U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2250 Mail: Stop SSOP, Washington, DC 20402–0001

32–738 PDF 2007

WHY DEFICITS MATTER

HEARING

BEFORE THE

COMMITTEE ON THE BUDGET 

HOUSE OF REPRESENTATIVES

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

HEARING HELD IN WASHINGTON, DC, JANUARY 23, 2007

Serial No. 110–2

Printed for the use of the Committee on the Budget

(

Available on the Internet: 

http://www.gpoaccess.gov/congress/house/budget/index.html 

(II)

COMMITTEE ON THE BUDGET 

JOHN M. SPRATT, JR., South Carolina, Chairman 

ROSA L. DELAURO, Connecticut, 

CHET EDWARDS, Texas 

LOIS CAPPS, California 

JIM COOPER, Tennessee 

THOMAS H. ALLEN, Maine 

ALLYSON Y. SCHWARTZ, Pennsylvania 

MARCY KAPTUR, Ohio 

XAVIER BECERRA, California 

LLOYD DOGGETT, Texas 

EARL BLUMENAUER, Oregon 

MARION BERRY, Arkansas 

ALLEN BOYD, Florida 

JAMES P. MCGOVERN, Massachusetts 

BETTY SUTTON, Ohio 

ROBERT E. ANDREWS, New Jersey 

ROBERT C. ‘‘BOBBY’’ SCOTT, Virginia 

BOB ETHERIDGE, North Carolina 

DARLENE HOOLEY, Oregon 

BRIAN BAIRD, Washington 

DENNIS MOORE, Kansas 

TIMOTHY H. BISHOP, New York 

PAUL RYAN, Wisconsin, 

Ranking Minority Member 

J. GRESHAM BARRETT, South Carolina 

JO BONNER, Alabama 

SCOTT GARRETT, New Jersey 

THADDEUS G. MCCOTTER, Michigan 

MARIO DIAZ–BALART, Florida 

JEB HENSARLING, Texas 

DANIEL E. LUNGREN, California 

MICHAEL K. SIMPSON, Idaho 

PATRICK T. MCHENRY, North Carolina 

CONNIE MACK, Florida 

K. MICHAEL CONAWAY, Texas 

JOHN CAMPBELL, California 

PATRICK J. TIBERI, Ohio 

JON C. PORTER, Nevada 

RODNEY ALEXANDER, Louisiana 

ADRIAN SMITH, Nebraska 

PROFESSIONAL STAFF

THOMAS S. KAHN, Staff Director and Chief Counsel 

JAMES T. BATES, Minority Chief of Staff 

(III)

C O N T E N T S

Page 

Hearing held in Washington, DC, January 23, 2007 ............................................ 1

Statement of: 

Hon. John M. Spratt, Jr., Chairman, House Committee on the Budget ..... 1

Hon. Paul Ryan, a Representative in Congress from the State of Wisconsin ............................................................................................................. 2

David M. Walker, Comptroller General of the United States ...................... 4

Edward M. Gramlich, Richard B. Fisher Senior Fellow, the Urban Institute ................................................................................................................. 25

Edwin M. Truman, Senior Fellow, Peterson Institute for International 

Economics ...................................................................................................... 28

Prepared statement of, additional materials submitted: 

General Walker ................................................................................................. 17

Response to Mr. Scott’s question about the value of permanent tax 

cuts .......................................................................................................... 55

Mr. Gramlich .................................................................................................... 27

Mr. Truman ....................................................................................................... 30

Responses to questions posed by Hon. Marcy Kaptur, a Representative in Congress from the State of Ohio .............................................. 68

(1)

WHY DEFICITS MATTER 

TUESDAY, JANUARY 23, 2007

HOUSE OF REPRESENTATIVES, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to call, at 10:07 a.m., in room 210, 

Cannon House Office Building, Hon. John M. Spratt, Jr. [chairman 

of the committee] presiding. 

Present: Representatives Spratt, DeLauro, Edwards, Cooper, 

Allen, Doggett, Boyd, McGovern, Sutton, Andrews, Scott, 

Etheridge, Hooley, Moore, Bishop, Ryan, Bonner, Garrett, Barrett, 

Diaz-Balart, Hensarling, Lungren, McHenry, Campbell, Porter, Alexander, Smith, and Tiberi. 

Chairman SPRATT. I will call the hearing to order and first recognize our witnesses and turn to the ranking member for any statement he wishes to make. 

On this day, when we will hear from the President on the State 

of the Union, I am pleased that we will also hear from our distinguished witnesses on why deficits matter. 

I wanted to thank our witnesses for today’s hearing: The Comptroller of the United States, who needs no introduction, he has 

been here plenty of times before and has become a very vocal, visible and responsible advocate for fiscal responsibility, David Walker, 

head of the Government Accountability Office; Dr. Edward 

Gramlich, who is the Richard B. Fisher Senior Fellow at the Urban 

Institute, and Dr. Edwin M. Truman, who is the Senior Fellow at 

the Peterson Institute For International Economics. 

As I have said, the topic for today is a very pressing and pertinent and timely one, and that is, do deficits matter? As we begin 

this 110th Congress, we find ourselves faced with a daunting task. 

Six years ago, the budget was in surplus, the surplus by official 

projections over 10 years to the tune of $5.6 trillion. Within 2 

years, that surplus was gone, vanished, disappeared. Within 2 

more years, the deficit reached record levels, over $400 billion. Fortunately, the deficit has come down a bit from there, but nobody 

can assume the deficit is on a glide path to being balanced or the 

budget is on a glide path to being balanced by any means, and nor 

should anyone assume that the task of bringing it back to balance, 

putting the budget back in surplus is going to be an easy one. It 

will not be. 

In the 1980s and 1990s, we had four different major efforts on 

the budget: Gramm, Rudman and Hollings, the Bush Budget Summit in 1990, 1991, the Clinton budget in 1993, and the Balanced 

2

Budget Act of 1997. It took us all of those budgets to finally bring 

the budget to heel and put it back in surplus. 

So today we will explore with our witnesses do deficits matter. 

Is this something that should be an urgent priority for this Congress or is this something that we can put on the back burner 

while we attend to other priorities? If they do matter, to what extent are they a problem and what should we do about the problem? 

Those are, broadly speaking, the questions we put to our witnesses today; and before turning first to General Walker, I want 

to turn to our ranking member, Mr. Ryan, for any statement he 

cares to make. 

Mr. RYAN. I thank the chairman for yielding. I would like to 

make a few opening remarks. 

Number one, I think both members, Republicans and Democrats 

here, share concern about the effects of chronic deficit spending. 

But it is not enough for us to just sit here and rail against deficits. 

We have got to understand the cause of today’s deficits; and we 

have got to recognize that deficits are a symptom, a symptom of excessive spending that is going to get dramatically worse if we don’t 

take the right steps to control it. 

First, let’s review how we got to this point. I have no doubt that 

we are going to hear later on today that Republicans squandered 

a $5.6 trillion surplus through reckless tax cuts and spending. We 

are going to hear this a lot in the next couple of years, I think, but 

it is important to note that the surplus was a projection, was a 

guess into the future, one that did not foresee the bursting of the 

dot-com bubble, economic slowdown and the recession of 2000 and 

2001, attacks on 9/11 and the ensuing war on terror. 

Tax relief was not the problem. Well-timed tax relief not only 

helped buoy the economy out of recession, it also unlocked investment, leading to significant job creation, sustained economic 

growth we have seen over the past few years. That economic 

growth results in the key factor in recent deficit reduction. In fact, 

despite an immense set of costly challenges, from the war on terror 

to last year’s hurricanes, we have had significant progress in reducing short-term deficits through pro-growth economic policies and 

spending restraint. 

Last year, the deficit fell to $248 billion, a drop of $114 billion 

since January estimates and the lowest deficit in 4 years. The current deficit is 2 percent of GDP. That is well below the average of 

the past 35 years and is projected to stay in that range to the end 

of the decade under current policies. 

Again, the primary reason for this improvement is double-digit 

growth in revenues coming into the Federal Treasury. I wish we 

did a lot more on spending, but we have plenty of revenues coming 

into the Federal Government. Even with accelerated tax relief that 

we have had, revenues for 2006 reached 18.4 percent of GDP and 

that is higher than the average of the past four decades; and, recently, both CBO and the Treasury reported the revenue for the 

first quarter of the fiscal year 2007 was 8.1 percent ahead of the 

prior year. 

On appropriations, over the past 3 years, we held nonsecurity appropriations to less than inflation, higher than I would have done 

it, but we held some limit on that. 

3

Entitlements, in 2005, for the first time in about a decade, we 

took the first step toward reining in the largest, least sustainable 

portion of our Federal Government, entitlement spending, by saving $40 billion over the next 5 years. 

But while the near-term fiscal outlook is improving, the oncoming retirement of the baby boomers—and the first of them just 

turned 60 last year—will bring rapidly swelling demands in the 

budget and in the economy. 

As this committee has been told time and again by experts ranging from our witness today, Dave Walker, to Doug Holtz-Eakin at 

CBO to Alan Greenspan, the chief threat to our Nation’s long-term 

fiscal health is spending, particularly the unsustainable growth 

rates in our Nation’s big three entitlement programs: Social Security, Medicare and Medicaid. These three programs right now consume about 9 percent of our economy, 9 percent of GDP. They are 

going to grow to about 15.5 percent of GDP by 2030. Without fundamental structural reforms, neither the budget nor the economy 

can sustain projected spending for these programs as they are currently structured. 

I just want to close with one quote from our esteemed witness, 

General Walker, who said in an earlier hearing, ‘‘We cannot grow 

our way out of this problem.’’ Eliminating earmarks will not solve 

the problem; lightening up fraud, waste and abuse will not solve 

the problem; ending the war or cutting way back on defense will 

not solve the problem; and letting the recent tax cuts expire will 

not solve the problem. We are going to have to do much bigger 

things in Congress. We are going to have to have much larger reforms, and all roads lead to fundamental restructuring of these entitlement programs if we are going to solve the problem. 

Do we want to give our kids and our grandkids a government 

that is literally twice the size of the government we have today, 

that we would literally have to tax about 40 percent of our Nation’s 

output in order to just pay for the programs that we have today 

in the future? I don’t think we want to do that, Mr. Chairman; and 

I appreciate the chance to have this conversation, this dialogue. We 

have great witnesses today, and I look forward to it. 

Thank you. 

Chairman SPRATT. Let me remind the gentleman that over the last 6 years we have accumulated $3.1 trillion in debt, statutory 

debt. The debt service on that debt will be with us for years to 

come, and that debt service widening—the widening wage in the 

budget is going to make it even harder than ever to resolve the entitlements problems. Because if there is one entitlement truly entitled mandatory spending it is interest on the national debt. We can 

change the other programs, but interest on the national debt is 

obligatory. And as it grows and grows and grows, it crowds out our 

ability to respond to other demands and promises we have made 

and keep those promises. 

But we didn’t come here to talk ourselves. We have come here 

to hear what you have to say, General Walker, and what our other 

two witnesses have. The floor is yours. We will make your statement a part of the record if you care to summarize it. The chart 

is on the wall, the screens on the wall are yours, too, because I am 

sure you have come armed with charts. 

4

Before I proceed, let me ask unanimous consent that all members 

be allowed to put their opening statement, if they care to file one, 

in the record at this point. 

General Walker, the floor is yours. 

STATEMENT OF DAVID M. WALKER, COMPTROLLER GENERAL 

OF THE UNITED STATES 

Mr. WALKER. Thank you Chairman Spratt, Ranking Member 

Ryan, members of the House Budget Committee. It is a pleasure 

to be back before you today to talk about why deficits matter. 

I do have a PowerPoint presentation which I am going to use. I 

find that when you are dealing with numbers this big, you need to 

have charts and graphs or else you really can’t convey the message 

effectively. You have a copy of my full statement which I have also 

provided for the record. 

Let me first answer the question, do deficits matter? The answer 

is, if you care about—pardon me—if you are concerned with stewardship and if you care about the future of our country, our children and our grandchildren, the answer is a clear yes, they do matter. 

Secondly, today in America we suffer from two maladies: nearsightedness or shortsightedness and tunnel vision. The analogy 

from a fiscal standpoint is, the short-term deficits aren’t our problem. It is where we are headed, and where we are headed could 

swamp the ship of state if we don’t get serious soon. The simple 

truth is, we do not face an immediate heart attack, but we have 

been diagnosed with cancer, and we need to change behavior, and 

we need to engage in dramatic and fundamental reforms, which I 

will touch on, in order to save our future. 

First slide, please.


gao1.eps
5

This represents deficits as a percentage of the economy, going 

back to World War II. 

A couple of comments. First, obviously, our country and our way 

of life was threatened in World War II. We did what it took and 

subsequently were able to pay off most of that debt for a variety 

of reasons. 

In the 1980s, we did have larger deficits as a percentage of the 

GDP than we do today, but we got something for it. We bankrupted 

the Soviet Union, we won the Cold War, and we declared a peace 

dividend. Only time will tell what we get for the current deficits. 

Next, please.

This represents deficits as a percentage of the economy for more 

recent years, since 1962. The red represents the on-budget deficit. 

The blue represents the off-budget surplus, primarily Social Security. The black line represents the unified deficit, and I think you 

can see here that we did run larger deficits as a percentage of the 

economy in the 1980s. 

We then took a number of dramatic steps. We turned deficits into 

surpluses. The trend turned negative. It has gotten better in the 

last several years, but let me reinforce my statement: The problem 

is not the short term. The problem is the long run. 

We should not be having a debate in my opinion, in my professional opinion, about whether or not deficits were larger in the 

1980s. The fact is, when you are flying a plane, driving a car, you 

need to look forward, not in the rear-view mirror, and it doesn’t 

really make a difference what the deficits were in the 1980s. What 

matters is where we are now and where are we headed and what 

the consequences to the country and our children and grandchildren. 

Next, please.


gao2.eps
6

This represents the future of unified surpluses and deficits as a 

share of GDP under two alternative fiscal policy simulations. One 

is CBO baseline extended. You can see, even with that, we face 

large problems in the years that grow. 

The second one, which is the red dotted line, shows discretionary 

spending growing with the economy and all tax provisions that are 

scheduled to expire being extended. Neither way sustainable. We 

are going to have to engage in dramatic and fundamental reforms. 

Next, please.


gao3.eps
7

In January and February of 2001, I testified before numerous 

committees in the House and the Senate about where we stood 

from a financial and fiscal standpoint. This represented GAO’s 

long-range fiscal simulation in January of 2001. It was based upon 

a number of assumptions, some of which proved to be valid, some 

of which did not. Anytime you go out 40-plus years, that is a long 

way to go; and, obviously, the power of compounding is such that 

the further out you go the more variance there can be. The bottom 

line is, based upon this, we had fiscal sustainability for 40-plus 

years; and, at that time, we were even on a path to pay down all 

of the national debt, although I know a lot of people were really 

concerned about that. Personally, I was never really concerned 

about that, but some people were. 

Next, please.


gao4.eps
8

When it comes up, you will see the next one represents the current simulation based upon CBO’s baseline extended. That represents the current simulation based upon CBO’s baseline extended; and, just to help, the black line represents revenues as a 

percentage of the economy, only Federal revenues. The bars represent spending as a percentage of the economy. So inflation is 

taken out of these numbers. 

When the bar is above the line, that is a deficit. And you can see 

that even under, you know, baseline extended, which assumes that 

all tax cuts will expire, which assumes that discretionary spending 

will only grow by the rate of the economy for the first 10 years and 

assumes a number of other things, including that we don’t have a 

long-term fixed AMT, you can see we have a large and growing 

problem in the outyears. 

Next, please.


gao5.eps
9

The following simulation assumes that discretionary spending 

grows by the rate of the economy, rather than the rate of inflation, 

and that the expiring tax cuts are made permanent and that somehow we do something with AMT such that we are basically maintaining about the historical level of taxation as compared to the 

economy. Well, on this, you can see that the fastest-growing cost 

by far is the bottom blue segment, which represents interest on the 

Federal debt. Now, unlike 2001, where we had fiscal sustainability 

for 40-plus years, under this, the model blows up in the 2040s. 

Next, please.


gao6.eps
10

We are on a path where, even if you exclude interest on the Federal debt, which, obviously, you can’t, the Federal Government is 

not going to default either on debt held by the public or, frankly, 

debt held by the trust funds. We are not going to default on that. 

We will deliver on that. It represents a priority claim on future 

general revenues. 

But if you exclude interest on the debt, which, obviously, we 

can’t, but for lesser purposes Social Security, Medicare and Medicaid alone are on a path, well, they will consume the entire revenues based on a historical percentage of our economy, these three 

programs alone. That obviously can’t be allowed to happen. 

Next, please.


gao7.eps
11

Now, this is important. In the last 6 years, the total liabilities 

and unfunded commitments of the United States government have 

gone up from $20 trillion—now you have to write 12 zeros to the 

right of that 20; it is really not impressive until you write it out—

$20 trillion to $50 trillion in 6 years, primarily due to Medicare. 

The Medicare prescription drug benefit alone comes with an $8 trillion price tag. That $8 trillion price tag is more than the entire unfunded obligation of Social Security. 

Mr. SCOTT. Present value? 

Mr. WALKER. Present value. 

Let me help explain this. This takes dedicated payroll tax and 

premium revenues over the next 75 years, estimated benefit payments based upon the best estimate assumptions of the trustees of 

Social Security and Medicare—and I used to be one from 1990 to 

1995. You calculate the difference, and you discount it back to current dollar terms at Treasury rates. 

So, in other words, how much money would you have to have 

today invested at Treasury rates in order to deliver on the promise 

with no reforms? This is how much money you would have to have. 

It has gone up almost—well, it has gone up 147 percent in 6 years. 

Now the next one I think is easier to understand.


gao8.eps
12

How can we take $50 trillion and translate that into terms that 

you and I and, you know, people on Main Street can understand? 

First, $50 trillion is 95 percent of the entire net worth of every 

American. $50 trillion is 95 percent of the estimated net worth of 

every American, individual net worth, doesn’t count corporate retained earnings. 

By the way, it was below—that percentage was below 50 percent 

6 years ago. Last year, the percentage was 91 percent. We are on 

a path to where it will exceed 100 percent within the next 2 years. 

$50 trillion is $440,000 per American household. Median household income in America is less than $47,000. So, stated differently, 

the typical American household has an implicit debt of over nine 

times our annual income. That is like having a mortgage but no 

house. And while this obligation will end up having to be discharged over a number of years, the only asset that people have to 

discharge this obligation is their citizenship in the United States 

of America, which does provide unparalleled opportunities, but it 

obviously is not a tangible asset.


gao9.eps
13

The next chart shows that part of our problem is that, in addition to the fiscal issue, we face slowing labor force growth. We have 

an aging society with longer life spans; people are wanting to retire 

earlier. That undercuts our ability to continue to grow economically, especially in a knowledge-based economy where it is brain 

power rather than brawn power that drives value and where people 

have an ability and hopefully an opportunity to work longer and to 

continue to contribute to our economy, both from the standpoint of 

the revenue side and to reduce the expenditure side over time. 

Next, please.


gao10.eps
14

Cash is key. This represents cash flows for the Social Security 

Trust Fund. The Social Security Trust Fund will start declining in 

its surpluses in 2009. Congress will therefore start going through 

withdrawal, because Congress has been accustomed and so has the 

executive branch to being able to spend those surpluses. So, starting in 2009, they will start to decline. In 2017, they will be G-ON-E, gone. There will be deficits, and we will start having to count 

on these bonds and trust funds which aren’t really trust funds, but 

that is a different story. We are already running a negative cash 

flow in Medicare; and, in fact, the Medicare Part A Trust Fund is 

expected to become exhausted in about 2017, 2018. 

Next, please.


gao11.eps
15

This is a possible way forward. Number one, we have to improve 

financial reporting, public education and performance metrics. You 

can’t solve a problem until people understand that we have a problem that needs to be solved and it is prudent to solve it sooner 

rather than later. We need to improve our transparency with regard to financial reporting, budgeting and other legislative processes, more truth in advertising about where we really are. 

Secondly, we need to strengthen budget and legislative processes 

and controls. I am happy to answer questions. We need to bring 

back the controls that we had in the 1990s, and we need more than 

we had in the 1990s because we are in worse shape than we were 

in the early 1990s, and the demographic tsunami of entitlement 

spending is very close to becoming a reality. 

The first baby boomer reaches 62 January 1, 2008, less than a 

year from now, will be eligible for early retirement under Social Security. They will reach 65 in 2011, will be eligible for Medicare. 

That will begin a surge in spending which could swamp the ship 

of state. 

And last but certainly not least, and I think Mr. Ryan touched 

on some of this, most of the Federal Government’s policies, programs, functions and activities, whether it is on the tax side, 

whether it is on the spending side, whether it is on the organizational structure and management models, are based on the 1940s 

to the 1970s. They get into the base, they are assumed to be okay 

and, in many cases, they are not effective, and they are outdated. 

And even if they are reasonably effective and not outdated, they 

may not be as high a priority for the 21st century as they were 

when they were put in place. 

We have got to engage in a fundamental reexamination and 

transformation of the entire Federal Government, entitlement proVerDate 0ct 09 2002 19:37 Mar 07, 2007 Jkt 000000 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 J:\DOCS\HEARINGS\110TH\110-2\32738.TXT HBUD1 PsN: DICK

gao12.eps
16

grams, spending policies and tax reform. Also, our organizational 

models. 

We published a document in February, 2005. Every Member of 

Congress received one. It is entitled, Reexamining the Base—pardon me. It is entitled 21st Century Challenges: Reexamining the 

Base of the Federal Government. It gives you an idea of the kinds 

of questions we will have to ask and answer. It will take us 20-

plus years, but we need to get started now. 

Last two slides.

This is not just about numbers. This is about values and people. 

The value that I would give you to focus on is stewardship. Stewardship means that leaders have an obligation not just to generate 

positive results today, not just to leave things better off when you 

leave than when you came, but better positioned for the future. My 

generation, the baby boom generation, individuals born between 

1946 and 1964, are on track to be the first generation in the history of this country not to discharge its stewardship responsibilities. That is not acceptable to me, and I would imagine it is not 

acceptable to you. So it is about values, and it is about people. 

Next and last.


gao13.eps
17

These are my three grandchildren. They did not create this problem. This is their problem. They will pay the price. They will bear 

the burden if tough choices are not made and not made soon. They, 

obviously, are too young to vote. They have voices, but their voices 

typically are not heard. I am their voice. 

Thank you, Mr. Chairman. 

Chairman SPRATT. Thank you very much, General Walker. 

[The prepared statement of David Walker follows:]

PREPARED STATEMENT OF DAVID M. WALKER, COMPTROLLER GENERAL OF THE

UNITED STATES

Chairman Spratt, Mr. Ryan, Members of the Committee: I appreciate this invitation to talk with you about why deficits matter—about our nation’s long-term fiscal 

outlook and the challenge it presents. Your decision to focus on this issue is an important statement about the seriousness with which you view this challenge and 

your commitment to begin to address it. 

