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78–012 2002

TAX RELIEF: THE REAL ECONOMIC STIMULUS FOR

AMERICA’S ECONOMY

HEARING

BEFORE THE

SUBCOMMITTEE ON TAX, FINANCE, AND EXPORTS

OF THE

COMMITTEE ON SMALL BUSINESS

HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

WASHINGTON, DC, DECEMBER 6, 2001

Serial No. 107–38

Printed for the use of the Committee on Small Business

(

(II)

COMMITTEE ON SMALL BUSINESS

DONALD MANZULLO, Illinois, Chairman

LARRY COMBEST, Texas

JOEL HEFLEY, Colorado

ROSCOE G. BARTLETT, Maryland

FRANK A. LOBIONDO, New Jersey

SUE W. KELLY, New York

STEVE CHABOT, Ohio

PATRICK J. TOOMEY, Pennsylvania

JIM DEMINT, South Carolina

JOHN R. THUNE, South Dakota

MICHAEL PENCE, Indiana

MIKE FERGUSON, New Jersey

DARRELL E. ISSA, California

SAM GRAVES, Missouri

EDWARD L. SCHROCK, Virginia

FELIX J. GRUCCI, JR., New York

TODD W. AKIN, Missouri

SHELLEY MOORE CAPITO, West Virginia

BILL SHUSTER, Pennsylvania

NYDIA M. VELA ́ ZQUEZ, New York

JUANITA MILLENDER-MCDONALD,

California

DANNY K. DAVIS, Illinois

BILL PASCRELL, JR., New Jersey

DONNA M. CHRISTENSEN, Virgin Islands

ROBERT A. BRADY, Pennsylvania

TOM UDALL, New Mexico

STEPHANIE TUBBS JONES, Ohio

CHARLES A. GONZALEZ, Texas

DAVID D. PHELPS, Illinois

GRACE F. NAPOLITANO, California

BRIAN BAIRD, Washington

MARK UDALL, Colorado

JAMES R. LANGEVIN, Rhode Island

MIKE ROSS, Arkansas

BRAD CARSON, Oklahoma

ANI ́BAL ACEVEDO-VILA ́ , Puerto Rico

DOUG THOMAS, Staff Director

PHIL ESKELAND, Deputy Staff Director

MICHAEL DAY, Minority Staff Director

SUBCOMMITTEE ON TAX, FINANCE, AND EXPORTS

PAT TOOMEY, Pennsylvania, Chairman

STEVEN J. CHABOT, Ohio

DARRELL ISSA, California

EDWARD SCHROCK, Virginia

TODD AKIN, Missouri

FRANK LOBIONDO, New Jersey

JIM DEMINT, South Carolina

JOHN THUNE, South Dakota

JAMES LANGEVIN, Rhode Island

GRACE F. NAPOLITANO, California

ANI ́BAL ACEVEDO-VILA ́ , Puerto Rico

DANNY K. DAVIS, Illinois

ROBERT A. BRADY, Pennsylvania

MIKE ROSS, Arizona

SEAN M. MCGRAW, Staff Director

(III)

C O N T E N T S

Page

Hearing held on December 6, 2001 ........................................................................ 1

WITNESSES

Edwards, Chris, Director of Fiscal Policy Studies, CATO Institute .................... 4

Beach, William, Center for Data Analysis, The Heritage Foundation ................ 6

Moore, Stephen, Senior Fellow, CATO Institute ................................................... 8

Lauster, Charles, Lauster & Radu Architects, P.C ............................................... 10

APPENDIX

Opening statements: Toomey, Hon. Patrick .......................................................... 24

Prepared statements:

Edwards, Chris ................................................................................................. 29

Beach, William .................................................................................................. 32

Moore, Stephen ................................................................................................. 62

Lauster, Charles ............................................................................................... 69

(1)

TAX RELIEF: THE REAL ECONOMIC STIMULUS

FOR AMERICA’S ECONOMY

THURSDAY, DECEMBER 6, 2001

HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON TAX, FINANCE AND EXPORTS, COMMITTEE ON SMALL BUSINESS, Washington, DC.

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

2360, Rayburn House Office Building, Hon. Patrick J. Toomey

(chairman of the subcommittee) presiding.

Chairman TOOMEY. The hearing will come to order. I want to

apologize for getting started a little bit late and thank our witnesses and invite them to take their respective seats at the witness

table, if they would; and I will begin with a brief opening statement.

