retirement security, and it would be

something that would be fairly easy to do.

Senator KERRY. Are you concerned, all of you, about the trend in

corporations just to punch out on these pensions? I mean, this is

money a lot of workers are giving away. They think it is their

money, and they suddenly wake up and find it is gone. What do

you think we ought to do about that? That is a form of savings.

Dr. BOSWORTH. I think that this has turned out to be a major

crisis of the retirement system in the United States, the ease with

which corporations can duck their responsibilities because they did

not properly fund their pension programs, nor their health care

programs that they promised to workers in retirement. So we need

to do something about that.

I think the number one answer is, retirement saving is too important to leave to your employer. They do not make good decisions

in your name. They will make decisions in their own name. Therefore, I favor the move away from defined benefit programs, which

are controlled by employers and have historically been under-funded, and then they dump the problem on the Federal Government.

So we should turn over to a system of defined contribution plans.

I think the idea to say that every employee should automatically

be enrolled is a good one.

I would go a step further. I think every employer ought to be

forced to offer such a plan to their workers. Unfortunately, I do not

think there is a way to raise private savings purely by incentives

and nice things. If you want to make Americans save more, you are

going to have to make them save more. And if they do not save,

they turn out to be a burden to the rest of us in retirement.

So the government has a legitimate claim to say that every

American worker should have a retirement program. There is a

limited number of choices that should be made because most of us

do not want to spend our life as an investment banker, so we do

not want to have to make all these decisions all the time.

You earlier spoke of a great model that could be used throughout

the country, and that is the Federal employee pension program.

This is a very good plan. You use it yourselves. It is very attractive

to you. Why do you not extend it and make it available to other

Americans with the same basic idea?

Senator KERRY. Mostly because other businesses will not be as

generous as we are with the American taxpayers’ dollar in the employer match. It is that simple.

Dr. BOSWORTH. It is their money, not your money, I guess.

Senator KERRY. But I would love to see it happen.

Let me just close. First of all, I am delighted to hear what you

just said. I think it is really important. I would like to work with

the Chairman on working to do that.

Senator SMITH. Absolutely.

Senator KERRY. Because this is, I think, a huge freight train

coming at us. But the only question I would have about that, if I

may ask the Chairman’s indulgence, wages have not been going up,

but cost of education has, energy costs have, health care costs have.

So the disposable income of the average American family has

gone down, or stayed about the same. It depends on where you are.

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They are having a harder time making ends meet. So how are you

going to get them to put this money away?

Dr. BOSWORTH. I think we have to differentiate here. The lower

half of the distribution of American families has been having a

tough time. The upper half of the distribution of American families

has never had it so good.

Senator KERRY. Agreed. Agreed.

Dr. BOSWORTH. This economy has been growing better in the last

2 decades than at any time in our history. We are doing very well

as a country. Our opposition and concern is about the distribution

of the benefits.

Usually in the past, the U.S. has followed the rule, let the markets operate and allocate most efficiently as possible. If we do not

like the distribution, we try to correct that with the tax and transfer system. So we ask upper-income people to pay a larger proportion of the cost of public services than people at the bottom. We do

not run budget deficits.

This is not really a question of low-wage workers not having

enough income. We are not redistributing the social services and

the payment of the social services in a rational fashion. Those at

the top are doing very well.

Senator KERRY. Does that include the Earned Income Tax Credit,

conceivably?

Dr. BOSWORTH. I think the Earned Income Tax Credit is the

most positive development that we have had in tax policy over the

last quarter century or so, and it is the type of mechanism—it is

hard to go further, but that is exactly what we need, is incentives

for people at the bottom to get a job and to work.

It has been very effective in that regard, and I think it helps

them, and I would encourage the expansion of it as soon as possible. But it is near its limit. You cannot do much more with the

Earned Income Tax Credit than you are now doing.

Senator KERRY. Well, I appreciate all of you taking the time to

testify. I appreciate the Chairman having this hearing.

Senator SMITH. Thanks, Senator Kerry.

I am intrigued, Dr. Bosworth, by your last comment. I am also

intrigued by Senator Kerry’s State legislature that just passed an

individual mandate on health care. I know a lot of conservative

commentators see that as Big Brother.

But my own sense is, if health care is a right, health care is also

a responsibility. I kind of like it, and I am happy to say that. I

wonder if maybe in what Massachusetts has done there is not a

model for savings as well.

Maybe Senator Conrad and I are not going far enough. We are

saying you can opt out, but you are automatically enrolled. Maybe

there ought to be some consideration to this whole idea of, you

have to participate in savings. I do not know if you have any ideas.

I would love to get them from Brookings, or anywhere else, because

it intrigues me.

But you all have been terrific, patient, and generous with your

ideas and your knowledge. I thank you for adding measurably to

my understanding of the problem, and I suspect Senator Kerry

feels the same.

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Eventually, the economic exigencies of our country are going to

line up with our politics. I am still looking for the date when that

crisis comes. So if you figure it out, let us know, because I would

sure like to get something done on these great issues while I am

here, however long or short that is. But thank you all so very, very

much.

We are adjourned.

[Whereupon, at 3:58 p.m., the hearing was concluded.]

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