You all have entitled this hearing ‘‘Why Deficits Matter.’’ Let me start with a very 

simple reason: they matter for the world we leave our children and grandchildren. 

As all of you know—and as I will discuss in this statement—it is not the short-term 

deficit that threatens us; it is the longterm fiscal outlook. We are on an imprudent 

and unsustainable path. Continuing on our current fiscal path would gradually 

erode, if not suddenly damage, our economy, our standard of living, and ultimately 

even our domestic tranquility and our national security. This is a great nation with 

much to be proud of and much to be thankful for. But today we are failing in one 

of our most important stewardship responsibilities—our duty to pass on a country 

better positioned to deal with the challenges of the future than the one we were 

given. 

The picture I will lay out for you today is not a pretty one and it’s getting worse 

with the passage of time. But this nation has met difficult challenges—including 

challenges to its very existence—in the past and I’m confident that we can do so 

again. 

The essence of my message today is no surprise to Members of this Committee: 

• Our current financial condition is worse than is widely understood. 

• Our current fiscal path is both imprudent and unsustainable. 

• Improvements in information and processes are needed and can help. 

• Meeting our long-term fiscal challenge will require (1) significant entitlement 

reform to change the path of those programs; (2) reprioritizing, restructuring and 

constraining other spending programs; and (3) more revenues—hopefully through a 

reformed tax system. This will take bipartisan cooperation and compromise. 

• The time to act to save our future is now! 


gao14.eps
18

When fiscal year 2006 ended a great deal of attention was paid to the fact that 

at $248 billion ‘‘the deficit’’ came in lower than originally predicted and lower than 

in 2005. And just this week press reports have noted that—as figure 1 shows—the 

(unified) deficit as a share of the economy is not terribly high. 

This is all true—and it is also misleading. First, a single year’s unified budget 

deficit is not the critical issue here. Certainly this improvement in the 1-year fiscal 

picture is better than a worsening in that picture, but it did not fundamentally 

change our long-term fiscal outlook. In fact, the U.S. government’s total reported liabilities, net social insurance commitments, and other fiscal exposures continue to 

grow and now total approximately $50 trillion, representing approximately four 

times the nation’s total output, or gross domestic product (GDP) in fiscal year 2006, 

up from about $20 trillion, or two times GDP in fiscal year 2000. 

Further, the long-term challenge is fast becoming a short-term one as the first of 

the baby boomers become eligible for early retirement under Social Security on January 1, 2008—less than one year—and for Medicare benefits in 2011—less than 4 

years from now. The budget and economic implications of the baby boom generation’s retirement have already become a factor in the Congressional Budget Office’s 

(CBO) 10-year baseline projections and will only intensify as the baby boomers age. 

Simply put, our nation is on an imprudent and unsustainable fiscal path. Herbert 

Stein once said that something that is not sustainable will stop. That, however, 

should not give us comfort. It is more prudent to change the path than to wait until 

a crisis occurs. 

And that brings me to my next point. While restraint in the near term and efforts 

to balance the budget over the next 5 years can be positive, it is important that actions to achieve this also address the long-term fiscal outlook. The real problem is 

not the near-term deficit—it is the long-term fiscal outlook. It is important to look 

beyond year 5 or even year 10. Both the budget and the budget process need more 

transparency about and focus on the long-term implications of current and proposed 

spending and tax policies. In this testimony I will suggest a number of things that 

I believe will help in this area. 

OUR FISCAL AND FINANCIAL CONDITION IS WORSE THAN WIDELY UNDERSTOOD

A great deal of budget reporting focuses on a single number—the unified budget 

deficit, which was $248 billion in fiscal year 2006. This largely cash-based number 

represents the difference between revenues and outlays for the government as a 

whole. It is an important measure since it is indicative of the government’s draw 

on today’s credit markets—and its claim on today’s economy. But it also masks the 

difference between Social Security’s cash flows and those for the rest of the budget. 

Therefore we also need to look beneath the unified deficit at the on-budget deficit—

what I like to call the ‘‘operating deficit.’’ And, finally, we should be looking at the 

financial statements’ report of net operating cost—the accrual-based deficit. 

Social Security currently takes in more tax revenue than it needs to pay benefits. 

This cash surplus is invested in Treasury securities and earns interest in the form 

of additional securities. The difference between the on-budget deficit and the unified 

budget deficit is the total surplus in Social Security (cash and interest) and the U.S. 

Postal Service. Excluding consideration of the $185 billion surplus in Social Security 

and a $1 billion surplus in the Postal Service, the on-budget deficit was $434 billion 

in 2006. Figure 2 shows graphically how the on-budget deficit and the offbudget surplus have related and combine to lead to the unified deficit. Since the Social Security trust fund invests any receipts not needed to pay benefits in Treasury securities, its cash surplus reduces the amount the Treasury must borrow from the public. 

As I will note later, this pattern of cash flows is important—and it is projected to 

come to an end just 10 years from now. 

The third number, net operating cost, is the amount by which costs exceed revenue and it is reported in the federal government’s financial statements, which are 

prepared using generally accepted accounting principles.1 Costs are recorded on an 

accrual basis—namely, in the period when goods are used or services are performed 

as opposed to when the resulting cash payments are made. However, most revenues, 

on the other hand, are recorded on the modified cash basis—that is, they are recorded when collected. The net operating cost can be thought of as the accrual deficit. The accrual measure primarily provides more information on the longer-term 

implications of today’s policy decisions and operations by showing certain costs incurred today but not payable for years to come, such as civilian and military pensions and retiree health care. In fiscal year 2006 net operating cost was $450 billion. 

All three of these numbers are informative. However, neither accrual nor cash 

measures alone provide a full picture of the government’s fiscal condition or the cost 

of government. Used together, they present complementary information and provide 

19

a more comprehensive picture of the government’s financial condition today and fiscal position over time. For example, the unified budget deficit provides information 

on borrowing needs and current cash flow. The accrual deficit provides information 

on the current cost of government, but it does not provide information on how much 

the government has to borrow in the current year to finance government activities. 

Also, while accrual deficits provide more information on the longer-term consequences of current government activities, they do not include the longer-term cost 

associated with social insurance programs like Social Security and Medicare. In addition, they are not designed to provide information about the timing of payments 

and receipts, which can be very important. Therefore, just as investors need income 

statements, statements of cash flow, and balance sheets to understand a business’s 

financial condition, both cash and accrual measures are important for understanding the government’s financial condition.2

Although looking at both the cash and accrual measures provides a more complete 

picture of the government’s fiscal stance today and over time than looking at either 

alone, even these together do not tell us the full story. For example, as shown in 

table 1, all three of these deficits improved between fiscal year 2005 and fiscal year 

2006.3 This improvement, however, did not result from a change in the fundamental 

drivers of our long-term challenge and did not signal an improvement in that outlook. To understand the long-term implications of our current path requires more 

than a single year’s snapshot. In this regard, the longterm outlook has worsened 

significantly in the last several years. That is why for more than a decade GAO has 

been running simulations to tell this longer-term story. 

THE CURRENT LONGTERM FISCAL OUTLOOK IS UNACCEPTABLE

As I mentioned, it is not the recent past shown in figure 1—nor the outlook for 

this year—that should concern us. Rather it is the picture in figure 3 that should 

worry us. 

Long-term fiscal simulations by GAO, CBO, and others all show that we face large 

and growing structural deficits driven primarily by rising health care costs and 

known demographic trends. GAO runs simulations under two sets of assumptions. 

One takes the legislatively-mandated baseline from CBO for the first 10 years and 

then keeps discretionary spending and revenues constant as a share of GDP while 

letting Social Security, Medicare, and Medicaid grow as projected by the Trustees 

and CBO under midrange assumptions.4 The other, perhaps more realistic, scenario 

based on the Administration’s announced policy preferences changes only two things 

in the first 10 years: discretionary spending grows with the economy and all expiring tax provisions are extended.5 Like the ‘‘Baseline Extended’’ scenario, after 10 

years both revenues and discretionary spending remain constant as a share of the 

economy. As figure 3 shows, deficits spiral out of control under either scenario. We 

will be updating these figures with the release of the new CBO baseline later this 

month, but even with the lower deficit in 2006, the long-term picture will remain 

daunting. 

Looking more closely at each scenario gives a fuller understanding of what the 

impact of continuing these trends would have on what government does. And it 

shows us ‘‘Why Deficits Matter.’’

First, it makes sense to look back to 2001—it is worth understanding how much 

worse the situation has become. As I noted, despite some recent improvements in 

short-term deficits, the long-term outlook is moving in the wrong direction. 

Figures 4 and 5 show the composition of spending under our ‘‘Baseline Extended’’ 

scenario in 2001 and 2006. Even with short-term surpluses, we had a long-term 

problem in 2001, but it was more than 40 years out. Certainly an economic slowdown and various decisions driven by the attacks of 9/11 and the need to respond 

to natural disasters have contributed to the change in outlook. However, these items 

alone do not account for the dramatic worsening. Tax cuts played a major role, but 

the single largest contributor to the deterioration of our long-term outlook was the 

passage of the Medicare prescription drug benefit in 2003. 

Figure 5 illustrates today’s cold hard truth, that neither slowing the growth in 

discretionary spending nor allowing the tax provisions to expire—nor both together—would eliminate the imbalance. This is even clearer under the more realistic scenario as shown in figure 6. Estimated growth in the major entitlement programs results in an unsustainable fiscal future regardless of whether one assumes 

future revenue will be somewhat above historical levels as a share of the economy 

as in the first simulation (fig. 5) or lower as shown in figure 6. 

Both these simulations remind us ‘‘Why Deficits Matter.’’ They illustrate that 

without policy changes on the spending and revenue side of the budget, the growth 

in spending on federal retirement and health entitlements will encumber an escaVerDate 0ct 09 2002 19:37 Mar 07, 2007 Jkt 000000 PO 00000 Frm 00023 Fmt 6633 Sfmt 6621 J:\DOCS\HEARINGS\110TH\110-2\32738.TXT HBUD1 PsN: DICK
20

lating share of the government’s resources. A government that in our children’s lifetimes does nothing more than pay interest on its debt and mail checks to retirees 

and some of their health providers is unacceptable. 

Although Social Security is a major part of the fiscal challenge, contrary to popular perception, it is far from our biggest challenge. While today Social Security 

spending exceeds federal spending for Medicare and Medicaid, that will change. 

Over the past several decades, health care spending on average has grown much 

faster than the economy, absorbing increasing shares of the nation’s resources, and 

this rapid growth is projected to continue. CBO estimates that Medicare and Medicaid spending will reach 6.3 percent of GDP in 2016, up from 4.6 percent this year 

(2007), while spending for Social Security will only reach 4.7 percent of GDP in 2016 

up from 4.2 percent this year. For this reason and others, rising health care costs 

pose a fiscal challenge not just to the federal budget but also to states, American 

business, and our society as a whole. 

While there is always some uncertainty in long-term projections, two things are 

certain: the population is aging and the baby boom generation is nearing retirement 

age. The aging population and rising health care spending will have significant implications not only for the budget but also for the economy as a whole. Figure 7 

shows the total future draw on the economy represented by Social Security, Medicare, and Medicaid. Under the 2006 Trustees’ intermediate estimates and CBO’s 

long-term Medicaid estimates, federal spending for these entitlement programs combined will grow to 15.5 percent of GDP in 2030 from today’s 9 percent. This graphic 

is another illustration of why we have to act. I do not believe we are prepared to 

have programs that provide income for us in retirement and pay our doctors absorb 

this much of our children’s and grandchildren’s economy. It is clear that taken together, Social Security, Medicare, and Medicaid under current law represent an 

unsustainable burden on future generations. 

While Social Security, Medicare, and Medicaid dominate the long-term outlook, 

they are not the only federal programs or activities that bind the future. Part of 

what we owe the future is leaving enough flexibility to meet whatever challenges 

arise. So beyond dealing with the ‘‘big 3,’’ we need to look at other policies that limit 

that flexibility—not to eliminate all of them but to at least be aware of them and 

make a conscious decision about them. The federal government undertakes a wide 

range of programs, responsibilities, and activities that obligate it to future spending 

or create an expectation for spending and potentially limit long-term budget flexibility. GAO has described the range and measurement of such fiscal exposures—

from explicit liabilities such as environmental cleanup requirements to the more implicit obligations presented by life-cycle costs of capital acquisition or disaster assistance. 

Figure 8 shows that despite improvement in both the fiscal year 2006 reported 

net operating cost and the cash-based budget deficit, the U.S. government’s major 

reported liabilities, social insurance commitments, and other fiscal exposures continue to grow. They now total approximately $50 trillion—about four times the nation’s total output (GDP) in fiscal year 2006—up from about $20 trillion, or two 

times GDP in fiscal year 2000. 

Clearly, despite recent progress on our short-term deficits, we have been moving 

in the wrong direction in connection with our long-range imbalance in recent years. 

Our long-range imbalance is growing daily due to continuing deficits, known demographic trends, rising health care costs, and compounding interest expense. 

We all know that it is hard to make sense of what ‘‘trillions’’ means. Figure 9 provides some ways to think about these numbers: if we wanted to put aside today 

enough to cover these promises, it would take $170,000 for each and every American 

or approximately $440,000 per American household. Considering that median household income is about $46,000, the household burden is about 9.5 times median income. 

PROCESS AND PRESENTATIONAL CHANGES TO INCREASE TRANSPARENCY AND FOCUS ON

LONG-TERM CONSEQUENCES CAN HELP

Since at its heart the budget challenge is a debate about the allocation of limited 

resources, the budget process can and should play a key role in helping to address 

our long-term fiscal challenge and the broader challenge of modernizing government 

for the 21st century. I have said that Washington suffers from myopia and tunnel 

vision. This can be especially true in the budget debate in which we focus on one 

program at a time and the deficit for a single year or possibly the costs over 5 years 

without asking about the bigger picture and whether the long term is getting better 

or worse. We at GAO are in the transparency and accountability business. Therefore 

it should come as no surprise that I believe we need to increase the understanding 

21

of and focus on the long term in our policy and budget debates. To that end—as 

I noted earlier—I have been talking with a number of Members of the Senate and 

the House as well as various groups concerned about this issue concerning a number 

of steps that might help. I’ve attached a summary of some of these ideas to this 

statement. Let me highlight several critical elements here. 

• The President’s budget proposal should again cover 10 years. This is especially 

important given that some policies—both spending and tax—cost significantly more 

(or lose significantly more revenue) in the second 5 years than in the first. In addition, the budget should disclose the impact of major tax or spending proposals on 

the short, medium, and long term. 

• The executive branch should also provide information on fiscal exposures—both 

spending programs and tax expenditures—that is, the long-term budget costs represented by current individual programs, policies, or activities as well as the total. 

• The budget process needs to pay more attention to the long-term implication of 

the choices being debated. For example, elected representatives should be provided 

with more explicit information on the long-term costs of any major tax or spending 

proposal before it is voted upon. It is sobering to recall that during the debate over 

adding prescription drug coverage to Medicare, a great deal of attention was paid 

to whether the 10-year cost was over or under $400 billion. Not widely publicized—

and certainly not surfaced in the debate—was that the present value of the longterm cost of this legislation was about $8 trillion! 

Of course, when you are in a hole, the first thing to do is stop digging. I have 

urged reinstitution of the statutory controls—both meaningful caps on discretionary 

spending and pay-as-you-go (PAYGO) on both the tax and spending sides of the 

ledger—that expired in 2002. However given the severity of our current challenge, 

Congress should look beyond the return to PAYGO and discretionary caps. Mandatory spending cannot remain on autopilot—it will not be enough simply to prevent 

actions to worsen the outlook. We have suggested that Congress might wish to design ‘‘triggers’’ for mandatory programs—some measure that would prompt action 

when the spending path increased significantly. In addition, Congress may wish to 

look at rules to govern the use of ‘‘emergency supplementals.’’ However, as everyone 

in this committee knows, these steps alone will not solve the problem. That is why 

building in more consideration of the long-term impact of decisions is necessary. 

MEETING THE LONG-TERM FISCAL CHALLENGE REQUIRES ACTION ON THE SPENDING

AND TAX SIDES OF THE BUDGET—COOPERATION AND COMPROMISE WILL BE NECESSARY

There is no easy way out of the challenge we face. Economic growth is essential, 

but we will not be able to simply grow our way out of the problem. The numbers 

speak loudly: our projected fiscal gap is simply too great. To ‘‘grow our way out’’ of 

the current long-term fiscal gap would require sustained economic growth far beyond that experienced in U.S. economic history since World War II. 

Similarly, those who believe we can solve this problem solely by cutting spending 

or solely raising taxes are not being realistic. While the appropriate level of revenues will be part of the debate about our fiscal future, making no changes to Social 

Security, Medicare, Medicaid, and other drivers of the long-term fiscal gap would 

require ever-increasing tax levels—something that seems both inappropriate and 

implausible. That is why I have said that substantive reform of Social Security and 

our major health programs remains critical to recapturing our future fiscal flexibility. I believe we must start now to reform these programs. 

Although the long-term outlook is driven by Social Security and health care costs, 

this does not mean the rest of the budget can be exempt from scrutiny. Restructuring and constraint will be necessary beyond the major entitlement programs. 

This effort offers us the chance to bring our government and its programs in line 

with 21st century realities.6 Many tax expenditures act like entitlement programs, 

but with even less scrutiny. Other programs and activities were designed for a very 

different time. 

Taken together, entitlement reform and reexamination of other programs and activities could engender a national discussion about what Americans want from their 

government and how much they are willing to pay for those things. 

Finally, given demographic and health care cost trends, the size of the spending 

cuts necessary to hold revenues at today’s share of GDP seems implausible. It is 

not realistic to assume we can remain at 18.2 percent of GDP—we will need more 

revenues. Obviously we want to minimize the tax burden on the American people 

and we want to remain competitive with other industrial nations—but in the end 

the numbers have to add up. 

As I noted, we need to start with real changes in existing entitlement programs 

to change the path of those programs. However, reform of the major entitlement 

22

programs alone will not be sufficient. Reprioritization and constraint will be necessary in other spending programs. Finally, we will need more revenues—hopefully 

through a reformed tax system. 

The only way to get this done is through bipartisan cooperation and compromise—

involving both the Congress and the White House. 

Delay only makes matters worse. GAO’s simulations show that if no action is 

taken, balancing the budget in 2040 could require actions as large as cutting total 

federal spending by 60 percent or raising federal taxes to two times today’s level. 

FURTHER DELAY WILL ONLY WORSEN THE OUTLOOK

For many years those of us who talk about the need to put Social Security on a 

sustainable course and to reform Medicare have talked about the benefits of early 

action. Acting sooner rather than later can turn compound interest from an enemy 

to an ally. Acting sooner rather than later permits changes to be phased in more 

gradually and gives those affected time to adjust to the changes. Delay does not 

avoid action—it just makes the steps that have to be taken more dramatic and potentially harder. 

Unfortunately, it is getting harder to talk about early action—the future is upon us. Next year members of the baby boom generation start to leave the labor force. 

Figure 10 shows the impact of demographics on labor force growth. 

Reflecting this demographic shift, CBO projects the average annual growth rate 

of real GDP will decline from 3.1 percent in 2008 to 2.6 percent in the period 2012-

2016. This slowing of economic growth will come just as spending on Social Security, 

Medicare and Medicaid will begin to accelerate—accounting for 56 percent of all federal spending by 2016 compared to 43 percent in 2006. 

As I noted earlier, today Social Security’s cash surplus helps offset the deficit in 

the rest of the budget, thus reducing the amount Treasury must borrow from the 

public and increasing budget flexibility—but this is about to change. 

Growth in Social Security spending is expected to increase from an estimated 4.8 

percent in 2008 to 6.5 percent in 2016. The result, as shown in figure 11, is that 

the Social Security surpluses begin a permanent decline in 2009. At that time the 

rest of the budget will begin to feel the squeeze since the ability of Social Security 

surpluses to offset deficits in the rest of the budget will begin to shrink. In 2017 

Social Security will no longer run a cash surplus and will begin adding to the deficit. That year Social Security will need to redeem the special securities it holds in 

order to pay benefits. Treasury will honor those claims—the United States has 

never defaulted. But there is no free money. The funds to redeem those securities 

will have to come from higher taxes, lower spending on other programs, higher borrowing from the public, or a combination of all three. 

I spoke before of how big the changes would have to be if we were to do nothing 

until 2040. Of course, we won’t get to that point—something will force action before 

then. If we act now, we have more choices and will have more time to phase-in related changes. 

CONCLUDING REMARKS

Chairman Spratt, Mr. Ryan, Members of the Committee—in holding this hearing 

even before the President’s Budget is submitted you are signaling the importance 

of considering any proposal within the context of the longterm fiscal challenge. This 

kind of leadership will be necessary if progress is to be made. 

I have long believed that the American people can accept difficult decisions as 

long as they understand why such steps are necessary. They need to be given the 

facts about the fiscal outlook: what it is, what drives it, and what it will take to 

address it. As most of you know, I have been investing a good deal of time in the 

Fiscal Wake-Up Tour (FWUT) led by the Concord Coalition. Scholars from both the 

Brookings Institution and the Heritage Foundation join with me and Concord in laying out the facts and discussing the possible ways forward. In our experience, having these people, with quite different policy views on how to address our long-range 

imbalance, agree on the nature, scale, and importance of the issue—and on the need 

to sit down and work together—resonates with the audiences. Although the major 

participants have been Concord, GAO, Brookings, and Heritage, others include such 

organizations as the Committee for Economic Development (CED); the American Institute of Certified Public Accountants (AICPA); the Association of Government Accountants (AGA); the National Association of State Auditors, Comptrollers and 

Treasurers (NASACT); and AARP. The FWUT also has received the active support 

and involvement of community leaders, local colleges and universities, the media, 

the business community, and both former and current elected officials. We have 

23

been to 17 cities to-date. The discussion has been broadcast on public television stations in Atlanta and Philadelphia. Earlier this month OMB Director Portman and 

former Senator Glenn joined us at an event at the John Glenn School of Public Affairs at Ohio State University in Columbus, Ohio. 

The specific policy choices made to address this fiscal challenge are the purview 

of elected officials. The policy debate will reflect differing views of the role of government and differing priorities for our country. What the FWUT can do—and what 

I will continue to do—is lay out the facts, debunk various myths, and prepare the 

way for tough choices by elected officials. The American people know—or sense—

that there is something wrong; that these deficits are a problem. If they understand 

that there truly is no magic bullet—if they understand that 

• we cannot grow our way out of this problem; 

• eliminating earmarks will not solve the problem; 

• wiping out fraud, waste, and abuse will not solve the problem; 

• ending the war or cutting way back on defense will not solve the problem; 

• restraining discretionary spending will not solve the problem; and 

• letting the recent tax cuts expire will not solve this problem; 

then the American people can engage with you in a discussion about what government should do and how. 