This morning, the House Small Business Subcommittee on Tax,

Finance and Exports convenes to address a number of economic

stimulus proposals and their possible impacts on our Nation’s economy. Heightened concerns about an economic slowdown have

spawned a number of proposals, ranging from tax relief to spending

increases, all in an effort to stimulate the economy. Despite the

passage of an economic stimulus package by the House, the Senate

has yet to consider their own version of this legislation, so I think

the input from the folks today is timely.

However, the delay, I think, has unfortunate consequences. Last

week, it was announced the economy has now slowed to an annual

rate of growth that is negative, negative 1.1 percent in the last

quarter. The current economic downturn, which began, arguably, in

September of 2000, was only accelerated by the events of September 11, 2001; and, since that time, over 400,000 jobs have been

lost. The unemployment rate for October anyway has reached a 5-

year high of 5.4 percent.

These job losses are impacting virtually every segment of our

economy and all across our Nation, and we all know there is a

heated debate on the approach that is most appropriate to resolve

our current economic woes. Some think government spending is an

appropriate stimulus. Others, including myself, believe that major,

immediate tax relief will do much more good than even more government spending.

Much of the ongoing debate of an economic stimulus package has

centered on the appropriate balance between spending and tax relief. Leaving aside the economic arguments for a moment as to

which would better stimulate growth and job creation, it is important to note that Congress has already approved or agreed to apVerDate 11-MAY-2000 06:23 Mar 19, 2002 Jkt 078012 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 E:\HR\OC\B012A.XXX pfrm11 PsN: B012A
2

prove spending increases that arguably approach $100 billion.

These cover everything from victims’ compensation to airline assistance, the emergency supplemental as well as additional discretionary spending. The economic stimulus package passed by the

House, for instance, contains $12 billion to assist workers displaced

as a result of the events of September 11.

However, at a time when the Nation is struggling to jump-start

the economy, I believe the most viable remedy is to provide meaningful tax relief to stimulate long-term and short-term growth. At

this time, more than any other, it is vitally important that we remove the barriers that working Americans face as they attempt to

provide for their families, and one of the biggest barriers is the tax

burden imposed by the Federal Government. The way to increase

the wealth of working Americans is to encourage more work, saving, investment, risk-taking and entrepreneurship. That is why incentive-driven or supply-side economics has such a successful track

record. When tax rates are reduced, people have more motivation

to be productive and to create wealth; and when they earn more

income, they are able to spend more, save more and invest more.

This hearing will focus on the impact meaningful tax relief will

have on the Nation’s immediate and long-term economic growth

and, in particular, emphasizing the impact on small businesses.

I look forward to the testimony of the witnesses before us today.

I want to particularly thank the subcommittee’s ranking member,

Bill Pascrell, who has been very flexible in scheduling this hearing

and very helpful. While we may have somewhat differing views on

the prescription for our economic woes, I certainly appreciate his

commitment to resolving our current economic crises. No one is

more dedicated to the well-being of the small business sector of our

economy than my good friend and colleague, whom I will now recognize for his opening statement. Mr. Pascrell.

Mr. PASCRELL. Thank you, Chairman Toomey, and thank you for

having this hearing today.

Yes, we do come at this issue from two different perspectives.

Right now, we are about to commence the debate on the floor of

the House of Representatives, an hour debate, no substitutes permitted. I thought I was in Red China for a moment this morning.

In a democracy attempting to air all ideas, we will be debating

by any other term Fast Track. We will be cutting up the pie, so

to speak. The debate has attempted to separate us into those who

are for trade and those who are against, and that is pretty sophomoric, because we all know we live in a global economy. We see the

effects of the global economy on American financial practices and

visa versa. So to deny trade is to have our head buried in the sand.

I carry the Constitution around with me, Mr. Chairman, and I

know what article 1, section 8 says, and I didn’t come here from

New Jersey to surrender my rights and my responsibilities and to

file away and to bevel my responsibilities as a Congressman and

to surrender the dust that accumulates in the executive office of

government. That is not why I am here. Just so you know how I

will vote later on this morning.

Mr. Chairman, recent announcements have confirmed that the

economy is in recession, something you and I talked about 6

months ago. Unemployment has reached 5.4 percent. There is an

3

overall need for a stimulus bill. We hope there can be compromise

so that we come up with something that not only looks nice but is,

hopefully, effective.