People ask me how I think this can happen. I know that some Members believe 

a carefully structured commission will be necessary to prepare a package while others feel strongly that elected officials should take up the task of developing that 

package. Whatever the vehicle, success will require the active and open-minded involvement of both parties in and both houses of the Congress and of the President. 

With that it should be possible to develop a package which accomplishes at least 

three things: (1) a comprehensive solution to the Social Security imbalance—one 

that is not preprogrammed to require us to have to come back again, (2) Round I 

of comprehensive tax reform, and (3) Round I of Health Care Reform. 

This is a great nation. We have faced many challenges in the past and we have 

met them. It is a mistake to underestimate the commitment of the American people 

to their children and grandchildren; to underestimate their willingness and ability 

to hear the truth and support the decisions necessary to deal with this challenge. 

We owe it to our country, to our children and to our grandchildren to address this 

fiscal imbalance. The world will present them with new challenges—we need not bequeath them this burden too. The time for action is now. 

Mr. Chairman, Mr. Ryan, Members of the Committee, let me repeat my appreciation for your commitment and concern in this matter. We at GAO stand ready to 

assist you in this important endeavor. 

APPENDIX I: IDEAS FOR IMPROVING THE TRANSPARENCY OF LONG-TERM COSTS AND THE

ATTENTION PAID TO THESE COSTS BEFORE DECISIONS ARE MADE

Supplemental Reporting in the President’s Annual Budget Submission 

• Produce an annual Statement of Fiscal Exposures, including a concise list and 

description of exposures, cost estimates where possible, and an assessment of methodologies and data used to produce such cost estimates. 

• Increase the transparency of tax expenditures by including them in the annual 

Fiscal Exposures Statement and, where possible, also showing them along with 

spending and credit programs in the same policy area. 

• Provide information on the impact of major tax or spending proposals on shortterm, mid-term, and long-term fiscal exposures and on the path of surplus/deficit 

and debt as percent of gross domestic product (GDP) over 10-year and longer-term 

horizons (and assuming no sunset if sunset is part of the proposal). 

• Cover 10 years in the budget. 

• Consider requiring the President to include in his annual budget submission a 

long-term fiscal goal (e.g., balance, surplus, or deficit as percent of GDP). 

Additional Executive Branch Reports 

• Prepare and publish a Summary Annual Report or Citizen’s Summary that 

summarizes, in a clear, concise, plain English, and transparent manner, key financial and performance information included in the Consolidated Financial Report. 

• Prepare and publish a report on long-range fiscal sustainability every 2 to 4 

years. 

Additional Cost Information on Proposals before Adoption 

• Require improved disclosure—at the time proposals are debated but before they 

are adopted—of the long-term costs of individual mandatory spending and tax proposals over a certain size and for which costs will ramp up over time. 

24

GAO Reports 

• An annual report or reports by GAO including comments on the Consolidated 

Financial Statement (CFS), results of the latest long-term fiscal simulations, comments on the adequacy of information regarding long-term cost implications of existing and proposed policies in the previous year as well as any other significant financial and fiscal issues. 

Other Areas in Which GAO Has Suggested That Congress Might Consider Changing 

the Budget Treatment 

• Use accrual budgeting for the following areas where cash basis obligations do 

not adequately represent the government’s commitment: • employee pension programs (pre-Federal Employee Retirement System employees); • retiree health programs; and • federal insurance programs, such as the Pension Benefit Guaranty Corporation 

and crop insurance. • Explore techniques for expanding accrual budgeting to • environmental cleanup and • social insurance—could consider deferring recognition of social insurance receipts until they are used to make payments in the future (this was suggested in 

GAO’s accrual budgeting report as an idea to explore, possibly with a commission 

designed to explore budget concepts). 

ENDNOTES

1The Financial Report of the United States Government, 2006 can be found at 

www.fms.treas.gov/fr/index.html. 2GAO is responsible for auditing the financial statements included in the Financial Report, 

but we have been unable to express an opinion on them for 10 years because the federal government could not demonstrate the reliability of significant portions of the financial statements, 

especially in connection with the Department of Defense. Accordingly, amounts taken from the 

Financial Report may not be reliable. 3The decline in both the cash and accrual deficits in 2006 was primarily driven by an increase 

in federal revenue by almost 12 percent. In addition, the decline in the accrual deficit relative 

to the cash deficit was primarily due to a decrease in accrual-based expenses resulting from 

changes in assumptions that are the basis for actuarial estimates for certain accrued long-term 

liabilities. For a discussion of how the accrual and cash deficits relate to each other see GAO, 

Understanding Similarities and Differences between Accrual and Cash Deficits, GAO-07-117SP 

(Washington, D.C.: December 2006) and Understanding Similarities and Differences between 

Accrual and Cash Deficits, Update for Fiscal Year 2006, GAO-07-341SP (Washington, D.C. January 2006). 4Social Security and Medicare spending is based on the May 2006 Trustees’ intermediate projections. Medicaid spending is based on CBO’s December 2005 long-term projections under midrange assumptions. 5 Additional information about the GAO model, its assumptions, data, and charts can be found 

at http://www.gao.gov/special.pubs/longterm/. 

6GAO, 21st Century Challenges: Reexamining the Base of the Federal Government, GAO-05-

325SP (Washington, D.C.: February 2005) and Suggested Areas for Oversight for the 110th Congress, GAO-07-235R (Washington, D.C.: Nov. 17, 2006).

Chairman SPRATT. Now I am going to propose something, if it 

agrees with your schedule. I would like to call the other two witnesses forward and put questions to you as a panel, if that is 

agreeable with everybody. 

Mr. WALKER. That would be fine, Mr. Chairman. 

Chairman SPRATT. Dr. Gramlich and Dr. Truman, if you would 

come forward and take your seats beside General Walker. While 

you are sitting down, I will introduce you further. 

Dr. Gramlich has had a long and distinguished career as an 

economist. He was a professor at the University of Michigan for 

much of his career, he served as a governor on the Federal Reserve 

Board from 1997 to 2005, and he was Acting Director of the Congressional Budget Office from 1986 to 1987. 

Dr. Truman is the Senior Fellow at the Peterson Institute for 

International Economics, has been since 2001. He was the Assistant Secretary for International Affairs and Treasury from 1998 to 

2001; and before that for a number of years he directed the Division of International Finance, for more than two decades apparVerDate 0ct 09 2002 19:37 Mar 07, 2007 Jkt 000000 PO 00000 Frm 00028 Fmt 6633 Sfmt 6602 J:\DOCS\HEARINGS\110TH\110-2\32738.TXT HBUD1 PsN: DICK
25

ently. We are proud and pleased to have you, and we look forward 

to your testimony. 

Chairman SPRATT. Dr. Gramlich, let’s begin with yours, if that 

is agreeable with you. 

STATEMENT OF EDWARD M. GRAMLICH, RICHARD B. FISHER 

SENIOR FELLOW, THE URBAN INSTITUTE 

Mr. GRAMLICH. Thank you, Mr. Chairman and committee members. 

I have submitted a statement, and I am just going to briefly 

summarize it. 

Chairman SPRATT. Dr. Gramlich, your statement and Dr. Truman’s statement will both be made part of the record, so you can 

summarize it as you wish. 

Mr. GRAMLICH. I am going to just refer to one chart that you see 

there. 

Before I get into my statement, let me say one thing. We were 

asked to talk about deficits and why they mattered, and much of 

my testimony involved current deficits and why they mattered. But 

I would strongly endorse what David Walker has just told you, that 

the real problem is not so much the short run. Short run has some 

difficulties, as we will talk about, but the real problem is the long 

run. And so I am going to start with the short run and talk about 

some of the issues there, and then I am not going to say much 

about the long run, because I can’t do it any better than David 

Walker already has, and then talk about the policy issues. 

Now, David used the cancer analogy, and I am going to be a little 

bit less dramatic on this. The analogy I used was—it is borrowed 

from Charles Schultze, who is a former budget director and Chair 

of the Council on Economic Advisors. He asked at one time whether budget deficits could be likened to a pussycat, that is not a problem; to a wolf at the door huffing and puffing and threatening to 

blow the house down; or to termites in the basement. 

The pussycat argument is basically that private savers will offset 

the deficit and make it no problem from a standpoint of national 

saving, and you can see the chart there. The top line is the national saving rate of the United States, and the bottom line is the 

budget contribution to that national saving. 

And you see particularly in the last 20 years that the two are 

highly correlated. That is when the budget went into surplus in the 

late 1990s, national saving went up, but before that it had gone 

down, and after that it has gone down. In other words, private savers have really not offset the behavior of the Federal budget, and 

so the deficit is not a pussycat. It does have real economic effect. 

The wolf at the door argument hinges on two aspects. One is, it 

is possible that the Fed would in effect—use an economist word 

here—monetize the deficits and let inflation get out of control. 

Well, the Fed doesn’t have to do that. There are ways to conduct 

monetary policy without doing that, and the Fed has been very 

firm in its resolve the past few decades to keep prices stable. It has 

done that. It can continue to do that. So I don’t think that is a realistic worry. It could be in some countries, but not here, not in the 

United States. 

26

The other part of the wolf argument is that bondholders would 

begin charging higher interest rates on long-term interest rates on 

this debt, and that really hasn’t happened either. That is one of the 

things that we used to worry about at the Fed, exactly why longterm interest rates were so low. Chairman Greenspan at one point 

called it a conundrum. This sent many bond traders to their dictionaries to find out what a conundrum was; and, once they found 

out, yeah, they agreed, yeah, it is a conundrum that long-term interest rates have not gone up. I will come back to that in a second. 

The argument I find most convincing, and it corresponds with 

David’s message here, is that the termites in the basement argument, that you can see from the chart that if we have deficits they 

really do lower national saving. When national saving goes down, 

one of two things must happen—this is mathematics—either domestic investment would go down, and I think most of you would 

agree, that would be a bad thing. That would weaken the country’s 

economy in the long run. Or we borrow the difference. Investment 

stays up, but our saving has gone down, and so we have to come 

up with the fund somewhere, so we borrow it from abroad. 

This is what Mr. Truman is going to talk about, and I am just 

going to raise three questions about it. I won’t go into that in great 

detail. 

One question you want to ask is, while we have been able to borrow the difference between investment and saving, for how long? 

How long can we do this? These are international lenders, and they 

may get cold feet at some point, and then if we can’t keep on borrowing, then our investment will have to go down. 

The second question that you could ask—and, again, Dr. Truman 

will address this—is what happens if this borrowing unwinds? You 

could have—the history of international finance has been that, very 

often, these periods are ugly, that currency rates change abruptly 

in a short period of time, and that causes lots of dislocation, and 

that is an issue, too. 

And the third question I would ask is, why do we put ourselves 

in this position? All we have to do is run responsible fiscal policy. 

We can keep our national saving at a higher rate, we don’t have 

this decline that we see there recently, and isn’t that a more stable 

and sensible and sound way to manage our economy. 

So my fundamental argument about deficits in the short run 

would be that we are just—this is not good risk management. We 

are just putting the economy of the country at risk in a way that 

we don’t have to do. 

Now, things get much worse in the long run, and you have already seen David Walker’s charts and so forth, and you know it is 

driven by entitlement spending, the demographics. I would just 

make one further point about that. 

Right now, we have roughly 3.3 workers per retiree; and by 2030 

we are going to have two workers per retiree. How are these workers in 2030—and these are our kids and grandkids—going to support us if we are still lucky enough to be alive in 2030? Well, they 

are going to need more capital. That is the way they are going to 

support us. And the only way they get more capital is by saving 

more; and so this is a very bad time, I would put, for national saving to drop as it has. 

27

The last point, one simple thing, I am going to try to be nonpolitical about this. Should we fix the deficit on the tax or expenditure side? In the long run, it is obvious. We really have to do something about the growth of entitlement spending. In the short run, 

I would say it is not so obvious. We could fix it on either side, and 

I know it is a huge political issue for all of you, but I would just 

make the simple point as an economist that the problem here is the 

deficits. These are what ought to be fixed. 

If your belief is that America needs lower tax rates, fine, great, 

congratulations, but you have to cut spending. If your belief is that 

in some areas America needs more spending, fine, great, congratulations, but you have to be willing to pay the taxes to cover that 

spending. 

Thank you, Mr. Chairman. 

Chairman SPRATT. Thank you, Dr. Gramlich. 

[The prepared statement of Edward M. Gramlich follows:]

PREPARED STATEMENT OF EDWARD M. GRAMLICH, RICHARD B. FISHER SENIOR

FELLOW, THE URBAN INSTITUTE

Thank you, Mr. Chairman and committee members, for soliciting my testimony 

on the federal budget deficit problem. It is indeed a problem, as I will try to argue. 

Arguments about budget deficits have gotten into the political domain, and it is 

probably no surprise that controversy has grown up about deficits—just how bad are 

they? To try to illustrate the exact nature of the problem, I will paraphrase Charles 

Schultze, the Brookings scholar and former budget director. Some years ago 

Schultze asked whether deficits could be likened to a pussycat, a wolf at the door 

(huffing and puffing to blow the house down), or to termites in the basement. Answering this question is critical in knowing whether deficits are a problem and why. 

The pussycat argument holds that deficits are not a problem because private savers offset them. As deficits rise, the argument goes, perceptive citizens foresee that 

future tax payments will be higher, or transfer payments less, and will save more 

to cover their future costs. This view can be contradicted by personal experience—

how many families do each of you know who save more when federal deficits rise? 

But if this reasoning is not convincing, refer to the attached chart, which compares 

the BEA concept of national saving with federal budget surpluses (+) or deficits (-

). Over nearly a fifty-year period the two track very well. This indicates that as federal deficits rise, private saving changes little, and national saving falls. In other 

words, private saving does not offset the deficits. 

The argument for the wolf at the door, huffing and puffing to blow the house 

down, takes almost a completely opposite position. This time the argument is that 

high federal deficits will either put pressure on the Fed to create money to finance 

the deficits, hence causing inflation, or worry lenders into charging higher interest 

rates to finance the deficits. The US has run large deficits for some years and neither has happened. For nearly three decades the Federal Reserve has been determined to keep inflation low and stable, it has been perfectly free to do that (financing as much of the deficit as it deems wise), and it has done just that. Deficits have 

come and gone, but the Fed has been able to keep inflation on track. 

As for bondholders, there has been speculation that they would insist on higher 

long-term bond rates as deficits rose, but this really hasn’t happened either. Longterm rates are well-behaved right now—indeed, former Fed Chairman Greenspan 

referred to their low levels as a conundrum—and most reasonable forecasts expect 

them to remain so in the near future. We could worry that high deficits will cause 

high interest rates, but that would be, well, crying wolf. 

So we are left with the termite argument, the one I favor. As the chart shows, 

deficits do lower national saving—of that there seems little doubt. When national 

saving declines, it is a mathematical truism that one of two things must happen: 

a) domestic investment in capital equipment must decline, lowering America’s 

long-term rate of productivity improvement; 

b) domestic investment will not decline but the country will borrow the difference, 

in the form of higher current account deficits in the balance of payments. 

This choice is not an assertion, it is true by definition. I could show a new set 

of charts here, but most of you know what happened. So far domestic investment 

28

has held up well, and the nation has made up the difference between saving and 

investment by borrowing from foreigners. 

I think most of you would accept the fact that if the deficit-induced decline in national saving were to erode domestic investment, that would be a bad thing. It is 

a competitive world out there and our nation has to invest in new equipment, keep 

new techniques coming on-stream, and maintain its economic strength. The harder 

part of the argument is on the foreign side—if foreigners persist in lending us whatever we need to keep investment high, why worry? 

My colleague, Ted Truman, will address this issue in depth, but let me make one 

simple point. How do we know that foreigners will keep on lending to us? And at 

a more basic level, why should the United States put itself at the mercy of foreign 

lenders? One would think we should manage our affairs to keep national saving as 

high as we think it should be, from an optimizing standpoint. If foreigners lend to 

us, our own investment will be that much higher. If not, we are protected against 

a decline in investment by our own national saving. The basic problem with letting 

national saving fall is that the country becomes vulnerable. 

There is also an important time dimension to the budget problem, stressed by 

Chairman Bernanke in his testimony to the Senate a few days ago. Soon the large 

baby boom cohort in the United States will hit retirement ages, and when that happens, projected entitlement spending rises rapidly. The Social Security trust fund 

contributes a cash surplus to the budget now, but that cash surplus will be gone 

in a little more than a decade and ultimately will become a big cash deficit. Simultaneously, health care spending is likely to be rising rapidly. The time to take matters 

under control, to get our deficits down and national saving up, is now. 

Looking at this issue another way, presently the nation has a little more than 

three workers per retiree. In 2030 there will be about two workers per retiree. If 

those workers are to support the rising number of retirees, they will need more capital. They can only get capital through higher national saving. That is exactly what 

we should be doing today—saving at higher rates. Instead we have let the budget 

deficits erode national saving. 

So this is the argument, Mr. Chairman. Deficits are not like a pussycat, with no 

effect. Nor are they likely to huff and puff and blow our house down. But they do 

either erode investment, or force the nation to borrow the difference, and in that 

way they do eat away at the foundation. Moreover, demographics is going to make 

the deficit problem much worse in the future than now. The time to act to get deficits under control is now. 

Politics is never far away from such discussions, so I can hardly campaign against 

deficits without commenting on whether they should be changed on the tax or expenditure side. Basically, as a macroeconomist, I don’t think it matters much. It is 

often argued that it is necessary to keep tax rates low. In truth, the US has probably never had a better macroeconomic decade than the 1990s, following tax increases at the beginning of the decade. There have been other eras when good performance followed tax cuts. When national tax rates get very high, there is a theoretical argument against letting them increase further, but at present moderate 

rates I do not think it matters much whether the budget adjustment is made on 

the tax or expenditure side of the ledger. 

Putting this challenge differently, some politicians may like to keep taxes lower. 

Fine, no problem, but these same politicians must then commit to keep spending 

lower, making the necessary cutbacks in spending. Some politicians may like a larger and more expansive government. Fine, no problem, but these politicians must 

then be willing to assess higher taxes. Deficits can be fixed on one side of the budget 

or the other, but from a long-term economic management point of view, they should 

be fixed.

Chairman SPRATT. Dr. Truman, we would be happy to hear from 

you now. 

STATEMENT OF EDWIN M. TRUMAN, SENIOR FELLOW, 

PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS 

Mr. TRUMAN. Thank you, Chairman Spratt, Mr. Ryan, members 

of the committee. 

It is a pleasure to appear before you today as a pinch-hitter for 

Fred Bergsten, who is the Director of the Peterson Institute for 

International Economics. Fred was called out of town on a family 

emergency. He regrets he cannot participate in your hearing on 

this important topic. 

29

I worked closely with him on preparation of his testimony. The 

words are his, but I fully share the thinking. These oral remarks 

are my own responsibility. 

Fred was asked in particular, as Ed Gramlich just indicated, to 

address the international dimensions on why U.S. budget deficits 

matter. Should we be concerned that foreigners now own more 

than 50 percent of U.S. Treasury debt that is in private hands? 

Should we be concerned that foreigners own about 15 percent of 

the value of U.S. long-term securities? We have tables in the testimony documenting all this. Should we be concerned that at the end 

of 2005, the latest comprehensive data available, our net debt to 

foreigners was 22 percent of our GDP and our gross debt to foreigners was $13.6 trillion, equal to almost 110 percent of our GDP? 

The answer is not entirely straightforward. On the one hand—

as a two-handed economist, we do not need to worry about foreign 

holdings of U.S. Treasury securities per se. Because of the size and 

liquidity of our capital markets, the form in which foreigners hold 

claims on the United States is of marginal importance. Who they 

are is also relatively unimportant, whether they are private holders 

or official holders. However, what is important is that foreigners as 

a group continue to hold existing claims on the United States in 

some form and continue to add to their holdings at a rate of about 

$2 trillion a year to cover both our current account deficits and our 

capital outflows. 

Our overall dependence on foreign financing is one of the major 

reasons why we should adopt a national policy objective of restoring the modest budget surpluses that were in place as recently as 

1998 to 2001, preferably by the end of this decade, and excluding 

off-budget financing. If we do not put our house in order, as the 

phrase goes, the performance of the U.S. economy is vulnerable to 

an abrupt cessation of foreign capital inflows. 

This is the one point I think in terms of your hearings where 

there is some difference between the sort of longer-term view that 

you have heard from David and Ned, which is certainly correct, 

but, in the short run, we may not have as long as we think we 

have, and that has to do with the vulnerability to foreign financing. 

As evidence of that vulnerability, note that over the past 5 years 

we have only been able to attract the foreign financing to cover our 

current account deficits at progressively lower exchange rates—in 

other words, by selling U.S. assets each year at lower prices. 

The cost is also rising in other dimensions. Our gross income 

payments to foreigners are now more than 41⁄2 percent of GDP, 

compared with less than 21⁄2 percent 3 years ago. Even with today’s 

low interest rates, that figure is rising at about a half a percentage 

point a year. 

In addition, we require—and this was Ned’s point—a net inflow 

of saving from abroad to cover more than 3⁄4 of our net domestic 

investment, investment that is critical to boosting the productivity 

of our economy as baby boomers retire. Thus, because of our dependence on foreign financing, the U.S. economy faces the risk of 

what is called a hard landing, not only in the form of a lower dollar, which is essentially inevitable, but in the form of higher interest rates, lower investments and a weaker economy. 

30

*EDITOR’S NOTE: Tables begin on page 35. 

Moreover, if we fail promptly to put our house in order, domestic 

residents may also lose confidence in our policies and seek to move 

their investments abroad. Their holdings of U.S. financial assets 

are three times those of foreigners. 

Our current account deficit has been widening steadily for 15 

years with only one recession-related narrowing in 2001. The deficit may be in the process of leveling out, but the prudent policy 

is to anticipate that the current account deficit will be cut in half, 

to about 31⁄2 percent of GDP, by the end of the decade. Not sure, 

but that would be the prudent assumption, in my judgment. 

If this process is to proceed smoothly, if we are to avoid a hard 

landing for our economy, which could happen even during this Congress, we should reduce our reliance on foreign savings. We should 

do so not by erecting barriers to foreign trade or to capital inflows 

but by boosting national savings. The only policy tool that we can 

expect with confidence to deliver such an increase in national savings is a comparable improvement in the Federal budget position. 

Thank you. I look forward to your questions. 

[The prepared statement of Edwin Truman follows:]

PREPARED STATEMENT OF EDWIN M. TRUMAN, PH.D., SENIOR FELLOW, PETERSON

INSTITUTE FOR INTERNATIONAL ECONOMICS

THE ISSUE

Foreigners account for about $2.2 trillion, or a little over half, of the outstanding total of $4.3 trillion of US Treasury securities held by the public. Official institutions, mainly central banks, account for about 60 percent of this total. In addition, 

foreigners as a whole probably hold close to $1 trillion, or about 15 percent, of US 

government agency securities. The data are in Tables 1-4,* prepared by our colleague Doug Dowson at our Peterson Institute for International Economics. 

These totals and ratios have risen rapidly over the past twenty years. From 1985 

to 2005, foreigners acquired almost 75 percent of the overall increase in outstanding 

Treasuries. From 1995 to 2005, domestic holdings actually fell while foreign holdings grew by twice the aggregate increase. Since 2001, foreign purchases of Treasuries have accounted for most of the rise in the total outstanding.1

These data raise the obvious question of whether the United States in general, 

and the US Government in particular, have become excessively dependent on foreigners to finance our domestic economy and indeed our federal budget. The ultimate concern is whether these holders, or perhaps some subset of them such as foreign governmental institutions, might precipitate a financial crisis by rapidly selling 

off large amounts of Treasuries for economic or even political reasons. 

FOREIGN HOLDINGS OF TREASURIES

The answer to these questions is two-fold. First, we do not need to worry very 

much about foreign holdings of US Treasury securities per se. The US capital markets are so large and so liquid, and the Treasury market is a sufficiently modest 

component of it, that foreign shifts from Treasuries to other dollar investments 

could readily be accommodated by a reallocation of the portfolios of other investors. 

We should worry even less about the risk of liquidation of Treasuries by foreign official institutions, including the largest holders in Japan and China, who are the least 

likely sources of disruption of our financial markets in view of their responsibilities 

for financial stability and their institutional aversion to being blamed for any disruption of the world economy—and, unfortunately, due to the desire of many of 

these countries to maintain undervalued exchange rates to bolster even further 

their international competitiveness.2

It would in fact be a mistake to overemphasize the 50 percent share of foreign 

holders of US Treasuries. The reason is that Treasury long-term debt accounts for 

less than 10 percent of the total stock of outstanding long-term US securities (Table 

3). The addition of USG agency securities, of which foreigners hold about 15 percent, 

leaves their holdings of all governmental paper at about 20 percent of the overall 

31

capital market. Hence there is plenty of room for reallocation of investment portfolios by different groups of investors among different asset classes. If foreigners decided to shift their holdings of Treasuries to US agencies or corporate bonds (or 

bank deposits or some other assets), as they in fact seem to be doing (at least from 

short-term Treasury bills) in recent years, other investors would be attracted by the 

reduction in prices of Treasuries to make switches in the opposite direction. There 

might be some alteration in the relative prices of the different US assets, with a 

modest increase in the cost of financing the federal debt, but major disruptions 

would be highly unlikely. 

When seen in this larger context of the entire US capital market, foreign holdings 

are more on the order of 15 percent. This is considerably less than their share of 

50 percent in the Treasury market by itself. Foreigners hold only about 10 percent 

of US equities and about 20 percent of corporate bonds. 

This conclusion receives strong empirical support from the experience of the last 

few years. Foreign holdings of Treasuries fell in 2000-01 but the exchange rate of 

the dollar continued to rise throughout that period. Conversely, foreign holdings of 

Treasuries rose sharply in 2003-04 while the dollar was declining steadily and substantially. There is simply no clear relationship between changes in foreign holdings 

of Treasuries and the value of our currency.3

TOTAL FOREIGN CAPITAL FLOWS TO THE UNITED STATES

Second, however, we do need to worry considerably about total foreign holdings 

of dollar assets and, in particular, the extent to which our economy has become dependent on new capital inflows to finance both our external and internal deficits because those inflows could slow abruptly or even totally dry up at virtually any time. 

Because of the direct impact of the federal budget position on total national saving, 

and thus on our current account imbalance with the rest of the world, I believe that 

this US dependence on foreign funding is one of the major reasons we should adopt 

a national policy objective of restoring the modest federal budget surpluses that 

were in place as recently as 1998-2001. 

At the margin, the role of foreigners in financing the US economy is much more 

salient than suggested by the averages cited above: they accounted for virtually the 

entire increase in the total holdings of all US long-term securities, including equities 

and corporate bonds, from 2000 to June 2005 (the latest date for which comprehensive data are available, see Table 3). It is true that this period is distorted by the 

sharp fall in equity prices after early 2000 and our ratio of dependence on foreign 

investors is considerably lower—though still close to 50 percent—if different base 

periods are chosen. But the United States has clearly become reliant on external 

funding for a very large proportion of the investment needed to fuel our domestic 

economy and we need to carefully consider the implications thereof in setting national economic policy. 

These financial flows are a manifestation of the very large and rapidly growing 

deficits in the US merchandise trade and current account balances with the rest of 

the world. Those deficits hit $850-875 billion in 2006, about 7 percent of GDP. They 

have increased by an average of $100 billion annually over the past four years (and 

by an annual average of over $80 billion for the past nine years). Funding those 

deficits requires the United States to attract $3-4 billion of foreign money (including 

direct investment as well as financial capital) every working day. As a result, our 

net foreign debt had climbed to $2.7 billion at the end of 2005. In addition, the 

United States exports capital (including direct investment as well as portfolio capital) in the range of $500 billion to $1 trillion every year, which must also be offset 

by capital inflows.4

Hence we must attract $7-8 billion of foreign capital every working day to avoid 

significant changes in prices, mainly of interest rates and exchange rates but also 

of equities and housing, throughout the US economy. Any substantial diminution of 

the total inflow of new foreign investment into the United States from this required 

total would have jarring effects on our financial markets and thus on our economy. 

The exchange rate of the dollar would fall, interest rates would rise, equity prices 

would almost certainly decline and the weakening of the housing market would be 

exacerbated. The scale of these shocks would depend largely on whether the reduction in foreign inflows took place quickly, producing a ‘‘hard landing,’’ or more 

gradually over a period of several years (as actually occurred in 2002-03 and again, 

albeit sporadically, in 2004 and 2006). With the US economy now at full employment, however, unlike in 2002-03 when considerable slack existed as we recovered 

from the recession of 2001, a rapid and sizable fall of the dollar could generate substantial inflationary pressure and push US interest rates up sharply, perhaps even 

into double digits, possibly triggering a severe recession.5

32

It would not matter whether the reduced inflow took place via the market for 

Treasury securities or for other asset classes. Nor would it matter whether the reduction came from foreign official institutions or, much more likely, private investors. What would count, perhaps severely, would be the cutback (or, in the extreme 

case, the drying up or reversal) of total foreign demand for additional dollar assets. 

The huge inflows of foreign capital in recent years have held down US interest rates 

and supported our economic expansion, thus obviating for a time the ‘‘crowding out’’ 

of private investment and growth that would otherwise have occurred as a result 

of the large budget deficits, but they have done so at considerable long-term cost 

to the economy (in terms of future debt service payments to foreigners) and with 

substantial ongoing risk to our stability and prosperity. 

Thus it would not require a liquidation of foreign holdings of Treasuries, or any 

other class of dollar financial assets, to cause considerable problems for the US 

economy. Such liquidations, from the current total of such holdings of more than 

$10 trillion, would obviously make the situation worse. But we have become so dependent on additional inflows of very large amounts of foreign funds that any significant setback therein would have substantial consequences for our economy. 

Some observers believe that the United States has not yet reached the point 

where there is serious risk of a large falloff in new foreign investment in the dollar.6

It is true that the ratio of US foreign debt to GDP is only about 20 percent, which 

is modest by historical standards. But it is also true that we are on an 

unsustainable trajectory: my colleague Michael Mussa, the former chief economist 

of the IMF for ten years and a member of the Council of Economic Advisers under 

President Reagan, notes that continuation of the external deficits at current levels, 

let alone any further increases, would carry that ratio to at least 50 percent within 

the next few years and ultimately to 100-120 percent. This would be exceedingly 

dangerous terrain for an advanced industrial country, let alone the supposed steward of the world’s key currency.7

Some observers also downplay the risk of any significant falloff in new foreign investments in the dollar on the grounds that ‘‘there is no place else to put the 

money.’’ That view has proved repeatedly to be wrong in the past as indicated by 

the sharp falls in the dollar that have occurred about once per decade over the last 

35 years, notably by more than 20 percent in 1971-73, about the same amount in 

1978-79, more than 30 per cent (and about 50 percent against the DM and yen) in 

1985-87 and (to its record lows) in 1994-95. 

Currently and in the future, however, that view is even more incorrect because 

of the systemic change represented by the creation of the euro. The dollar was the 

world’s dominant currency for most of the past century for a simple reason: it had 

no real competition. No other currency was based on an economy that was anywhere 

near the size of the United States nor was able to support financial markets of the 

breadth, depth and resiliency of ours. The euro, however, is based on an economy 

that is almost as large and that in fact features considerably larger levels of international trade and monetary reserves. Hence it presents, for the first time, a true 

alternative to the dollar and an alternative locus for footloose international investment that might previously have come into dollar assets.8

Indeed, euro-denominated bonds have attracted more international investment 

than dollar-denominated bonds for the past two years. The US financial market (at 

$48 trillion) is still considerably larger than the financial market of the Eurozone 

($27 trillion) but now accounts for only one third of the global total and the 

Eurozone market is growing twice as fast. The periodic diversifications by foreign 

central banks of their reserve holdings out of dollars are primarily into euros and 

reflect this new international financial reality (though all these shifts have been 

handled in a way that avoids market disruption, supporting the conclusion suggested above that foreign official institutions are highly unlikely to destabilize markets).9

THE POLICY RESPONSE

The only effective response to this potentially severe threat to US economic stability and prosperity is to substantially reduce the external deficit in our trade and 

current account balances.10 The goal should be to cut that deficit at least in half, 

to about 3-31⁄2 percent of GDP (at which level external funding might well be sustainable) rather than the 7 percent or so at present. 

This will require a series of changes in economic policy in the United States and 

other major countries. One essential part of the package is to reduce the gap between saving and investment in the United States by a like amount of 3-4 percent 

of GDP, most or all of which should be accomplished by increasing national saving 

since reducing investment would weaken both our growth prospects and continued 

33

improvements in US productivity. The chief policy tool that we can deploy with 

some confidence to promote achievement of this objective is a shift in the budget 

position of the federal government over the next several years from today’s deficits 

of 2-3 percent of GDP to modest surpluses a ́ la 1998-2001.11

It must be noted that there is no automatic link between the US budget and current account deficits. The external imbalance in fact soared anew during the late 

1990s while the budget was moving into surplus (because domestic investment was 

running at postwar highs and continuing declines in private saving offset much of 

the reduction in public dissaving). In theory, there could be some offset to increases 

in public saving achieved by budget improvement via reduced private saving 

(though the two have tended to move in similar rather than opposite directions in 

the United States in recent decades). 

The deficits were much more closely related throughout most of the 1980s, however, when both reached their previous record highs and required substantial adjustment. The external deficits would probably be much larger today had the budget 

not improved so dramatically during the 1990s. The tax cuts and rapid spending increases of the early years of this decade clearly worsened our external position, by 

further reducing national saving, and played central roles in pushing it to today’s 

precarious levels. Indeed, less expansionary fiscal policy in recent years would have 

reduced the need for tightening of monetary policy by the Federal Reserve and produced a weaker dollar that would have strengthened our current account. Budget 

correction would almost surely promote external adjustment under current circumstances, perhaps by around one half of the improvement in the budget itself.12

Trade policy is not the topic of this hearing but I would note, before closing, that 

the creation of new US barriers to imports of goods or capital would be an ineffectual and wholly inappropriate response to our trade and current account deficits. 

As indicated throughout my statement, these large imbalances are a macroeconomic 

problem that require macroeconomic (including exchange rate) remedies. It would 

be particularly counterproductive to discourage inflows of direct investment or any 

other forms of foreign capital, which we must continue to attract as long as we run 

current account deficits, as might well be the result of some of the current proposals 

for ‘‘reforming’’ the Committee on Foreign Investment in the United States (CFIUS) 

and US policy in that area more broadly.13

I believe there are strong reasons to convert the current, and especially prospective, US budget deficits into modest surpluses without appealing to these international aspects of the issue. But the vulnerability of the US economy to large and 

prolonged reductions in foreign capital inflows, especially if they occur abruptly, 

surely counsel that we ‘‘put our house in order’’ as promptly as possible. I am delighted that the Committee is assessing these issues as part of its deliberations on 

the fiscal situation and hope they will help persuade you to adopt an aggressive 

stance to sharply improve the prospects over the coming budget cycle. 

ENDNOTES

1 Estimates of these longer trends are presented in Philip D. Winters, ‘‘Growth in Foreign 

Holdings of US Debt,’’ Congressional Research Service, November 13, 2006. 2One possible caveat is that rumors of sizable liquidations by foreign official holders could 

spook the markets and trigger a run on the dollar. Such rumors concerning Kuwait were in fact 

widely cited as a factor in the sharp fall of the dollar in late 1978, the closest the United States 

has ever come to experiencing a ‘‘hard landing.’’ Similar rumors in more recent periods, however, 

have been largely shrugged off by the markets. 3On this issue see especially Edwin M. Truman and Anna Wong, The Case for An International Reserve Diversification Standard, Working Paper 06-2, Washington, Institute for International Economics, May 2006. 4This large US capital outflow reminds us that Americans, at least as much as foreigners, 

could trigger a run on the dollar that would have the consequences described later. 5Martin Neil Baily, ‘‘Persistent Dollar Swings and the US Economy,’’ in C. Fred Bergsten and 

John Williamson, eds., Dollar Overvaluation and the World Economy, Washington, Institute for 

International Economics, February 2003. 6See Richard N. Cooper, ‘‘Living with Global Imbalances: A Contrarian View,’’ Washington, 

Institute for International Economics, November 2005. 7See Michael Mussa in ‘‘Sustaining Global Growth While Reducing External Imbalances,’’ in 

C. Fred Bergsten and the Institute for International Economics, The United States and the 

World Economy: Foreign Economic Policy for the Next Decade, Washington, January 2005. See 

also William R. Cline, The United States as a Debtor Nation, Washington, Institute for International Economics, September 2005. 8See C. Fred Bergsten, ‘‘The Euro and the Dollar: Toward a ’Finance G-2’?’’ in Adam S. Posen, 

editor, The Euro at Five: Ready for a Global Role? Washington, Institute for International Economics, April 2005, especially pp. 30-35. 9See Truman and Wong, The Case for an International Reserve Diversification Standard, 

Working Paper 06-2, Washington, Institute for International Economics, May 2006. 

34

10These imbalances also add substantially to the difficulties of maintaining an open trade policy in the United States. See C. Fred Bergsten, ‘‘A New Foreign Economic Policy for the United 

States,’’ in C. Fred Bergsten and the Institute for International Economics, The United States 

and the World Economy: Foreign Economic Policy for the Next Decade, Washington, Institute 

for International Economics, January 2005. 11Detailed scenarios for doing so can be found in Cline, The United States as a Debtor Nation, 

Chapter 4, and Mussa, ‘‘Sustaining Global Growth While Reducing External Imbalances,’’ especially pp. 193-196. It would of course be highly desirable to increase US private saving as well. 

This may happen spontaneously, at least to a limited extent, from the decline in the housing 

market and the rise in interest rates more generally but, unfortunately, there are no policy tools 

that can confidently be deployed to do so. 12There is a wide range of estimates of this relationship but they tend to cluster around 50 

percent. The main outlier is the Federal Reserve, whose much lower estimates are explained 

and criticized in Cline, The United States as a Debtor Nation. 13 Edward M. Graham and David M. Marchick, US National Security and Foreign Direct Investment, Washington, Institute for International Economics, May 2006.

35

TABLE 1.—MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES 

[In billions of dollars; Holdings1 at end of period] 

Country June 2005 (V) June 2005 (VI) July 2005 Aug 2005 Sept 2005 Oct 2005 Nov 2005 Dec 2005 Jan 2006 Feb 2006 Mar 2006 Apr 2006 May 2006 Jun 2006 Jul 2006 Aug 2006 Sep 2006 Oct 2006 Nov 2006

Japan .................................................. 681.2 667.1 669.4 670 672.8 667 667.9 670 653.4 656.4 639 639.4 636.8 636.2 636.3 645 639.6 639.6 637.4China, Mainland ................................. 243.3 298 296.4 302.1 306.3 301.7 303.9 310 313.9 317.2 317.4 319.2 322.3 325.4 330.4 339.2 342.4 345 346.5United Kingdom2 ................................ 140.8 58.8 73.2 87.2 95.8 100.3 135.5 146 157.2 162.3 179.1 166.8 175 201.5 190.3 200.8 207.8 207.5 223.5

Oil Exporters3 ..................................... 57.2 68.5 64.1 65.2 66.1 75.4 79.3 78.2 89.4 96.2 98 99.1 102.6 101.5 103.1 107.2 104.4 97.9 97.1

Korea ................................................... 59.4 63 62.6 62.4 64.1 63.7 68.8 69 71.2 72.8 72.4 70.9 68.8 68.9 68.4 66.7 69 69 67.7Taiwan ................................................ 71.3 67.8 68.8 68.4 68.9 68.9 68.3 68.1 68.7 68.9 68.9 68.9 67.5 67.1 66.7 65.6 65 64.5 63.2

Carib Bnkng Ctrs4 .............................. 66.9 70.9 65.2 67.4 68.3 75 81.2 77.2 64 52.9 60.5 60.1 58.2 60.2 68.7 63.7 51.4 56.3 63.6

Germany .............................................. 61.2 44.1 44.8 47.9 46.4 47.3 48.6 49.9 48 47.9 46.4 46.7 47.2 48.7 50.3 51.9 52.9 52.7 52.1Hong Kong .......................................... 48.7 44.5 44.7 43.6 44.4 44 42.8 40.3 44.6 44.9 46.6 49.4 48.4 48.8 48.9 50.6 49.6 50.6 51Canada ............................................... 43.8 18.5 21.4 23 22.4 26.3 28.5 27.9 29.6 33.3 34.7 36.8 40.8 41.2 42.3 49.1 49.6 49.5 47.8Brazil .................................................. 20.9 22.1 24.5 25 27.5 27.1 28.8 28.7 30.1 33.3 31.4 30.8 32.9 33.4 31.7 43.2 45 46.4 51.1

Mexico ................................................. 31.9 29 32 32.9 32.1 34.9 36.6 35 36.5 37.6 40.1 41.9 43.4 45.7 45.7 39.9 39.9 40 38.2Luxembourg ........................................ 43.5 38.8 36.9 38.2 37.6 36.7 36.6 35.6 35.2 36.2 36.6 37.5 38.5 37.4 38 37 37.3 38.1 39.1Singapore ............................................ 29.9 34.4 34.1 34.2 33.9 33.9 33.4 33 32.9 33.5 33.1 36.7 35.7 34.6 34.3 34 33.3 30.5 30.3France ................................................. 19.2 23.2 26.4 28.5 28.5 30 31.3 30.9 32 34.9 34.7 30.1 30.7 29.2 25.6 26.9 21 30 33.7Switzerland ......................................... 39.5 34.9 32.3 32.9 32 32.6 30.7 30.8 30.4 31.2 30.9 31.1 30.5 30.6 31 30.9 29.8 29.7 28.4Ireland ................................................ 15.6 22.2 23.1 18.9 19.1 22.1 23 19.7 21.1 19.3 19.6 17.7 19 20 19.8 21.3 20.8 21.9 21Turkey ................................................. 13.8 15.3 16.6 15.5 14.6 15.7 18.5 17.4 18.9 21.6 21 21.6 21.5 19.1 21.8 23.3 22.9 21.5 22.7Netherlands ........................................ 13.3 19.1 19.6 18.7 18.2 19.1 16.9 15.7 15.7 15 15.3 15.4 15.4 17 16 14.4 15.8 17.6 18.2Sweden ............................................... 19.4 16.9 16.4 16.8 16.8 16.7 17.1 16.3 17.4 17.1 17.9 18 18.1 18.2 18.3 18.3 17.8 16.9 16.7Belgium .............................................. 15.9 15.4 15.6 15.8 15.7 15.4 15.6 17 16.7 17.2 17.1 17.4 17.5 17 18.4 17.8 17.1 16.6 16.3Thailand .............................................. 12.9 16.3 15.6 15.7 14.8 16.2 16.2 16.1 17 17.9 17.5 15.6 15.5 15.8 15.8 16.4 16.3 16.1 16.5Israel ................................................... 9.5 10.9 10.5 11.4 11.8 11.9 10.8 12.5 12.5 12.4 12.3 13.4 13.4 11.4 10.4 10.2 13.1 15.2 15.6Italy ..................................................... 14.4 13.1 14.4 14.9 14.2 15.1 16.5 15.4 15 14.3 13.7 13.9 14.2 15.4 14.9 15 14.5 14.7 16.8Poland ................................................. 11.4 12.4 12.2 12.1 12.9 13.2 13.4 13.7 11.3 12.4 12.2 12.3 13.3 11.4 12.8 13.7 13.1 14.4 14.2All Other ............................................. 186.5 152.3 158.3 157 144.5 154 163.8 159.4 163.2 166.6 161.7 150.8 138.5 132.5 139.9 144.8 142.7 160.4 170.3

Grand Total ........................... 1971.3 1877.5 1899.2 1925.9 1929.6 1964.3 2034 2033.9 2045.9 2073.2 2078.2 2061.6 2065.7 2088.1 2099.9 2146.8 2132.1 2162.5 2199

Of which: ........... .............

For. Official ................................ 1236.6 1258.6 1261.9 1267.8 1256.7 1267.1 1291.8 1284.7 1299.7 1317.9 1310 1303.1 1286.8 1272.1 1281.6 1302.1 1299.2 1316.8 1325.5Treasury Bills ............................. 204.9 204.9 203.2 205.4 195.4 199.8 214.9 201.9 210.5 216 215.5 197.5 195.1 185.1 186.3 190 179.4 178.5 186.2T-Bonds & Notes ....................... 1031.7 1053.7 1058.7 1062.4 1061.3 1067.3 1077 1082.8 1089.2 1101.9 1094.6 1105.6 1091.7 1087 1095.2 1112.1 1119.8 1138.3 1139.3

36

TABLE 1.—MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES—Continued

[In billions of dollars; Holdings1 at end of period] 

Country June 2005 (V) June 2005 (VI) July 2005 Aug 2005 Sept 2005 Oct 2005 Nov 2005 Dec 2005 Jan 2006 Feb 2006 Mar 2006 Apr 2006 May 2006 Jun 2006 Jul 2006 Aug 2006 Sep 2006 Oct 2006 Nov 2006

Total Marketable Outstanding ............ 4012.6 4012.6 4059.1 4087.6 4066.1 4112.5 4166.5 4165.8 4176.3 4259.5 4321.7 4264.5 4250.5 4235.1 4261.3 4325.3 4283.8 4318.6 4361.4

Department of the Treasury/Federal Reserve Board, January 17, 2007.1 Estimated foreign holdings of U.S. Treasury marketable and non-marketable bills, bonds, and notes reported under the Treasury International Capital (TIC) reporting system are based on annual Surveys of Foreign Holdings of U.S. Securities and on monthly data. 2 United Kingdom includes Channel Islands and Isle of Man. 3 Oil exporters include Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria. 4 Caribbean Banking Centers include Bahamas, Bermuda, Cayman Islands, Netherlands Antilles and Panama. 