For small businesses in particular, their most immediate need is

working capital. We have said that in this committee many times

discussing many different issues. Small businesses have few lines

of credit or other financial sources that would provide them a selfsustaining source of support during this recession. Some tax relief

is needed.

Mr. Chairman, it is not the only solution. A few weeks ago, we

heard Grover Nordquist declare that even a bad tax cut is a good

tax cut. Even Bill Safire would have a tough time on that one, but

I find that it is often hard to have a good debate with people who

harbor such blind allegiance to one philosophy or another, but I

keep trying. Because of my naivete ́, perhaps I will see the light

some day.

This committee has the responsibility as representatives of small

business—that is what it says outside on the wall—to focus on proposals that are targeted to small businesses, not corporate America. Many have used this committee’s forum to argue for cutting

the capital gains tax, accelerating the rate cuts, eliminating the

corporate AMT, all of which are proposals benefiting big business.

In difficult economic times, economic theory from some is always

the same, enact these proposals for large, established corporations

and the wealth will trickle down to the minions. I just don’t think

that is right. Come to think of it, that may be the philosophy during any economic time for some. When the economy is good, we

need tax cuts. When the economy is bad, we need tax cuts.

During periods of lower consumer confidence, the solution for

small business is very different than that for corporate America. It

is unfair and has frequently been the case to lump together the

economic problems of two very different kinds of enterprise. Small

businesses need working capital. I believe that a stimulus package

must be responsible, targeted and temporary, must take effect immediately, that those who spend money on goods and services—we

have enough data to see who are those folks—and last as long as

the country needs it.

The economic stimulus bill that the House passed, Mr. Chairman, fails the test. Its tax relief provisions are not targeted primarily to those who will spend and boost the economy. They include a permanent reduction of the capital gains tax, which benefits the top 2 percent of earners, and a permanent repeal of the alternative minimum tax for 2001, which will cost $25 billion to accomplish.

We were in deficit in June, long before September 11. It was

pointed out time and time again that we would have to go into the

Social Security and Medicare trust funds. And now, under the

cover of a tragedy unlike we have ever seen before on September

11, we have decided that we are in a recession, and we understand

the mounting unemployment ranks, we say.

Citizens for Tax Justice reports American corporations will receive $7.4 billion in tax rebates from the House stimulus package.

General Motors would receive $833 million from a full repeal of the

corporate AMT. According to a November 23 Washington Post artiVerDate 11-MAY-2000 06:23 Mar 19, 2002 Jkt 078012 PO 00000 Frm 00007 Fmt 6633 Sfmt 6602 E:\HR\OC\B012A.XXX pfrm11 PsN: B012A
4

cle, General Motors has roughly $8 billion in cash, has no plans to

increase its investments.

The Congressional Budget Office found that reducing the tax,

quote, would make a relatively small change to a tax that applies

to relatively little capital income, unquote. As for small businesses,

this proposal would do nothing to help them, because the Tax Code

already provides them an exemption.

Let me conclude on this point. Economist Joseph Stiglitz, the

Nobel lawyer in economics for 2001, argues that accelerating the

rate of reductions would benefit wealthy individuals only and thus

would not have a significant effect on consumption but only increase their savings. He must know something about economics.

In short, contrary to some claims that even a bad tax cut is a

good tax cut, not only are tax cuts not the only solution but the

most effective tax cuts in a stimulus package would direct the largest share of benefits towards helping small businesses stay afloat

in these tough, tough times.

Thank you, Mr. Chairman.

Chairman TOOMEY. Thank you, Mr. Pascrell.

At this time I would like to welcome and thank Mr. Chris Edwards, the Director of Fiscal Policy Studies from the CATO Institute. Thank you for joining us this morning, and I would welcome

your testimony.

If we could try to keep the testimony to about 5 minutes. The red

light will indicate when the time is out, and we will try to limit

our questions accordingly.

STATEMENT OF CHRIS EDWARDS, DIRECTOR OF FISCAL

POLICY STUDIES, CATO INSTITUTE

Mr. EDWARDS. Thank you, Mr. Chairman and members of the

committee. Thank you for inviting me to testify today on proposals

for economic stimulus.

The U.S. Economy is now in recession. The right tax policy can

speed up the economy’s return to growth. As large businesses are

cutting jobs by the thousands now, we need small businesses and

entrepreneurs to take up the slack and start new businesses and

invest more. Let us make these risky decisions easier for them by

cutting their tax burden.