37

TABLE 2.—MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES 

[Share of total outstanding including bills (percent); Holdings1 at end of period] 

Country 

Q2 

2005 

(V) 

Q2 

2005 

(VI) 

Q3 

2005

Q4 

2005

Q1 

2006

Q2 

2006

Q3 

2006

Oct 

2006

Nov 

2006

Japan ............................................................ 17.9 17.5 17.4 16.9 15.5 15.8 15.7 15.5 15.3

China, Mainland .......................................... 6.4 7.8 7.9 7.8 7.7 8.1 8.4 8.4 8.3

United Kingdom2 .......................................... 3.7 1.5 2.5 3.7 4.4 5.0 5.1 5.0 5.4

Oil Exporters3 ............................................... 1.5 1.8 1.7 2.0 2.4 2.5 2.6 2.4 2.3

Korea ............................................................ 1.6 1.7 1.7 1.7 1.8 1.7 1.7 1.7 1.6

Taiwan .......................................................... 1.9 1.8 1.8 1.7 1.7 1.7 1.6 1.6 1.5

Carib Bnkng Ctrs4 ....................................... 1.8 1.9 1.8 1.9 1.5 1.5 1.3 1.4 1.5

Germany ....................................................... 1.6 1.2 1.2 1.3 1.1 1.2 1.3 1.3 1.2

Hong Kong .................................................... 1.3 1.2 1.1 1.0 1.1 1.2 1.2 1.2 1.2

Canada ......................................................... 1.2 0.5 0.6 0.7 0.8 1.0 1.2 1.2 1.1

Brazil ............................................................ 0.5 0.6 0.7 0.7 0.8 0.8 1.1 1.1 1.2

Mexico .......................................................... 0.8 0.8 0.8 0.9 1.0 1.1 1.0 1.0 0.9

Luxembourg .................................................. 1.1 1.0 1.0 0.9 0.9 0.9 0.9 0.9 0.9

Singapore ..................................................... 0.8 0.9 0.9 0.8 0.8 0.9 0.8 0.7 0.7

France .......................................................... 0.5 0.6 0.7 0.8 0.8 0.7 0.5 0.7 0.8

Switzerland ................................................... 1.0 0.9 0.8 0.8 0.8 0.8 0.7 0.7 0.7

Ireland .......................................................... 0.4 0.6 0.5 0.5 0.5 0.5 0.5 0.5 0.5

Turkey ........................................................... 0.4 0.4 0.4 0.4 0.5 0.5 0.6 0.5 0.5

Netherlands .................................................. 0.3 0.5 0.5 0.4 0.4 0.4 0.4 0.4 0.4

Sweden ......................................................... 0.5 0.4 0.4 0.4 0.4 0.5 0.4 0.4 0.4

Belgium ........................................................ 0.4 0.4 0.4 0.4 0.4 0.4 0.4 0.4 0.4

Thailand ....................................................... 0.3 0.4 0.4 0.4 0.4 0.4 0.4 0.4 0.4

Israel ............................................................ 0.2 0.3 0.3 0.3 0.3 0.3 0.3 0.4 0.4

Italy .............................................................. 0.4 0.3 0.4 0.4 0.3 0.4 0.4 0.4 0.4

Poland .......................................................... 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3

All Other ....................................................... 4.9 4.0 3.7 4.0 3.9 3.3 3.5 3.9 4.1

Grand Total ..................................... 51.8 49.4 49.9 51.2 50.5 51.8 52.3 52.3 52.7

Of which: 

For. Official ......................................... 32.5 33.1 32.5 32.4 31.8 31.6 31.9 31.9 31.7

Treasury Bills ...................................... 5.4 5.4 5.1 5.1 5.2 4.6 4.4 4.3 4.5

T-Bonds & Notes ................................. 27.1 27.7 27.5 27.3 26.6 27.0 27.5 27.6 27.3

Department of the Treasury/Federal Reserve Board, January 17, 2007.

1 Estimated foreign holdings of U.S. Treasury marketable and non-marketable bills, bonds, and notes reported under the Treasury International Capital (TIC) reporting system are based on annual Surveys of Foreign Holdings of U.S. Securities and on monthly data. The total 

debt outstanding excludes debt held by the U.S. Treasury and other federal agencies and trust funds and holdings by the Federal Reserve 

Banks. 2 United Kingdom includes Channel Islands and Isle of Man. 

3 Oil exporters include Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria. 4 Caribbean Banking Centers include Bahamas, Bermuda, Cayman Islands, Netherlands Antilles and Panama. 

TABLE 3.—VALUE OF FOREIGN–OWNED U.S. LONG–TERM SECURITIES AND SHARE OF THE TOTAL 

[Outstanding, by asset class, as of selected survey dates; Billions of dollars except as noted] 

Type of security Dec. 

1984

Dec. 

1989

Dec. 

1994

Mar. 

2000

June 

2002

June 

2003

June 

2004

June 

2005

Equity: 

Total outstanding1 ............................. 2,131 4,638 7,767 24,703 17,904 17,941 20,779 22,041

Foreign-owned .................................... 105 275 398 1,709 1,395 1,564 1,930 2,144

Percent foreign-owned ....................... 4.9 5.9 5.1 6.9 7.8 8.7 9.3 9.7

Marketable U.S. Treasury: 

Total outstanding2 ............................. 873 1,515 2,392 2,508 2,230 2,451 2,809 3,093

Foreign-owned .................................... 118 333 464 884 908 1,116 1,426 1,599

Percent foreign-owned ....................... 13.5 22 19.4 35.2 40.7 45.5 50.8 51.7

U.S. government agency: 

Total outstanding3 ............................. 507 1,167 1,982 3,575 4,830 5,199 5,527 5,591

Foreign-owned .................................... 13 48 107 261 492 586 619 791

Percent ............................................... 2.6 4.1 5.4 7.3 10.2 11.3 11.2 14.1

Corporate and other debt: 

Total outstanding4 ............................. 1,305 2,599 3,556 5,713 7,205 7,852 8,384 8,858

38

TABLE 3.—VALUE OF FOREIGN–OWNED U.S. LONG–TERM SECURITIES AND SHARE OF THE 

TOTAL—Continued

[Outstanding, by asset class, as of selected survey dates; Billions of dollars except as noted] 

Type of security Dec. 

1984

Dec. 

1989

Dec. 

1994

Mar. 

2000

June 

2002

June 

2003

June 

2004

June 

2005

Foreign-owned .................................... 32 191 276 703 1,130 1,236 1,455 1,729

Percent foreign-owned ....................... 2.5 7.3 7.8 12.3 15.7 15.7 17.6 19.5

Total U.S. long-term securities: 

Total outstanding .............................. 4,682 9,904 15,700 36,583 32,169 33,443 37,499 39,583

Foreign-owned .................................... 268 847 1,244 3,558 3,926 4,503 5,431 6,262

Percent foreign-owned ....................... 5.7 8.6 7.9 9.7 12.2 13.5 14.5 15.8

1 Source: Federal Reserve Statistical Release Z.1, Flow of Funds Accounts of the United States, Table L213, row 1, minus: Table L213, row 

3, plus Table L214, row 1, plus Table L206, row 1. 2 Source: Bureau of the Public Debt Table 1 Summary of Public Debt Summary of Treasury Securities Outstanding, Total marketable held by 

the public less Bills. 3 Source: Federal Reserve Statistical Release Z.1, Flow of Funds Accounts of the United States, Table L210, row 1, less the amount of this 

figure determined by staff research to represent short-term securities (approximately $587 billion as of June 30, 2005). U.S. government agency securities include all securities issued by federally sponsored agencies and corporations, as well as all securities guaranteed by the Government National Mortgage Association (GNMA). 4 Source: Federal Reserve Statistical Release Z.1, Flow of Funds Accounts of the United States, Table L212, row 1, less Table L212, row 3, 

plus Table L211, row 1, less Table L211, row 3. 

TABLE 4.—VALUE OF FOREIGN HOLDINGS OF U.S. SECURITIES, BY MAJOR INVESTING COUNTRY 

AND TYPE OF SECURITY, AS OF JUNE 30, 2005

[Billions of dollars] 

Country Total Equity Treas. 

LT debt 

Agency LT debt Corp. LT debt ST 

debt ABS Other ABS Other 

Japan ......................................................................................... 1,091 178 572 54 86 37 66 100

United Kingdom ......................................................................... 560 260 45 12 11 71 144 16

China, P.R. ................................................................................ 527 3 277 56 116 7 29 40

Luxembourg ............................................................................... 460 151 30 13 21 36 172 37

Cayman Islands ........................................................................ 430 152 30 32 10 77 103 26

Belgium ..................................................................................... 335 18 13 1 50 38 210 5

Canada ...................................................................................... 308 221 14 * 4 18 37 13

Netherlands ............................................................................... 262 161 17 12 6 22 36 8

Switzerland ................................................................................ 238 129 29 4 7 29 26 15

Bermuda .................................................................................... 202 59 24 16 12 22 48 20

Country unknown ....................................................................... 196 2 * * * 1 192 1

Rest of world ............................................................................. 2,254 811 546 63 203 96 214 322

Total ............................................................................. 6,864 2,144 1,599 264 527 453 1,276 602

Of which: Holdings of official foreign institutions ................... 1,938 177 1,054 63 261 17 44 322

* Greater than zero but less than $500 million.

1 Asset-backed securities. Agency ABS are backed primarily by home mortgages; corporate ABS are backed by a wide variety of assets, such 

as car loans, credit card receivables, home and commercial mortgages, and student loans.

Asset-backed securities (ABS) are securities backed by pools of assets, such as pools of residential home mortgages, which give the security owners claims against the cash flows generated by the underlying assets. Unlike most other debt securities, these securities often repay 

both principal and interest on a regular basis, thus reducing the principal outstanding with each payment cycle. However, some classes of 

ABS replace repaid principal with additional assets for a set period of time, thus holding the total principal outstanding constant. 

Chairman SPRATT. Thank you very much, all of you, for your testimony. 

General Walker, let me go back to one of your charts. I have forgotten one which—and they all, I think, have this underlying problem. I think we can solve Social Security. It requires that we come 

together, put everything on the table, bring everybody to the table. 

We have got a model for that, 1983. It worked. We made Social Security solvent for the next 60 years, in effect; and we can do that 

again. 

Medicare is the conundrum. It is the big, difficult problem. And 

the underlying reason for that, the major reason, is that the cost 

39

of medical care is going up at 21⁄2 percent to 3 percent over and 

above the CPI, the rate of inflation in our economy, every year. As 

you compound that, you see the problems, the outyears looking just 

impossibly enormous, as you have just shown on your table. Would 

you agree that the real resolution of Medicare’s problem is a subset 

of the resolution of the whole problem of the cost of healthcare delivery in the country? 

Mr. WALKER. Yes, I would. Healthcare represents the single largest fiscal challenge of the Federal Government. Healthcare represents the single largest, arguably, domestic policy challenge in 

the United States; and the two big drivers to the Federal longrange fiscal imbalance are demographics and healthcare cost. As 

you can see from the numbers that I have put up, that Medicare 

is in five times plus worse shape than Social Security, just Medicare alone. That doesn’t count Medicaid or civilian and military, 

you know, healthcare. 

Chairman SPRATT. Healthcare entitlements, TRICARE, Medicaid, 

Medicare, all of them are afflicted with this problem. 

Mr. WALKER. Correct. And, ultimately, I believe that we are 

going to have to engage in comprehensive reform of our entire 

healthcare system in installments over a number of years. 

Chairman SPRATT. Dr. Gramlich, Dr. Truman, do you care to 

comment on that? 

Mr. GRAMLICH. I would certainly agree. I was Chair of the Social 

Security Advisory Council in the mid-1990s, and the first thing you 

said, can we fix Social Security, yes, I firmly believe we can, and 

there are many ways to do it, and they are not that painful. 

But the health programs, you throw up your hands at. Because, 

number one, the dollars are much more and the ethical issues are 

much worse. With Social Security, you are only talking money. 

Somebody gets a little bit more or a little bit less. We can deal with 

those kinds of questions. But, with Medicare, you start talking 

about denying treatments for this and that sort of thing, and you 

just take the whole discussion to a new level, and that becomes 

much harder for anybody to think about and also much harder to 

think about politically. 

Chairman SPRATT. Dr. Truman, we were all raised on Samuelson 

in Economics 101; and we were taught by Paul Samuelson that we 

owed the debt to ourselves, so not to worry. It is fundamentally different today. Are you concerned about that? And when do we hit 

the wall? When do we reach the limit of foreigners’ willingness to 

keep purchasing dollar-denominated assets? 

Mr. TRUMAN. Well, the honest answer to that question is, we 

don’t know when we hit the wall. 

I was joking with Ned Gramlich yesterday that, when I was still 

at the Federal Reserve, we presented a presentation to the Board 

and FOMC, suggesting that the current account deficit was on an 

unsustainable trajectory. That was in 1996. We are now in 2007. 

I still believe we are on an unsustainable trajectory, but it is true 

that there is no assurance about when they are going to hit a wall. 

What is true is that the costs are going up, and the risks of—

because the debt is larger today, the risks are, in my view, larger. 

Therefore, to pick up a phrase that Ned used in another context, 

prudent risk management would say you should start addressing 

40

those risks so that when the inevitable change in the availability 

of foreign savings comes about—and it may well be starting now 

because it looks like the current account is about leveled out—then 

you are replacing the savings that we have been sucking in from 

abroad by savings at home. 

The alternative, the arithmetic that Ned had in his chart, the alternative is is that investment will go down. Investment goes down, 

growth goes down, and then solving some of these other problems, 

right, generating the revenues that are necessary to—and the income that is necessary to generate the programs will be that much 

more difficult. 

So I don’t predict the end of the world, if I might put it that way, 

but I think the risk—right—the probability statement is non-zero 

that we could have a messy period over the next 3 or 4 years, and 

that is the sense in which in some sense—and that is driven by 

confidence in our policies, what is done here and the sense in which 

we have gotten our hands around some of these longer-term problems. Because our financial markets have a way of bringing home, 

bringing back to today the problems that we see on these charts 

out there 20 years from now. 

But, as always, it doesn’t happen instantaneously, and no set of 

economists can tell you what has happened, but we have had several periods of very abrupt and painful dislocative movements of 

the dollar and associated movements in interest rates in the last 

30 years, and I think you can’t rule out another one. 

Chairman SPRATT. Mr. Walker. 

Mr. WALKER. We have three financial deficits that are of concern 

and somewhat interrelated. We have a budget deficit, which we 

have talked about. We have a balance of payments deficit, and we 

have a savings deficit. There is absolutely no question that we are 

on an imprudent and unsustainable fiscal path. There is absolutely 

no question that our risk will increase over time. Nobody knows for 

sure when and if we will hit the wall and how bad it will be, but 

it is fundamentally imprudent to continue on our current path. 

Chairman SPRATT. Thank you all for your testimony. 

Mr. Ryan. 

Mr. RYAN. I thank the Chairman for yielding. 

Mr. Walker, I love it when you come and give these presentations that are extremely helpful and very valuable. 

You know, our big problem is we don’t seem to be able to come 

together for a fundamental entitlement reform, and I blame politics 

as a big reason for that, both sides. You know, we do seem unwilling to come together, bite the bullet, even though we know it might 

cost us politically, and actually fundamentally fix these things and 

change these things. 

I am not going to ask you to give us political solutions. That is 

not your job. But what can we do in the form of metrics to improve 

our understanding and appreciation for the situation that we are 

in? 

I think the chairman is right—he is not right when he said that 

we were all raised on Samuelson. Many of us may have studied 

him, but some of us were raised on Friedman. But he is right in 

saying that Social Security is pretty easy to fix. Social Security is 

a containable problem within itself. 

41

The healthcare stuff is all—they are manifestations of the 

healthcare situation we have. So a much, much bigger obstacle to 

tackle. 

The question that I want to ask you is in the context of this: We 

can fix these entitlement programs easily if we wanted to. We 

could just raise FICA taxes, and we could just raise the payroll tax 

to 25 percent and pretty much probably fix the problem. 

The problem is we have two economic threats. We have the entitlement threat, which is a fiscal meltdown, but we also have 

globalization. We have competitiveness. We have the threat that 

confronts our standard of living with a new kind of sense of competition we have never seen before that confronts us in the 21st 

century, and so we—at least many of us believe we need to think 

about our international competitiveness and the competitiveness of 

our workers as we figure out how to fix these entitlement problems. 

So that is why many of us don’t want to just tax our way out of 

this problem. Because we know, if we will do so, we will lose our 

prosperity and just eviscerate our standard of living. 

So how do we better measure this stuff? What metrics can we 

use to give policymakers and the public a better appreciation for 

the real mix that we are in and to do so within the context of realizing we have to keep an eye on our international competitiveness 

so that we can enjoy good jobs at good wages so we can enjoy a 

higher standard of living? 

Mr. WALKER. I think additional transparency in metrics are very, 

very important in order not only to help the Congress understand 

what needs to be done and to help manage the way forward but 

to help the American people understand where we are, where we 

are headed, the need for tough choices, the prudence of doing it 

sooner rather than later so that, frankly, they will reward members 

who have the courage to think about our future, rather than penalizing them and not returning them to office. 

Mr. RYAN. That is exactly the question I am trying to ask. How 

can you shift——

Mr. WALKER. Two ways. Two ways. Number one, I and others 

have been involved since September of 2005 in something called 

the Fiscal Wake-Up Tour, where myself from the government as 

well as the Concord Coalition, the Heritage Foundation, the Brookings Institution and a variety of other groups, including AICPA, 

AGA, AARP, Committee for Economic Development, have been 

going to various cities around the country—we have been to 15 already; we average about one a month—to state the facts and speak 

the truth about where we are, where we are headed, the need for 

action, the consequence of inaction. 

I use a number of the graphics that I have showed you there. 

The American people are pretty smart. They get it. They get it 

pretty quickly. So that is one thing we are doing. We are doing it 

to try to prepare the way, to till the ground so that people can end 

up making tough choices. 

I might note Diane Rogers, who is on this Committee’s staff, has 

been a participant in some of those past Fiscal Wake-Up Tour 

events. 

The second thing that is, in addition to congressional testimony, 

one of the things I am going to be sending to every Member of ConVerDate 0ct 09 2002 19:37 Mar 07, 2007 Jkt 000000 PO 00000 Frm 00045 Fmt 6633 Sfmt 6602 J:\DOCS\HEARINGS\110TH\110-2\32738.TXT HBUD1 PsN: DICK
42

gress, probably on Groundhog Day, February 2—which is my dad’s 

birthday, I might add——

Mr. RYAN. It is my daughter’s birthday. 

Mr. WALKER. There you go. It is my dad’s birthday. On Groundhog Day I plan to send to every Member of Congress a concise, 

plain English summary of key financial and fiscal facts. I think it 

is important that Members have a foundation, a level playing field 

as to the past, the present and where we are headed in the future 

in order to help them understand this. 

In the end, I would respectfully suggest that when you talk about 

after we improve transparency, after we impose budget controls, we 

are going to have to do three things: Number one, dramatically and 

fundamentally reform entitlement programs, and we are going to 

have to get the most money out of that. Number two, re-engineer, 

restructure, reprioritize and constrain other spending. We are 

going to have to get money out of that. And, thirdly, engage in comprehensive tax reform in ways that will generate additional revenues. We are going to have to get some money out of that. 

And I would respectfully suggest, you want to try to minimize 

tax burdens in order to maximize economic growth, maximize disposable income and maximize our competitive advantages compared to other countries. At the same time, in the final analysis, 

you have got to have enough revenues to pay your current bills and 

deliver on your future promises. We are short today. We are going 

to get a lot shorter in the future. 

Mr. RYAN. So you are saying minimize tax burdens to maximize 

growth and output, meaning entitlement reform. Focus on reforming the actual entitlement programs themselves more than just 

going down the road of just raising taxes is basically——

Mr. WALKER. Well, you are not going to solve your problem without serious adverse consequences merely by raising revenues. But, 

again, I don’t know anybody who is talking about that. 

Again, you are going to have to do all three. Entitlement reform 

and probably get the most money out of that with regard to gap 

spending, restructuring, prioritization, constraint, and then tax reform with additional revenues. You are going to have to do all 

three. That is probably relative weighting. 

And round one I would respectfully suggest is as follows: Social 

Security reform, you don’t want to do what was done in 1983. You 

don’t want to be preprogrammed to have to come back. There is no 

need to preprogram to have to come back. 

Number two, round one of healthcare reform and, number two, 

round one of tax reform. Those three would represent a significant 

down payment, a significant credibility enhancement on behalf of 

the public and a significant confidence builder on behalf of the Congress. 

Mr. RYAN. Since we are so demographically driven, since our systems are a pay-as-you-go system to a full-funded system with respect to our entitlements? 

Mr. WALKER. Well, obviously, it depends on how you would go 

about achieving that; and one of the concerns would be is that, to 

the extent you have a funded system where the money does not belong to individuals, then history shows that it might get spent on 

other things. Let’s keep in mind that last year there was a $185 

43

billion Social Security surplus, and we spent every dime of that Social Security surplus, and we have been doing it for years. 

Mr. RYAN. So if you go to a full-funded system, it has got to have 

property rights to protect the government from taking it away from 

people? 

Mr. WALKER. Well—or at least put it in a real trust fund with 

real fiduciary responsibilities and liability. That has been discussed 

before. 

For example, I have been involved in conversations over the 

years where there was a possibility of creating a separate account 

within, like the Federal Thrift Savings Plan, that would be invested in passive investments, index funds that could end up, you 

know, actually walling off the money so the money would not be 

spent. Now, depending on how much you are talking about, it could 

grow to a very sizable sum. But history has shown that, without 

some type of constraints, that the money is likely to get spent. 

Mr. RYAN. Thank you. 

Chairman SPRATT. Mr. Gramlich, would you like to add something to that? 

Mr. GRAMLICH. Yes, I do. These programs are hard because they 

are social insurance programs, and you can’t—you know, it is great 

to talk about entitlement reform, and we need it. But it is a little 

bit of a buzzword, you know; and I think at some point we have 

to get specific about what we mean. 

Now, first off, we played this out a couple of years ago. There are 

serious risks in going to just making everything into individual accounts because there are social risks here, especially you can see 

it in the medical programs, that some people, just through the difficulties of health, are going to need a lot of money. So I am not 

sure the private solution does things. 

The other thing I tell you is, on your point about metrics, Congressman, it has always seemed to me that the real problem is that 

people don’t get this information in the form of trade-offs. For example, having been through Social Security, I think one of the most 

intriguing ideas about how to resolve that is to have the retirement 

age grow slowly with life expectancy. I mean, you know, when people are living longer and longer and longer and they are on the Social Security system, it just becomes unaffordable at some point; 

and if we had the retirement age grow as life expectancy grows and 

every person would work a constant share of their adult life and 

be retired a constant share of their adult life——

Well, as you know, you are all politicians, and you know that 

raising the retirement age is not popular. And I heard some polls 

on that last fall. Do you want to raise the retirement age in Social 

Security? And everybody said, no, we don’t. 

Well, that is not the question I would put. The question is, do 

you want to raise the retirement age or do something else, like pay 

10 percent more taxes or do this or that? These questions can’t be 

given to people in the form of takeaways. They have to be given 

to people in the form of tradeoffs. Do you want to do this or that? 

Neither one is going to be pleasant, and you have got to make the 

judgment. 

I have always felt that that is the problem, more than the 

metrics. I think people in a vague sense do know what David is 

44

talking about. They do know that the population is aging. They do 

know that there are going to be fewer people to support their retiree population. They do know that the cost of healthcare is rising. 

We all see that in our daily life. What they don’t know is what the 

trade-off is. And I think the information that should go to people 

is that, do you want to work longer or do you want to pay more 

taxes, you know, that kind of thing. 

Chairman SPRATT. Mr. Cooper. 

Mr. COOPER. Thank you, Mr. Chairman. 

Thank you, each one of the witnesses, for your wisdom. We need 

it. 

You know, Congress is undergoing mandatory ethics training 

right now, but we have a too narrow definition of ethics. I think 

according to your testimony, particularly Mr. Walker’s, since this 

is a values question, how we handle these budget deficits may be 

the ultimate ethics question. Because we are robbing our children 

and grandchildren today the way we are conducting business in 

this country. 

The key to me is diagnosis. If we believe on this committee in 

a bipartisan basis that it is cancer, as Mr. Walker said, and not 

a bad cold, as some people would like to suggest, then the treatment options become more agreeable. It is never fun to undergo radiation or chemotherapy, but if you have got cancer, that can be 

your salvation. So I want to work on the diagnosis. 

You all agree that deficits do matter. I think it is a problem 

sometimes, though, getting us to realize the implications of that. 

For example, Mr. Walker mentioned how every penny of the Social 

Security surplus has been spent. In my opinion, one reason that 

happens is because we only report the net deficit number, which 

allows us to hide the gross borrowing figure and the fact that we 

do make off with the Social Security surplus every year. 

The President has held a couple of press conferences bragging 

about how small the net deficit is, but he has always omitted the 

gross borrowing numbers and so much of that money, 185 million, 

was borrowed from Social Security and spent on other things not 

related to Social Security. 

Another way of measuring the deficit is to use what businesses 

across America use, which is the accrual deficit number or net operating costs. The President has never mentioned that deficit either. Precious few people in Congress have mentioned it, but that 

says that the deficit is 450 billion or 760 billion, not in the 200 billion range. And that is a number that Rotarians across America 

and Lions Club members, Civic Club members can relate to because that is the way they are required to measure their business. 

They cannot pretend back home in Main Street, America that pension and health care liabilities are not liabilities. Only the Federal 

Government is able to do that. 

As you know, business was required to account for pension and 

health care liabilities back in 1992, State and local governments 

have had to do it in recent years. The Federal Government is the 

last holdout. So I am worried that this committee operates in an 

air of unreality. 

You mentioned the Medicare drug bill, $7.9 trillion present value 

liability added to our books, and one of the reasons we were able 

45

to vote on it is because the Budget Committee under prior leadership pretended under our little budget window that if the bill came 

in under 400 billion it was okay for us to vote on. That was, as 

Bruce Bartlett, a Reagan economist, has said, possibly the worst 

bill ever passed in American history because it is one of the least 

funded bills ever passed. 

So I am worried that this committee sometimes unintentionally 

under old rules contributes to the air of unreality. And the two primary airs of unreality are not only hiding the fact that we are 

stealing the Social Security surplus but also the fact that according 

to the chief actuary of Social Security, Social Security isn’t even a 

promise, it is a scheduled benefit. Beneficiaries, even though in all 

of our speeches we say it is a sacred commitment, untouchable, as 

an accounting matter it is completely discretionary with the Federal Government. 

So those are the issues I am concerned about. Let’s focus on diagnosis. Then the treatment options will seem a lot more palatable. 

Any comment? 

Mr. WALKER. Yes. First, let’s talk a little bit about metrics. For 

fiscal 2006 there are three annual deficit numbers. The first is a 

unified budget deficit, $248 billion. The second is the on-budget deficit, $434 billion. The third is the net operating cost accrual, $450 

billion. But of that 450 there was a significant actuarial gain, so 

but for the number dealing with the VA the number would have 

been much higher. 

With regard to pensions and health care, the Federal Government is already ahead of the private sector on accounting for employer-sponsored pension and health care costs. We book the entire 

unfunded liability for pension, accrued pension and health cost for 

civilian and military employees, and that is on the books. 

However, the Federal Government is not where it needs to be 

with regard to accounting for social insurance programs. I do not 

believe for a variety of reasons which I won’t go into here that you 

want to book a liability for the $40 trillion that I put up. I don’t 

think it is appropriate, I think it is misleading, and we shouldn’t 

do it. 

However, I do believe that we ought to have more transparency 

with regard to fiscal sustainability and generational equity and I 

do believe there is an additional liability that ought to be booked. 

Do any of you realize that the bonds that are in the Social Security 

and Medicare Trust Funds are not deemed to be a liability of the 

United States Government. You will not find it on the financial 

statements of the U.S. Government. That is wrong, in my view. 

We took the people’s money, we spent the people’s money, we replaced it with a bond that is guaranteed by the full faith and credit 

of the United States as to principal and interest. It is in the socalled trust fund, which isn’t really a trust fund. We will honor 

that commitment. Whether or not we will honor things beyond that 

is a different question but we will honor that, and I think that 

needs to be changed. So we do need to change our financial reporting and quite frankly the other thing you need to do on the budget, 

I would respectfully suggest that you need to disclose the discounted present value dollar cost of any major spending and tax 

proposals before you vote because there is a lot of gamesmanship 

46

that goes on to where the costs explode beyond the 5 or 10-year horizon and that is just when our wave comes in. That is when the 

wave crest is beyond that 10-year horizon. 

We are shooting ourselves by doing that. 

Chairman SPRATT. Mr. Barrett. 

Mr. BARRETT. Thank you, Mr. Chairman. General, I love to hear 

your testimony. It is a breath of fresh air. It is a true wake-up call. 

I have got a couple of questions, one for you, then one for all three 

of you gentlemen. You talked about working together for fresh air 

and sunshine with a lot of different organizations throughout 

America to let people know exactly what is going on. When it 

comes to the problem of entitlements if there’s 435 Members of 

Congress, there’s 435 different ways to handle how we need to go 

forward, whether they are spending caps, whether it is reconciliation legislation or whatever. 

Is there anything that you are doing right now, and if not I 

would encourage you to get these groups together, General, whether they be conservative, moderate, liberal, doesn’t matter, and work 

a road map. Are you doing anything like that right now to give us 

a road map and in doing that are you thinking about major wholesale changes, and I think that might be wrong because I think I 

heard you mention several times doing it in kind of a step fashion. 

Second question to all three of you gentlemen, we talk about national savings, we talk about Social Security, one of the pieces that 

they have talked about is a personal retirement account that has 

an individual’s name on it that is money just for them. This is not 

a novel idea. But my question to you is doesn’t it make sense to 

proceed with something like that but start it in the first year of 

someone’s life, whether it is incentivize or give them or whatever, 

I don’t know. We are missing 18 years of productivity and sometimes more if they go into the higher ed market or something like 

that to encourage national savings that you can add, take tax 

breaks out for something like that. Just throw those two out to you. 

Mr. WALKER. First, the organizations that are involved in the 

Fiscal Wake-Up Tour agree that our financial condition is worse 

than advertised, they agree that we face large and growing structural deficits to the known demographic trends in rising health 

care costs and that tough choices are required, the sooner the better. 

They generally agree that you are going to have to look at all the 

elements that I have talked about, although there are disagreements between the individual groups about how much of the gap 

should be closed through entitlement reform versus spending constraint versus tax policy, tax reform and additional revenues. 

My personal view is that I think this Congress needs to seriously 

consider whether or not you form a credible, capable and bipartisan 

commission to do three things. Number one, come up with a comprehensive reform to Social Security. I could write it in 3 minutes 

and exceed the expectation of every generation of Americans. Number two, round one of tax reform; and number three, round one of 

health care reform. I also think that you might need to think about 

some budget and additional transparency things if they don’t get 

acted on before that. 

47

Congressman Wolf and Senator Voinovich have such a bill that 

they have just introduced in this Congress. That is a way, it may 

not be the way. There are other bills that are emerging. I know 

that Senator Domenici and Senator Feinstein have introduced a 

bill. There are other Members such as Senator Conrad and Senator 

Gregg that would prefer to do something that is not a commission, 

would prefer that something be created that is only Members. 

You are going to have to have a package that is credible, that 

you can focus on in order to make the tough choices, in my view. 

I think we can help there. I know I can help there and would be 

happy to do it. 

With regard to the last issue, individual accounts. I would respectfully suggest that, and we should not look at things in isolation. Let’s take retirement income security. Social Security is the 

foundation of retirement income security in America. It is the only 

thing that is nearly universal. In the private pension system only 

about 50 percent of full-time workers have a pension plan. And 

most of those are in defined contribution plans, individual accounts. 

The savings rate in America for individuals, negative in 2005. 

The last year that happened, 1933. Wasn’t a good year for America. 

All right. I would respectfully suggest that you need to think seriously about reforming Social Security, making it solvent, sustainable and secure as a defined benefit program with potentially a 

supplemental individual account on top for a lot of different reasons as a way to try to enhance personal savings, as a way to provide a pre-retirement death benefit, as a way to help finance longterm care and a variety of other things. We need to start looking 

comprehensively. 

Mr. GRAMLICH. Yes, Congressman. I will just talk about the last 

issue, the individual accounts. I actually agree with I think what 

you are thinking and what David just said. I do think we need—

I do think it would be a good idea to have accounts on top of Social 

Security. Indeed, I recommended that 10 years ago when I worked 

on Social Security. 

But there is a pitfall and we have got to be very careful about 

this. From an economic standpoint the problem is low national saving, and so if we get in the position of having to give away too 

many tax advantages to get people to save; if for example to get 

me to save a dollar you have got to give away a dollar from the 

budget, then national saving hasn’t improved. 

We have got to focus on the sum of government and private saving. If private savers are going to respond to tax incentives, that 

is great and it might be a good idea, but we have actually had a 

lot of saving incentives in the tax system over the past 25 years 

and still the private saving rate has gone down. 

So we have to be very careful about this and not give people tax 

inducements to save when they are not going to increase their saving because if we do that then national saving goes the wrong way. 

Chairman SPRATT. Mr. Allen. 

Mr. ALLEN. Thank you, Mr. Chairman. Thank you all for being 

here. These challenges are so great. One thing is absolutely obvious 

to me, we cannot solve them except on a bipartisan basis. They are 

simply not subject to resolution by one party or the other. And I 

48

think that where Mr. Ryan was saying we can’t just tax our way 

out of these problems, I agree with that. We also can’t just reduce 

spending on these entitlement programs and get out of the problem 

that way. 

I do think that probably no place in the Congress reflects the debate over these issues better than the debates we have had in this 

committee over the last few years and there are some things like 

sometimes I think we are stuck in the 1980’s debate about the role 

of government all across the range here and I wanted to bring up 

one point. The President did—this is from a Wall Street—I am 

sorry, a Washington Post summary of one issue and it begins: 

President Bush wrote in a Wall Street Journal op-ed 2 weeks ago 

that, quote, it is also a fact that our tax cuts have fueled robust 

economic growth and record revenues. And the Post says: The 

claim about fueling record revenue is flat wrong. 

And they go on to discuss studies by Greg Mankiw, well known 

to the administration, by the Congressional Budget Office and by 

the Treasury, which basically make the point that tax cuts generate only—in terms of additional revenue, tax cuts generate only 

a fraction, a relatively small fraction, though of course it is debatable, of the loss in revenue. So the tax cuts cause the deficits to 

go up in a significant way, in fact citing the Treasury study, the 

Post says that those who did that study concluded that economic—

let me go back to another point here. Since the Federal Government collects about 18 percent of gross domestic product and taxes 

enlarging GDP by .7 percent, which is what they say would be the 

impact of making the Bush tax cuts permanent, would result in an 

extra tax revenue equivalent to 0.13 percent of GDP. That would 

offset less than a tenth of the revenue that would be lost because 

of the tax cuts. 

It seems to me that we have got to get a balance here in terms 

of how we think about additional taxes to deal with this unprecedented pressure on our entitlement programs and how we deal 

with reform itself. So my question to you is since tax cuts increase 

the deficit and since you have said, Mr. Walker, let’s start with 

you, that there needs to be some tax reform which goes to added 

revenue, what do you suggest? I mean how do you best keep economic growth continuing and still generate added revenues to deal 

with these entitlement programs? What would you recommend? 

Mr. WALKER. First, there is a lot of misinformation and 

disinformation in this area. A few key points. Not all tax cuts stimulate the economy. Very few tax cuts pay for themselves. The only 

studies that I have seen where tax cuts potentially pay for themselves are dramatic reductions in marginal tax rates and significant reductions in tariffs. There is a difference between whether or 

not you generate more revenues and whether or not you generate 

as much revenues as otherwise you would have had if you didn’t 

have the tax cut. Merely due to inflation we are going to generate 

more revenues. I mean you can see that with AMT. We don’t index 

the AMT and more and more people are subject to that if you don’t 

end up doing something about it. 

There are several things we need to do. One, we need to focus on the tax gap, it is $345 billion. We need additional information 

returns, we need additional withholding. We also need to engage 

49

in more fundamental tax reform to simplify the Tax Code that 

would broaden the base and try to keep rates as low as possible 

but broaden the base in order to facilitate compliance and enforcement among other things. 

We need to put tax preferences on the table. They need to be 

subject to periodic review and reexamination. We forego $700 to 

$800 billion a year in revenue due to tax preferences. It is backdoor 

spending. It is not on the budget, it is not in the appropriations 

process, not in the financial statements. Needs to be on the radar 

screen, needs to be reviewed just like spending. Ultimately I think 

we are going to need to think about moving towards a consumption-based type of tax. 

Mr. GRAMLICH. A couple of points, Congressman. First off, I 

would agree with both you and David that in general tax cuts don’t 

pay for themselves. The other thing, if you think about it, in the 

short run tax cuts do stimulate output in spending some, but 

spending increases do as well. And I don’t think there is, and the 

evidence I know of would not suggest a huge difference. 

On your broader question of how can we possibly do it, well, it 

may not be that hard. In the 1990s, not that long ago, we had a 

period where we actually had government surpluses. If you remember my chart there, government surpluses were high, national saving was high, and that was one of the better decades ever in American history. So it is not necessary to run deficits to have a good 

economy. 

In the very recent history we have shown that you can have a 

very fine economic outcome with government surpluses and high 

national saving. 

Chairman SPRATT. Mr. Bonner. 

Mr. BONNER. Thank you, Mr. Chairman. Mr. Walker, I am going 

to try to break from the mold of the previous question which took 

4 minutes and 30 seconds, only to give you about 30 seconds to respond. I would like for you to talk a little bit more about your most 

recent answer to Mr. Allen and that is your views on a consumption tax. 

Mr. WALKER. Well, I am not a Ph.D. Economist but I do a lot of 

reading and you do have two Ph.D. Economists here. But I think 

what I do know is several things. Income and wealth in the United 

States are distributed fundamentally differently today than they 

were in the early 1900s when our income tax system came into 

place. 

Secondly, the world economy is fundamentally different than it 

was in the early 1900s; and thirdly, that one of the things that we 

need to do is that we need to encourage real savings in order to 

stimulate investment, in order to enhance R&D, in order to improve productivity, in order to stimulate additional economic 

growth and further grow our standard of living. All right. 

And most research that I have read would say that while you 

will probably never move away from an income tax in toto, but to 

the extent that we can do more consumption-based taxation, it is 

better for economic growth, it is a better chance for us to have 

more savings and generate all of those positive aspects that I just 

talked about. 

50

The last thing, quite frankly, a lot of the special savings incentives don’t work. They don’t really generate real additional savings 

broadly, and I think when I talked before about potentially an additional individual account on top of Social Security, I was talking 

about mandatory savings. 

Mr. BONNER. Would either of those two gentlemen? 

Mr. GRAMLICH. First off, I was talking about mandatory saving 

on top of Social Security as well. On your point, Congressman, I 

think most economists if you catch them in a classroom talking to 

undergrads, they would probably argue that if you could start over 

a consumption tax system would be better than an income tax; that 

you would in effect tax people on how much they take out of the 

system, not on how much they put into it. 

I think most people in their heart of hearts would prefer that. 

But economists have worried about this issue for years and years 

and it is incredibly hard to get from one tax system to another, 

raising hundreds of issues. So I think a lot of people who even in 

their heart are consumption tax advocates have just gotten ground 

down by the problems in transitioning from one system to another. 

In the particular case I think you have to be very careful of these 

hybrid situations because right now the tax system is giving saving 

incentives but it also gives you full write-off on your borrowing so 

I can borrow on my house, claim the interest deduction, and save 

tax free. And so the government loses and I may not save any 

more. So you have got to be very careful of these hybrid systems. 

If we go all the way to a consumption tax that would be great, 

but it is very difficult to do, I think maybe even harder than solving Medicare. So I just give you those words of caution. 

Mr. TRUMAN. Two points here. One is I think the crucial point, 

and this builds on what Ned Gramlich just said, is whether a consumption tax would be more efficient in terms of raising a given 

amount of revenue especially given the transitional problems. That 

is a very complicated issue, especially in the transition area. The 

second point, just to emphasize again but put a slightly different 

way, there is—the reason why the academic and his undergraduate 

classroom favors consumption taxes is because you say you are taxing consumption but you are not taxing savings, and savings adds 

to investment and that helps. But the problem is if it is easier to 

save but you only have a target to save X, right, you will still save 

X. 

And so by not taxing the savings there is no assurance that you 

will increase savings. That is the lesson of all the gimmicks that 

we have used through the tax system and other things to increase 

savings, not to, to go back to the earlier question, not that we don’t 

save too little, not that I don’t think it is a good idea to teach our 

children or grandchildren how to save. My grandchildren have one 

piggy bank for savings and one for spending, I think that is a terrific idea. But don’t fool yourself that you can make it up because 

this is the difference between what we economists call income and 

substitution effects. And the net may be no more savings for the 

economy as a whole, and if you are interested in generating savings 

for investment in order to support when you get down to two workers per retired person, you need a bigger capital stock in order to 

support those people. 

51

Chairman SPRATT. Allen Boyd. 

Mr. BOYD. Thank you very much, Mr. Chairman. This is like my 

second or third hearing and I tell you what, I am intrigued by the 

subject that we are doing here and really enjoying it. I was thinking this morning we went yesterday from a first grade lesson in 

budgeting that we went through to something today that is as complex as how do we solve the long-term budgeting problems of our 

country. 

My question, I am going to be very brief, Mr. Walker, I think 

that you answered a question a few moments ago to Tom Allen 

about which tax cuts pay for themselves. And I wanted you to clarify. I thought I understood you to say that dramatic cuts in marginal tax rates and also you mentioned tariffs. Would you restate 

that and elaborate? 

Mr. WALKER. The research that I have seen, but my colleagues 

here on the panel may want to jump in, is the two that potentially 

could pay for themselves would be dramatic reductions in marginal 

tax rates like what happened when JFK was President. You are 

talking about huge reductions in marginal tax rate, not several percentage points, and dramatic reductions in tariffs, which promotes 

additional trade and economic growth. 

Mr. BOYD. So the presumption would be you have to have a very 

large marginal national tax rate to start with to get a dramatic cut. 

Mr. WALKER. That doesn’t mean there is not some positive economic stimulus. There is a difference between paying for themselves and being stimulative. That is my key point. As Dr. 

Gramlich said, additional spending can stimulate economic growth 

at a price. Tax cuts can stimulate economic growth at a price as 

well. What is going on right now is we have a national credit card 

with no credit limit and we are charging it and our kids are going 

to have to pay off the bill with compounded interest costs. 

Mr. BOYD. I think I understand. 

Mr. GRAMLICH. Just to elaborate on one point. The starting point 

matters in this business because if you have a situation let’s say 

90 percent marginal tax rates, which we have had in this country, 

and you cut it to 80 percent, you know, you may well get a big increase in effort and tax revenue and so forth. If you go from 36 to 

34, you know, that is a different issue. 

Mr. BOYD. I understand. The next question, if I could, Mr. Walker. In terms of this discussion about our economy and the budget 

problems that exist, the long-term issues related to deficits, the 

mandatory spending programs, the crisis that faces us 10 or 12 

years down the road, at what point in time do the national, international markets begin to react to that gloomy crisis. Would you 

be willing to expound on that? 

Mr. WALKER. Only God knows. In all seriousness. I mean——

Mr. BOYD. But it happens at some point in time. 

Mr. WALKER. In my view there is no question that ultimately we 

will pay a price. The question is what will that price be. One could 

argue that we will have a gradual erosion over time rather than 

a sudden catastrophic event. A gradual, continual erosion in the 

value of the dollar, a gradual increase in interest rates over time, 

a gradual drag on economic growth, on standard of living and a variety of other issues. That is a possible scenario, rather than a catVerDate 0ct 09 2002 19:37 Mar 07, 2007 Jkt 000000 PO 00000 Frm 00055 Fmt 6633 Sfmt 6602 J:\DOCS\HEARINGS\110TH\110-2\32738.TXT HBUD1 PsN: DICK
52

astrophic event, a precipitous decline in the dollar, a dramatic increase in interest rates. 

But the bottom line is as we know we are on an unsustainable 

path so we ought to do something about it. 

Mr. TRUMAN. I think that is the point. You have had several occasions in our history, right, where the movements in the exchange 

value of the dollar, in the early 70s, the late 70s, and the late 

1980’s have triggered very unpleasant periods in our economy, 

maybe not a full-fledged hard landing but in the late 80s, for example, we had a period of very low growth and part of that was that 

we were cutting ourselves off from foreign savings, right, and domestic savings wasn’t picking up and so we damped investment, 

and it was a period in which GDP growth was low, we ultimately 

had a recession but that had more to do with oil prices. 

So you can easily go through that period as David Walker was 

just saying, that makes things no big crisis, though in 1987, just 

to remind you, in 1987 the dollar was falling, right, and we, I say 

we because I was then part of the government, we begged the foreigners to come help us and they said we are not going to help you 

until you have a budget summit which will put on the table a credible commitment to cut the budget deficit. I think it was all of $76 

billion, but the point is there was a sense at that point that that 

issue—with the weak dollar following the stock market crash in 

October 1987—came right into this hearing room in a very painful, 

painful, painful way and it was all against the background of very 

slow growth. Very slow growth means that these 10 percent rates 

of increase in revenues aren’t going to be there. 

I think no one can say when. The question is how long do you 

want to take the risk that it is not going to be; another decade or 

not. 

Mr. BOYD. Thank you very much. Mr. Chairman, thank you. 

Chairman SPRATT. Mr. Garrett. 

Mr. GARRETT. Thank you, Mr. Chairman. I thank the panel as 

well. We will start off with I appreciate one of the opening comments that you made with regard to your wake-up tour that you 

are traveling around the country about. I just learned of that yesterday. I would invite you all to come to my home State which is 

the great State of New Jersey where we may need the wake-up. 

Our State is going through equally difficult budgetary times. 

Where other States saw revenue increases and be able to cut their 

taxes, New Jersey is in dire straits right now financially. We were 

supposed to have a budget forum recently to try to solve those 

problems and instead they dealt with other social issues as well so 

we are on the same cusp in our State. 

We have taken a different tact in the State of New Jersey. 

Whereas Congress has in the past several years cut taxes to try to 

stimulate the economy and that sort of thing, New Jersey has gone 

the other direction and has actually raised taxes. The result is 

what you see right now and the dilemma that we face and, as Ronald Reagan used to say, people vote with their feet, and last year 

60,000 people voted with their feet and saw a decline in our population. I welcome you to come and educate our State. 

I commend the General’s comment. At the opening comment he 

made two statements. One is we should be looking forward in this 

53

committee and not in the rear view mirror. We can debate all day 

long as to what the problems were but we need to look forward and 

I appreciate your last slide with the grandkids as to who it is all 

about. 

This Congress passed last session the increase in the benefits for 

Medicare and it is true, and correct me if I am wrong, that people 

that are receiving that benefit today are not the people who are 

paying for it nor is this generation really paying for it, it is your 

grandkids and other grandkids who will be paying for the beneficiaries today. 

So I go to my first question is the structural reform that you 

mentioned, how do we get to the structural reform, and ask for the 

comments in this sense as far as entitlement reform based upon 

two comments you all made. One is to minimize the tax burden, 

this was the answer to Mr. Ryan’s question, to minimize the tax 

burden is to increase economic growth; so is the converse true, to 

increase the tax burden to decrease economic growth. 

And also in light of Mr. Gramlich’s comment, a better tax system 

would be not putting a tax you put on the system but a tax you 

take out of the system. Since I may not have enough time on this 

I will ask my last question now and you can answer these, and that 

is going to the Social Security and the whole issue of tradeoffs. Mr. 

Gramlich, you said we need more transparency and more of a show 

to show the tradeoffs to people. Can we do anything with regard 

to the information that recipients get every year in our Social Security packets or statement on your birthday every year as to show 

the people what the tradeoffs really are. This is what my investment today is in Social Security, but show them really what their 

tradeoffs are in the future as far as the alternatives they could 

have gotten had they been in other markets. 

Thank you, gentlemen. 

Mr. WALKER. I will touch on a couple. First, bad news flows 

downhill. We are talking about the Federal fiscal challenge today. 

State and local governments have their own fiscal challenges. And 

for those that are interested in having a Fiscal Wake-Up Tour 

come to your State, Bob Bixby, who is executive director of the 

Concord Coalition, is the point person. He is the one that schedules 

the different visits. And we have not been to New Jersey yet. 

Secondly, my point on taxes is you want to try to minimize tax 

burdens in order to maximize economic growth, maximize disposal 

income, and maximize our competitive advantages. But, in the end, 

if you don’t want to mortgage the future of our kids and our 

grandkids and if you want to mitigate the risk of the imprudent 

and unsustainable path that we are on, you have got to have a situation where ultimately we are going to generate enough revenue 

to pay our current bills and deliver on our future promises. So we 

need to recognize that we can’t have it all. 

Mr. GRAMLICH. Just a quickie on your very last idea to make 

what are known as the PEB statement, personal earning and benefit, even more complicated by putting in these tradeoffs, I don’t 

think people would understand it. I would rather have the PEB 

statements go out just as they are now but have the fiscal wakeup tour go around and explain the issue because it is—there are 

too many options. You can’t put in something about the retirement 

54

age or something about this or something about that and have people have any clue what they are getting. I think it would just confuse people. And I would rather have it done with a little instruction and then focus groups and that kind of thing. I think you get 

farther that way. 

Chairman SPRATT. Mr. Scott. 

Mr. SCOTT. Thank you, Mr. Chairman. Several people have mentioned this commission idea. The only problem with the commission 

is that suggests a one-time fix and then it is solved. Like Social Security, you had a commission and solved it for 5, 10, 15, maybe 20 

years. But if you have the one-time fix, the following year you can 

just mess it up all over again. We had this thing pretty much on 

the right track in 2000 and all of a sudden it got messed up. 

Unless you have some people willing to continually make the 

tough choices, you are not going to get very far with a one-time 

commission. 

The Social Security question, let me, Mr. Walker, ask you a question. You have—on your long-term fiscal exposures you had Social 

Security benefits at 3.8 in 2000 and 6.4 in 2006. Does that mean 

we could have fixed it with 3.8 in 2000? 

Mr. WALKER. Yes and no. 

Mr. SCOTT. For 75 years. 

Mr. WALKER. Yes, but the next year we would have had a deficit. 

And the reason being is because of known demographic trends. 

What is happening right now, in the short term we have surpluses, 

so every year that passes we drop a surplus year and we add on 

to the end of 75 years an increasing deficit year. And that is why 

it is important that we recognize that reality and that the next 

time there is a commission we try to do something to try to assure 

sustainability beyond that. 

Mr. SCOTT. Could we have paid 75 years with 3.8? 

Mr. WALKER. We could have, but we wouldn’t have solved the 

problem. 

Mr. SCOTT. Now 75 years is going to cost 6.4. 

Mr. WALKER. It goes up about $600 billion a year. 

Mr. GRAMLICH. Congressman, could I interrupt? There is a way 

to deal with this, and we got it in our dealing with Social Security. 

When you have groups come together the wrong question is to 

make the system sustainable for 75 years because, as David said, 

1 year passes and all of a sudden it is out of balance. 

The right way to do it is to make it sustainable for 75 years and 

have no change in what is known as the trust fund ratio in the last 

10 years because that is the ratio of assets to spending, basically, 

and if that ratio is stable then you can presume that as we go forward it won’t change in the 11th year, the 12th year. 

Mr. SCOTT. If you fixed it, the next year you would have a different 75 years. But if you could fix it to 75 years, that gives you 

75 years starting off now to fix it for the next 75 years. Maybe another program or something. But we could have fixed 75 years for 

$3.8 trillion. 

Mr. WALKER. Correct. Importantly——

Mr. SCOTT. It gets worse as you go forward. Now we had a surplus of 5.5. How much—what is the present value of making the 

tax cuts permanent? 

55

1 A 2004 paper by Brian Jenn and Donald Marron when they were economists at the Joint 

Economic Committee noted the problems in comparing the cost of extending the tax cuts to ‘‘current law’’ when current law—as noted above—would project taxes as a share of GDP at levels 

exceeding the post-World War II average by more than 5 percentage points. (See ‘‘The LongRun ‘Cost’ of Tax Cuts’’ by Brian H. Jenn and Donald B. Marron, in taxanalysts July 20, 2004)

Mr. WALKER. I will be happy to provide it for the record. 

[The information follows:]

GENERAL WALKER’S RESPONSE TO MR. SCOTT’S QUESTION ABOUT THE VALUE OF

PERMANENT TAX CUTS

CBO’s January 2007 outlook shows the cumulative difference—not present 

value—between assuming the 2001 and 2003 tax cuts expire and making them permanent to be $1.9 trillion over the period 2008 to 2017. This estimate does not include extending the 2006 AMT adjustment into the future. If the higher AMT exemption amount is extended then the cumulative difference of these changes would 

rise to $2.8 trillion over the 10 year period. Under CBO’s baseline in which the tax 

cuts and the increased AMT exemption are allowed to expire, revenues reach 20.1 

percent of GDP in 2017. In contrast, if the tax cuts are made permanent and the 

2006 exemption is continued, revenues would be about 18 percent of GDP in that 

year. 

Calculating the present value of the tax cuts over a longer period of time is more 

difficult because it is less obvious what the reference point should be.1 Because of 

inflation, bracket creep, and the alternative minimum tax, current tax policies if left 

in place would result in revenue as a share of GDP approaching 24 percent by 2050. 

It does not seem reasonable however to use this as the point of comparison—in the 

years since the end of World War II Congress and the President have taken actions 

to keep the overall tax burden within a relatively narrow range around an average 

of about 18 percent of GDP. Any analysis of the present value of any tax cuts would 

need to make an assumption about the level of future taxes to use as a comparison. 

Mr. SCOTT. It was 12 trillion a couple of years ago. Does that 

sound about right? 

Mr. WALKER. I can tell you this, as I showed, even if you don’t 

make the tax cuts permanent, you are still going to have to do 

more. But that is obviously a big number. 

Mr. SCOTT. A couple of years ago make the tax cuts permanent 

was equivalent to the present value of the Social Security Trust 

Fund 75-year deficit and the Medicare Trust Fund 75-year deficit. 

Mr. WALKER. Not the Medicare; no way it could have been that 

big. We were in the hole $15 to $20 trillion on Medicare Parts A 

and B before Medicare prescription drug was passed. And so it 

wouldn’t have been the combination of both Social Security and 

Medicare. It did exceed Social Security, there is no question about 

that. 

Mr. SCOTT. The top 1 percent we are going to get out of making 

the tax cuts permanent was in the same order of magnitude as the 

Social Security 75-year trust fund. 

Mr. WALKER. By itself, right. 

Mr. SCOTT. Let me just get in one more question. The trade deficit and the capital deficit, we have a capital deficit now. What does 

the trade deficit do to that, the combination? 

Mr. TRUMAN. We have actually, as was put in the 2006 Council 

of Economic Advisors report, we have a surplus on capital because 

the surplus is coming in to pay for our trade deficit. The problem 

is that the trade deficit represents the fact that we are adding currently to our consumption at a higher rate than we are adding to 

our production. And so we send IOUs abroad in order to finance 

our current consumption. So we are not sending the IOUs internally, as we said before, we are sending them abroad. Ultimately 

56

at a minimum we are going do continue to pay interest on those 

IOUs and so that goes up just like the interest on the debt here 

and we will have to at a minimum probably have to stop piling up 

those IOUs because they will exhaust the appetite for those and ultimately conceivably we will have to pay off some of those IOUs. 

So we have to pay the interest all along, we have to reduce the rate 

at which we are piling up IOUs and we may have to pay them off 

and that means you have to bring down the current account deficit 

in order to attract that and bring up the trade balance in the process. I hope that is clear. 

Chairman SPRATT. Mr. Hensarling. 

Mr. HENSARLING. Thank you, Mr. Chairman. I am certainly 

happy to hear from all of our panelists on this subject, on why deficits matter, although I am not sure it is much of a subject of debate 

within this committee. I am hopeful that you can all return and in 

the future we can have a hearing entitled while spiraling unfunded 

obligations and entitlement spending matters, which I believe is, 

from the testimony I hear, clearly a place where this committee 

needs to put some focus. 

General Walker, I don’t have the slide number here but I am 

looking at one of your handouts, Composition of Spending as a 

Share of GDP Under Baseline Extended, August 2006. If I am interpreting this correctly, under these base assumptions all the tax 

relief that many believe is the root of all evil expire. We do not 

have an AMT patch, and yet by 2040 we still have apparently 

spending as a percentage of GDP go from roughly 18, 19 percent 

of the economy to roughly 30 percent. I am just eyeballing it. 

Mr. WALKER. It goes from about 20 percent, a little over 20 percent of the economy to about 30 percent. 

Mr. HENSARLING. From roughly 20 to 30, which would suggest on 

kind of back of cocktail napkin math I believe the average family 

of four in the U.S. pays roughly $20,000 combined in Federal taxes. 

That would seem to suggest an increase of 50 percent in their tax 

burden to balance the budget by 2040. So in inflation adjusted 

terms might their tax burden go up to 30,000 a year? 

Mr. WALKER. If you saw that solely through tax increases, which 

I don’t know anybody who is proposing that, and if you waited until 

2040 to do it, then you would have to increase tax burdens by 

about 50 percent, but then again you have to keep in mind that is 

only at that point in time. If you look out further from there we 

have still got a long range problem so that wouldn’t solve it. Similar to the 1983 Social Security, we solved it for 75 but we didn’t 

solve it long term for the reasons Ed Gramlich talked about. 

Mr. HENSARLING. But for those who do not wish to engage in a 

bipartisan dialogue on reform of entitlement spending, if you take 

away again the Bush tax relief, ultimately then you would be looking at what I believe many would view as an unconscionable tax 

increase upon American families and our economy. 

General Walker, speaking of tax relief, I think I heard you say 

that from your perspective in order for tax cuts to quote, unquote, 

pay for themselves I think you have said only significant decreases 

in marginal rates and significant decreases in tariffs would meet 

that criteria. But recently we had a rather dramatic decrease in 

the tax gains cap rate, and if I did my homework correctly, we have 

57

doubled our capital gains realizations from 269 billion in 2002 to 

539 billion in 2005, which has led to a 45 percent increase in tax 

revenue from these realizations. 

Would cap gains be part or not part, if properly designed, part 

of a tax relief package that might pay for itself? 

Mr. WALKER. Well, first I would say that I don’t think you can 

look at the capital gains in isolation, I think you have to look at 

what has happened in the capital markets during that period of 

time, what has happened to real estate prices, stock and bond 

prices and things of that nature. One of the things that happened 

to us in the late 1990s is we assumed that—or the early part of 

this millennium, we assumed that the past was prologue and gains 

turned into losses and they were carried forward. The others may 

have a comment. 

Mr. GRAMLICH. Just on that, I don’t know what the answer is but 

you have to be careful of these realizations because it could be the 

bigger number, the 500 was just pulling money out of some other 

year. That is the problem with these capital gains realizations. You 

have large accrued gains and then the question is when you realize 

them, and if you realize them this year, you may not realize them 

next year. So you have to consider all years in that kind of calculation. 

I don’t know how it would come out, but I do know that these 

are tricky calculations for capital gains. 

Mr. HENSARLING. In the less than 20 seconds I have left, just to 

make sure I understand what I heard earlier, General Walker, I 

think I heard you say something along the lines we cannot grow 

our way out of this problem and perhaps we can’t tax our way out 

of our problem. Is it fair to say that in your opinion the most important fiscal reform we could undertake is trying to find some bipartisan reform to the growth curves and entitlement spending? 

Mr. WALKER. There is no question that is number one. By the 

way, with regard to your question and Mr. Scott’s question, of the 

two commissions that are on the table right now, I am sure many 

others will be, one is a one-time commission that has a broad 

scope. That is the Wolf-Voinovich commission, that includes a 

broad scope, and is a one-time group. The Domenici and Feinstein 

commission deals solely with entitlements, so it is narrow scope—

but it is permanent, or long term. 

Chairman SPRATT. Mr. Etheridge. 

Mr. ETHERIDGE. Thank you, Mr. Chairman. Let me thank you for 

the opportunity to participate in this and thank you three gentlemen. Someone said earlier and I think it is true, all of us get an 

education here and I wish more citizens could see it, hear it and 

be a part of it. 

I believe, Mr. Walker, you said earlier we have a budget deficit, 

balance payments deficit, and a savings deficit. I think we can 

probably agree on that. Let me ask one other question and maybe 

all three of you maybe want to comment on this because usually 

what happens when we start talking, even when we get together 

jointly, is we want to fix the narrow piece that we have been involved in and don’t want to pay attention to the broader issue. 

Reminds me of a family that wants to buy a new car, looks at 

their revenue and can’t figure out how they can buy it but they are 

58

going to decide to do it, find a dealer who will let them have it for 

the lowest amount of money they can get, whether they own the 

car at the end of the day or not, and are ultimately headed toward 

a cliff. They will have neither the car nor the home nor anything 

else if they don’t deal with it. 

So let me ask you on one other issue, we haven’t talked about 

this but I think it does have an impact on the overall piece, what 

the value of the U.S. dollar was in terms of the international markets, say in 2000. We had a strong dollar. All of a sudden we have 

seen that dollar go down in value dramatically. I don’t know how 

much it has gone down but it has gone down substantially, whatever the dollar is today versus whatever it was in 2000, which is 

on the American consumer a tax any way you cut it. And tie that, 

if you will, to the questions or the issue as relates to investment, 

because when we own the debt, those dollars that the Federal Government was paying for the debt that was turned over in our economy today is turned over in the economies of other countries so we 

are sending the dollar overseas to increase their investment for the 

products we are going to buy and how that helps hit the wall sooner. 

Mr. TRUMAN. I can’t go to 2000, but from the peak of the dollar, 

which was in February of 2002 to today in real terms, adjusting for 

inflation rates on the broadest average that the Federal Reserve 

computes, the dollar is down 15 percent. It is down a lot more 

against the Euro and other currencies like that but it is down a 

lot less against the Chinese yuan. So the dollar is down 15 percent. 

The second question: is that a tax on American consumers? The 

answer to that question is yes. But it is probably in the category 

of an inevitable tax on American consumers in the sort of death 

and taxes type of thing because you need to have a lower dollar in 

order to stimulate us to import less and for the rest of the world 

to buy more of our exports. And it is the one way that we close, 

one, not the only way that we close this current account deficit and 

stop having to send IOUs abroad, as I said to Mr. Scott, IOUs 

abroad that we have to pay interest on. 

And we economists say there is a terms of trade loss in that because in fact we are now paying more for a given level of imports, 

sending more bushels of wheat abroad for every Lexus that we are 

importing. So that actually acts like a tax, but it is a necessary 

part of how the process works of correcting the current account deficit, and what this hearing is about is to make sure that as that 

process of squeezing that comes on, we actually can generate 

through the principle reason—we have the savings to replace the 

savings that we have been importing from abroad. And that is 

where these questions about raising taxes and going into entitlements and other mechanisms come into play. 

Mr. WALKER. I would just say that arguably the way that we 

have felt the pain so far is decline in the dollar rather than an increase in long-term borrowing cost. We do have competition. The 

U.S. is still a global currency. We are not the only one in town anymore. 

Mr. ETHERIDGE. Thank you. 

Chairman SPRATT. Mr. Alexander. 

59

Mr. ALEXANDER. Thank you, Mr. Chairman. General Walker, this 

sheet here is almost black but I believe it says major fiscal exposures of 50 trillion. What does that mean? 

Mr. WALKER. What it means is it includes total explicit liabilities, which would include debt held by the public, military and civilian pensions, the unfunded obligations there, and Social Security 

and Medicare. It doesn’t include everything. It doesn’t include Medicaid, it doesn’t include a variety of other things. So it is selected 

fiscal exposures. And the numbers down below with regard to Social Security and Medicare are the discounted present value dollar 

difference between dedicated revenues and likely expenditures 

based on the Trustees’ best estimates. 

Mr. ALEXANDER. The reason I ask is the members of the Blue 

Dog Coalition have signs posted outside most of their offices around 

and their numbers don’t come anywhere close to this. 

Mr. WALKER. Those signs are too low. Those signs are too low. 

That is part of our problem. We have got the wrong metrics. We 

are focusing on debt held by the public, all right, which is a small 

subset of this. It is basically a down payment of this number. And 

so we need to change how we keep score. 

Another example is if you are heading for a cliff and you slow 

the car down to half speed by the time you hit the cliff that ain’t 

going to get the job done. We need to change our metrics and measurements. 

Mr. ALEXANDER. In another illustration earlier I think I saw two 

lines running parallel to each other, national savings versus individual savings. When an individual saves something, it is something tangible. Explain national savings. 

Mr. GRAMLICH. National saving is the amount that we—that we 

reserve from production for growing investment, basically. And so 

when an individual saves, that money goes in a bank and can be 

used to finance corporate investment. If the government comes 

along and runs a deficit then a lot of the individual’s money gets 

used up in paying for the deficit. And so the national saving would 

then go down. So that is why you have to worry about what the 

government is doing. 

What we want to do is have both individuals save a lot and have 

the government not be detracting from the individual saving by 

mopping up their saving just to finance a deficit. You want to have 

that saving rooted all the way back to corporate investment. 

Mr. ALEXANDER. Thank you. Thank you, Mr. Chairman. 

Chairman SPRATT. Thank you, Mr. Alexander. Mr. McGovern is 

not here. Mr. Smith is not here. Mr. Doggett. 

Mr. DOGGETT. Thank you very much. Thank you for the testimony you all have provided. Mr. Walker, if I understand your testimony, while we cannot rely exclusively on increased revenues to 

address these problems, there is no way we can solve these problems without a substantial increase in tax revenue over the long 

haul. 

Mr. WALKER. Over the long haul I don’t believe you are going to 

be able to solve the problem with taxes at 18.2 percent of GDP. I 

do think you want to keep it down as much as you can for the reasons I have articulated, but I don’t think—politically I don’t think 

you can solve the problem at 18.2 percent of GDP. 

60

Mr. DOGGETT. You have indicated we have a shortfall of revenues 

today and we will have a much greater shortfall in the future if we 

continue on the present course. 

Mr. WALKER. Correct. 

Mr. DOGGETT. And that you have seen very few tax cuts that pay 

for themselves. 

Mr. WALKER. That is the authoritative literature. 

Mr. DOGGETT. Would you take a look back at page 5 of your 

charts where you talk about the baseline that you presented to this 

committee in January of 2001. 

Mr. WALKER. I am familiar with it, yes. 

Mr. DOGGETT. At that time did it appear that the spending and 

even entitlements were sustainable at the current revenue? 

Mr. WALKER. Based upon the assumptions that existed at that 

point in time, some of which proved not to be valid, yes. I mean 

the assumption then, if you will note, there is no interest cost because the assumption then was we were going to pay off all the 

debt. We actually were going to have savings that we were going 

to invest. 

Mr. DOGGETT. I remember the testimony to the Ways and Means 

where he was concerned we were going to pay off too much debt. 

Mr. WALKER. So really some of the assumptions may have 

changed. The situation we find ourselves in today is largely the result of policy decisions that have been made in the last 6 years. 

Largely but not solely. 

Mr. DOGGETT. That is right. 

Mr. WALKER. For example, back in January of 2001 I testified 

about fiscal risk. The highest risk thing I said that Congress could 

do was increase entitlements. Guess what, that is what Congress 

did, called Medicare part D. 

Mr. DOGGETT. The prescription drug program, and you have outlined the cost for that. And there has also been a reduction in revenues over that time, too, hasn’t there? 

Mr. WALKER. The combination of several things, changes in assumptions, number one; there has also been an increase in entitlements, there has been a significant increase in spending as compared to historical levels, not all of which is defense and homeland 

security, for a significant part is; and thirdly, tax cuts. 

Mr. DOGGETT. You mentioned health care as perhaps the greatest public policy challenge that we face in the country today. 

Health care is responsible for a significant number of personal 

bankruptcies being taken across the country. As we look at how to 

address this looming crisis that you have described don’t we also 

have to consider the crises that individual families are faced with 

health care and address those deficits in health care and education 

as well? 

Mr. WALKER. Health care is the number one fiscal challenge for 

the Federal and State governments; number two, it is the number 

one competitiveness challenge for American business; and number 

three, it is a growing challenge for American families. Let me just 

tell you if there is one thing that can bankrupt America, it is 

health care. We need dramatic and fundamental reforms in phases 

over time and I am happy to talk about that some other time if you 

want. 

61

Mr. DOGGETT. It could bankrupt our country or it could continue 

to bankrupt more and more families in the country if we don’t find 

a way to address it. 

Mr. WALKER. It would have an adverse affect on many players. 

Mr. DOGGETT. I thank you for your testimony. 

Chairman SPRATT. Mr. Moore. 

Mr. MOORE. General Walker, I was at the White House with the 

Blue Dog leadership and the new Dem leadership about a month 

ago and had a chance to meet with the President, and when it was 

my turn the speak for 2 minutes I said, Mr. President, I have seven 

and a half grandchildren and we have mortgaged the future of our 

children and grandchildren. So I very much appreciate the slide 

with your three grandchildren because I think that is what all of 

us on this committee and Congress should be looking at because 

they are our future and we have done horrible things to their future. We need to change the way we are doing business. And I said 

to the President this should not be about Democrats and Republicans, we are all in this together as are future generations in our 

country. 

I mentioned Blue Dogs. What should be the number instead of $8.9 trillion national debt, what should be the number on the Blue 

Dog sign right now? 

Mr. WALKER. $440,000 per household. 

Mr. MOORE. What does that come to in terms of trillions of dollars? 

Mr. WALKER. $50 trillion. 

Mr. MOORE. Just in round numbers, right? 

Mr. WALKER. In round numbers. That is big enough. We can round off at $50 trillion. 

Mr. MOORE. I understand, I really truly do understand, and I 

mentioned this shouldn’t be partisan at all and I have heard from 

the other side and I am not trying to point fingers here but it gets 

frustrating when you hear that tax cuts kind of pay for themselves, 

and we have heard some difference this morning, and I understand 

we need to look at the whole big picture here if we are really going 

to make a difference here. It is about entitlements certainly. That 

is the big one that you have identified and others have identified. 

It is about spending, and we have got to look at that, and we have 

also got to look at tax cuts because I believe all tax cuts aren’t created equal and they don’t all pay for themselves. Some do, but 

some don’t. 

But what—what change in metrics, if any, I mean do you have 

any suggestions, and I heard you mention too that health care is 

the big, the big thing in the picture out here. Can you give us 

just—I know you don’t have time to go into a lot of detail. I have 

got 3 minutes left. Can you give us just a summary of some of the 

ideas you have for reforming health care to make it better for us 

in the future? 

Mr. WALKER. Well, first, I think you need to reconsider the Part 

D benefit. 

Mr. MOORE. Yes, sir. 

Mr. WALKER. Number two, we need to move the national practice 

standards, which would help us to control cost, improve consistency 

and reduce litigation. 

62

Number three, we need to expand case management approaches 

within the Federal healthcare programs. 

I mean, those are just a few examples, but since this is the Budget Committee, let me suggest that some of the things that need to 

be considered—we need to go back to PAYGO rules on both sides 

of the ledger. We need discretionary spending caps. We need mandatory reconsideration triggers when certain mandatory spending 

programs get to a certain size of the budget. We need to have more 

transparency and mandatory reconsideration triggers on tax preferences and tax expenditures as well. And whether you have a 

commission or not, you have got to have better transparency and 

strong budget controls in place to make sure you don’t slip back 

and undo the good things that ultimately, hopefully, will get done. 

Mr. MOORE. Well, I will pledge to the two members of the minority now that are on the other side here that are here that I really 

appreciate what you all have said. I have had private conversations 

with the ranking member about some of these items; and I, again, 

just hope we can come together and put aside some of the rhetoric 

and really work together to address some of these. Because that is 

what needs to happen not for us but for the American people and 

our country in the future. 

One more question that is kind of a tag-along, I guess, is China right now, I understand, holds over half a trillion dollars, over $500 

billion of our debt. What would be—and I understand—I have read 

some of the materials that have been provided that say it is probably not going to happen. What would be the result, though, if 

China and some others who hold our debt decided they didn’t want 

to hold our debt anymore? What would be the impact on our country? 

Mr. TRUMAN. Going on the principle of comparative advantage, 

I think the first question is, if they sell treasuries and they buy equities, right, in the United States, the answer is nothing. Maybe 

the price of the treasuries goes down and the price of equities goes 

up. 

Mr. MOORE. My question is, if they decide they didn’t want to be 

involved——

Mr. TRUMAN. If they sell their holdings and they buy Euro dollars, Euro assets, denomination in Euros or yen or whatever you 

want to think in, then what you have is a—you could have, as you 

said, as you stipulated, not likely—these are sophisticated financial 

people, they don’t want to shoot themselves in the foot—but you 

could have, if there was a widespread tendency for foreigners—or 

domestic residents, for that matter—to say, I have too much dollar 

assets because the United States government—people and government can’t get their hands around the problems that Mr. Walker—

General Walker—described, then you could have a sharp fall in the 

dollar, and that surely would shrink the current account deficit, 

and it surely would reduce the availability of savings from abroad, 

and that surely would put interest rates up, and whether our 

friends at the Federal Reserve could manage that without a recession is something you could bet on. I mean, one would hope so, but, 

at a minimum, you would have—as we did in the late 1980s, you 

would have sharply lower growth for a sustained period of time. 

Mr. MOORE. Thank you. 

63

One last comment, I just want to thank you for the good work 

you are doing in educating the American people and the Congress 

about what all this means to the future of our country. Thank you. 

Chairman SPRATT. Mr. Andrews. 

Mr. ANDREWS. Thank you, Mr. Chairman. I thank the witnesses. 

Dr. Gramlich, on the second page of your testimony, you say 

there has been speculation that bondholders would insist on higher 

long-term bond rates as deficit grows, but this hasn’t really happened. Long-term rates are well behaved right now, and most reasonable forecasts expect them to remain so in the near future. We 

could worry that high deficits will cause high interest rates, but 

that would be crying wolf. 

I am not crying wolf, but I fear the wolf. I do. And one of the 

reasons that I do is inherent in General Walker’s testimony. I look 

at his graph on page 4. If I read it correctly, he says that under 

the most likely policy scenario that we are presently on, by 2010 

we would be running a deficit of 4 percent of GDP, give or take; 

by 2015, it would be about 5 percent of GDP, give or take, trending 

up to 7 percent in 2020 and 10 percent in 2025. 

Here is my question for all three on the panel: If General Walker’s assumptions are correct and that is the path that we are on, 

do you think that we would reach a point where the wolf would 

visit the door and we would be punished in terms of higher interest 

rates, number one. 

And, number two, if that is a scenario that we should be concerned about, what level of remedy do we need to achieve now to 

forestall or postpone that? In other words, how much deficit reduction in the short run is enough to mitigate the probability we 

would face that wolf at the door? 

Dr. Gramlich, do you want to——

Mr. GRAMLICH. Yes, Congressman. I brought up the wolf, so I 

probably ought to deal with it. 

I think what you are seeing—this is the conundrum. You know, 

given all these things—I mean, the international financial traders 

have seen David’s charts. They know these numbers, but yet they 

are still not charging very high interest rates, and it is puzzling. 

I think the reason is, to be honest, that there is still a reservoir 

of faith in the American economy, in American politicians that, by 

the time this happens, the problem will be fixed. So, in some sense, 

the committee—there is almost nobody left here, but the committee 

could view this as a challenge—I mean, that you want to prove the 

bond traders right. 

Mr. ANDREWS. My question is, what do we need to do to retain 

that faith? 

Mr. GRAMLICH. I would say, put the deficit on a sustainable path. 

I mean, if you had the—I would prefer that the deficit be zero. I 

mean, that would be my heart of hearts. But there is a policy short 

of that where the debt-to-GDP ratio over time does not rise. It 

might be tantamount to deficits of 1 or 2 percent continuing, I 

mean, without the explosion that you see in the charts there. If 

that were the case, I think, you know, the bond traders would be 

okay with it. What I think they don’t like is the unsustainability. 

Mr. ANDREWS. Right. 

General, what do you think? 

64

Mr. WALKER. I think you need to address the biggest deficit that 

America has, which is not budget, which is not balance of payments, which is not savings, it is leadership. All right? That is the 

biggest deficit we have. 

My view—I will come back to what I said before. If you improve 

transparency, if you enact meaningful budget controls and if you 

can achieve Social Security reform, round one of healthcare reform 

and round one of tax reform, that will go a long way towards helping to avert a potential crisis, and then we are going to have to reengineer and reprioritize government. It is going to take 20 years. 

Mr. ANDREWS. Do you think there is a quantitative manifestation 

of those goals, that either is percentage of debt to GDP or size of 

the deficit? 

Mr. WALKER. I don’t know that there is specific metric on that. 

I can just tell you right now that I think people are counting on 

Congress ultimately doing something and the President ultimately 

doing something, and I think it will by the way. We just need to 

do it sooner rather than later. 

Mr. ANDREWS. I certainly agree with that. 

Dr. Truman? 

Mr. TRUMAN. On the first part of your question if we had that 

scenario, would the wolf bark at some point down the line? I think 

yes, but I can’t tell you when. It could be as early as 2 years from 

now, within the next 2 years or it could be another decade—but I 

think it is unsustainable; and, ultimately, that will read into 

everybody’s desire to hold claims on us. 

The question of how much of a fix, I think—my view, and as I 

said in my testimony or as we said in our testimony, I think there 

is a sort of short-term objective, which might be phrased in terms 

of a surplus by the end of the deficit, preferably an on-budget surplus, so not on the unified basis. 

Mr. ANDREWS. You mean by the end of the decade? 

Mr. TRUMAN. The decade. Excuse me. I misspoke. Thank you for 

correcting me. By the end of the decade, preferably an on-budget 

surplus, because the off-budget surplus, as has been described, will 

go away anyhow. So you need to get yourself ready for that. 

The more sophisticated way of doing it would be to sort of set 

some longer-term sort of constraints, maybe buttressed by David 

Walker’s triggers to sort of, when you go off the track, you are 

forced to go back and reconsider things. That would be a sensible 

way of forcing yourself to re-examine these kinds of issues. 

I am, however, tempted—maybe because I spent too many times 

in this hearing room sitting back there, rather than up here—to 

quote the two chairmen—two of the four chairmen of the Federal 

Reserve I worked for, Paul Volcker and Alan Greenspan, who, 

faced with similar circumstances, each said to a Budget Committee—I am not sure whether it was this one or whether it was 

your counterpart in the Senate—I don’t lie awake worrying that 

you will do too much. 

Mr. ANDREWS. Thank you very much, gentlemen. 

Chairman SPRATT. Thank you all. 

Could I put two questions to you quickly for Rosa DeLauro? She 

had to leave and go to a leadership meeting. And we will take a 

65

quick answer so Dr. Gramlich can get out of here, and particularly 

by 12:30. 

We face serious challenges in the energy sector, college tuition, 

healthcare cost, including some of the highest prescription drug 

prices in the world; and I, Rosa DeLauro, want to ask a simple 

question: How is the deficit, the cost of servicing the debt, impacting our ability to address these issues? 

Mr. WALKER. The largest item of waste in the Federal budget arguably is interest on the Federal debt. It is the fastest-growing 

line-item in the Federal budget; and, therefore, it serves to squeeze 

out the ability of the government to do other things at a given level 

of taxation. 

We have a number of sustainability challenges in America. 

Today, we have only talked about the fiscal one. I could give you 

8 or 10 other ones. 

Mr. GRAMLICH. Just on that issue, it is always possible to go 

through the budget and find this good thing and this good thing 

and this good thing. Each of these good things should be evaluated 

on their face, but there is an overall test, and, as I said in my testimony, if you really want all these good things, well, we just have 

to pay for them. 

Mr. TRUMAN. I agree. I don’t have anything to add, in the interest of time. 

Chairman SPRATT. Final question. Rosa DeLauro. Together tax 

cuts and spending increases for security programs account for 84 

percent of the increases in debt racked up by Congress and the 

President over this recent period. At the same time, the administration insists in making the tax cuts of 2001 and 2003 permanent 

and, on the spending side, there is not much inclination to cut discretionary spending beyond the levels we have already cut. Given 

the long-range deficits that we face, what do you think is the wisdom of this proposal? 

I think by that she means what is the wisdom of the proposal 

to make permanent the 2001 and 2003 tax cuts? 

Mr. WALKER. I think you need PAYGO rules on both sides of the 

ledger. If you want to make them permanent, you pay for them. 

And I also would say that there is waste in defense and homeland 

security, billions and billions and billions a year. Don’t assume 

there is not, because there is. 

Chairman SPRATT. Dr. Gramlich, do you agree? 

Mr. GRAMLICH. Fine, yes. 

Chairman SPRATT. Dr. Truman? 

Mr. TRUMAN. I think there is one qualification, right, that seems 

to me should be made, and that is that putting PAYGO into place 

at a time when you are dealing with the deficit that is already 

there, right, especially if you use some of the larger numbers that 

David Walker has in his little chart, that doesn’t really help you 

because you actually—it helps you, it helps things from getting 

worse, but it doesn’t help you dig out of the hole that you have already created. 

And one can argue about where the tax take is going to have to 

be over the next 25 years on average, and I think I agree with—

as a projection, as a forecast, I agree with David in this, that 18 

percent is going to be higher. 

66

I also agree that going to 40 percent will not sustain the U.S. 

economy. And I suspect it will be lower, the bottom end of that 

range, rather than the top of that range. 

These things, again, have to add up, and I think the thrust of 

Congresswoman DeLauro’s question is that, in a way—and this 

was the thrust of David Walker’s answer earlier, put another 

way—is you now have to pay for some of the things that you have 

been doing over the last 5 years, both in terms of actual expenditures and in terms of commitments to future expenditures. And 

that I think is a really tough issue that the Congress has to address. 

Mr. WALKER. Just to quickly reinforce, PAYGO is not enough. 

We need discretionary spending caps, mandatory spending reconsideration triggers. We need to disclose the discounted present 

value dollar cost of major tax and spending dollar proposals in 

present value terms. We need to do a lot more, because we are in 

rougher shape today, and the tsunami is closer to hitting our 

shores. 

Chairman SPRATT. The problem with discretionary caps is that 

half or more of discretionary is defense, and there are substantial 

variables to deal with that due to the cost of the war which comes 

to us in the form of supplemental. 

But, quickly, I turn to Mr. Ryan for a final question. 

Mr. RYAN. I know, Dr. Gramlich, you have to get going, so I am 

going to ask David a question. 

First, just to kind of correct the record, we don’t think that all 

tax cuts pay for themselves. No one says that on our side of the 

aisle. Just the point is that not all tax cuts are the same. Some 

produce more growth than others, some produce more jobs and realizations and economic growth than others, some may partially 

offset each other. So that is just a point the for the record. 

My question for you—well, and one more point. It may be easier 

to just reform the whole Tax Code than get rid of the AMT and 

make the tax cuts permanent. We have got a whole tax tidal wave 

hitting us at the end of this decade where we will have 25 million 

people paying the AMT and we will have something close to a $2 

trillion tax increase when these things expire which would wreak 

havoc on our economy. So maybe the way out of this thing is to 

fundamentally reform our Tax Code and do it based on a consumption and one that is internationally competitive. 

I just throw that out there. I am a member of Ways and Means, 

and we spend a lot of our time thinking about that. 

David, the quick question I have is this: You mentioned doing 

benefit changes on Social Security to get solvency, but then you 

threw sort of—I guess I will just paraphrase it—add-on accounts 

on top. Clawback accounts can be a part of reaching solvency; addon accounts don’t. But you can have a—component add-on accounts 

that do ultimately contribute to solvency. I hate using the word 

‘‘clawback,’’ but that is the feature that some—and I have been 

more of a clawback guy. Are you proposing that we do mandatory 

add-on accounts with some kind of a solvency gaining feature to 

them or just total free add-ons? 

67

Mr. WALKER. A possible way forward—I am not saying ‘‘the’’ possible way forward—would be as follows: Increase the normal retirement age gradually and index it to life expectancy. 

Mr. RYAN. Longevity indexing? 

Mr. WALKER. Right, change the replacement rates to reduce the 

replacement rates for middle- and upper-income individuals. 

Mr. RYAN. Indexing factors? 

Mr. WALKER. That is one way to do it, the indexing factors or 

whatever. 

Thirdly, strengthen the minimum benefit for the poor. 

Fourth, you can do that and a few other things without more revenues. You may politically have to consider an increase in the taxable wage base. You don’t—politically, you may have to do it. You 

can make the numbers work without doing that. 

And then, on top of a restructured, solvent, sustainable and secure defined benefit program, consider mandatory individual savings on top of that would go—that would be real savings into a real 

trust fund with a limited investment option like the Federal Thrift 

Savings Plan on top of that. 

Now that Congress is poised to increase the minimum wage, the 

people that would be the most pressed by that would be those persons—and history has shown that when you end up saving on a 

payroll deduction basis and it is automatic and people don’t touch 

the money, you actually can get real savings increases. 

Mr. RYAN. Okay. So, just to paraphrase, progressive indexing 

plus longevity indexing gets you solvency, basically, right there. 

Correct me if I am wrong. And then you are saying, throw some 

add-on accounts on top that are mandatory add-on accounts that 

are pre-taxed, that are carved out from your current tax base? 

Mr. WALKER. It is mandatory. I don’t know why you would make 

it pre-taxed. 

The question is, what are you going to do with the build-up? If 

it is mandatory, it is mandatory. Why give a tax preference? They 

have to do it. It is their money. 

I will also argue that is not a tax increase, because it is their 

money, and they will have an irrevocable right to it from day one. 

It will go to a trust fund in their name, and they will be able to 

control the investment of it, pre-retirement death benefit and funding mechanism for long-term care, et cetera, et cetera. 

Mr. RYAN. And the money goes to you free and clear at the end 

when you retire? 

Mr. GRAMLICH. Yes. Congressman, I think a lot of us like these 

add-on accounts, but it is fundamentally about saving, and it is not 

about solvency at the system. It is a separate issue. 

Mr. RYAN. Exactly. Some people who propose add-ons add a solvency component to it. I just wanted to see if that is what he was 

saying or not. 

Mr. WALKER. Solvency sustainability is outside of the individual 

accounts. I am talking primarily for savings, pre-retirement, death 

benefit, et cetera, et cetera, having this supplemental individual account. 

Mr. RYAN. Thanks for clearing it up. 

Chairman SPRATT. Thank you very much indeed for your valuable contribution, understanding the problem we are faced with. 

68

Mr. Scott. 

Mr. SCOTT. The ranking member asked about tax cuts having a 

different effect. Could you give us some information on which tax 

cuts actually do stimulate the economy more than others? Is there 

information on that for the record? 

Mr. WALKER. We will coordinate with CBO and others and see 

what we can do here. 

Chairman SPRATT. I ask unanimous consent that members who 

did not have the opportunity to put questions to our witnesses 

today be permitted to do so by submitting questions for the record. 

[The information follows:]

PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS, 

1750 MASSACHUSETTS AVENUE, NW, 

Washington, DC, February 15, 2007. 

Mr. John M. Spratt, Jr., 

Chairman, Committee on the Budget, House of Representatives, Washington, DC. 

DEAR CHAIRMAN SPRATT: Enclosed are my answers to Representative Kaptur’s 

questions that you transmitted to me on February 8. 

Again, I appreciated the opportunity of testifying before the committee on this important set of issues. 

Sincerely, 

EDWIN M. TRUMAN, 

Senior Fellow. 

RESPONSES TO QUESTIONS BY REPRESENTATIVE KAPTUR

1. I understand that in the recent past nearly 90% of new public debt was purchased by foreigners. To your knowledge, is there any linkage between our trade deficit and this increased foreign holdings of US debt?

Foreigners have purchased a very large proportion of the net increase in US 

Treasury debt outstanding in recent years. From December 2001 to November 2006, 

they purchased an estimated 85 percent. Over the immediately preceding 12 

months, the share was 86 percent. There is no direct connection between our trade 

deficit and foreign purchases of US Treasury debt. In 2006 our deficit on goods and 

services rose $46.9 billion (census basis) while foreign purchases of treasuries rose 

only $5 billion. However, our large trade and current account deficits along with US 

capital outflows have as their counterpart inflows of foreign capital from abroad. 

During the first three quarters of 2006, the gross inflow of foreign capital to the 

United States was an annualized $1,723 billion, $1,543 billion excluding foreign direct investment in the United States. Foreign purchases of treasures were only 14 

percent of the $1,543 billion in financial inflows. We require financing from abroad 

for our large trade and current account deficits. What is important is that foreigners 

buy some type of US assets not what type of assets they purchase.

2. Why is it that foreign buyers are purchasing this [US Treasury] debt and not 

American buyers? Do American investors simply not have the resources, or do they 

consider American debt an unwise investment?

As of the end of 2005, foreign holdings of US financial assets (excluding foreign 

direct investment) were an estimated $10,828, of which $1,994 billion or 18.4 percent was US Treasury debt. About 65 percent of that amount was foreign official 

holdings although that figure is probably somewhat understated. Thus, foreigners 

purchase a wide range of US financial assets, but they have a relative preference 

for US Treasury debt compared with US investors. There are many possible explanations for that relative preference, but the most likely is that US Treasury debt 

is liquid and the highest quality even though as a consequence its yield is lower 

than on other types of US financial assets. According to the Board of Governors of 

the Federal Reserve System, the personal sector (households, non-farm non-corporate business, and farm business) added $1,977 billion to their financial assets (at 

an annual rate) over the first three quarters of 2006, increased holdings of US 

Treasury debt were about 3 percent of that total. As noted in my answer to the previous question, US Treasury debt was 14 percent of foreign purchases of US financial assets over the same period (at an annual rate). Thus, American investors have 

the resources to acquire financial assets and are doing so. However, they have a relative preference for higher yielding and less liquid assets than US Treasury debt.

69

Chairman SPRATT. Once again, thank you for your contribution 

to understanding the daunting and difficult problems we are faced 

with. Thank you very much for coming today. 

[Whereupon, at 12:30 p.m., the committee was adjourned.]

Æ