Tax reforms can aid entrepreneurs in three ways—the decision

to launch a new business, the ease of finding financing and the decision to expand. Let me run through each of these.

First, Congress can make the decision to start a new business

more attractive by accelerating the already enacted income tax rate

cuts. This will boost after-tax returns for sole proprietors, partnerships and S corporations. Treasury figures show that 63 percent of

tax filers in the top 39 percent tax bracket have small business income, so cutting the top rate targets exactly the people who can get

the economy moving again.

The capital gains tax rate is also very important to encouraging

start-ups. This country has scores of so-called serial entrepreneurs,

as we have seen particularly in high-tech in recent years. They

start a new business which they grow for a few years and then, if

it is successful, they sell their business, realizing a capital gain.

Then they turn around and invest in a new start-up. Cutting the

5

gains rate makes successful start-up more valuable and allows entrepreneurs to keep more funds for reinvestment in new businesses.

As a side note on start-ups, there is a quirk in the Tax Code that

would be very timely to fix right now. There is a requirement that

new businesses write off start-up costs over 5 years, rather than

allowing immediate deduction. These start-up costs include such

items as market research and employee training. They may not be

immediately deducted, so I recommend that the committee look

into this disincentive and lower the tax hurdle to new businesses.

The second way that tax reforms can help is easing business financing. The committee is aware of the important role played by

venture capital in the economy. So-called angel investment in startups is maybe even more important and, by some estimates, twice

as large. Angel investors are usually wealthy individuals who are

fully taxable. Microsoft billionaire Paul Allen, for example, has put

his money into over 100 new companies. The return these investors

receive is capital gains on the start-ups that succeed.

By the way, during the 1990s many large corporations became

venture investors in new growth companies, particularly again in

high tech. Corporate capital gains are taxed at a high 35 percent

rate, so cutting the corporate capital gains rate may also increase

investment flows to small companies.

Some have questioned what lowering the capital gains rate

would do right now with the stock market down. But angel and VC

investors know the market will rise again, and they are looking to

realize gains in new investment perhaps 2 years or more in the future. So cutting the gains rate permanently will draw more investment into new high-growth firms right now.

Thirdly, accelerating the individual income tax rate cuts will

stimulate existing small businesses to expand. A series of studies

by four tax economists who are cited in my written testimony examined the effect of the 1986 tax rate cuts on sole proprietors.

Their results show a 5 percentage cut in rates would increase capital investment by about 10 percent. They also found that dropping

the top rate from 40 percent to 33 percent would increase hiring

by about 12 percent. Those are substantial effects.

Other than tax rate cuts, liberalizing depreciation will lower

overall or effective tax rates on new investment. The depreciation

provision in the House bill is a step forward, but we need to do

much more and make it permanent. The small business expensing

limit, now $24,000, should be raised substantially, and ultimately

we should move to full capital expensing for all businesses. The

Tax Executives Institute, which is a group of lawyers and accountants, testified before Congress this year that the depreciation rules

are hopelessly outdated and needlessly complex. We should scrap

them and move to expensing, which would eliminate many investment distortions. Workers would be the ultimate beneficiaries as

more capital investment would raise worker productivity and

produce higher wages.

Let me make a final note on the issue of broader tax reform. In

the 1980s, the U.S. was a leader in tax rate cuts in the world. But

the 1990s was a lost decade for tax reform in this country, while

other countries have been moving ahead. The average corporate tax

6

rate for 25 OECD countries fell from 41 percent in 1986 down to

31 percent today. Our corporate tax rate is now 4 percentage points

higher than the average of our trading partners. So we are a high

tax country when it comes to corporate taxes. The average individual tax rate for OECD countries fell from 55 percent in 1986

down to 41 percent today. And regarding capital gains, a number

of countries, such as the Netherlands, exclude it from taxation altogether.

A new study by Arthur Anderson compared 9 major countries as

to how good their business environment is particularly for entrepreneurial growth companies, based on various tax and regulatory

factors. As it turned out, the U.S. was not number one, as we

would usually expect. We finished second behind Britain. Britain,

by the way, has a 30 percent corporate tax rate. Let us not fall behind any further. We should pursue further tax reforms and create

the best possible tax environment in the world for business and entrepreneurs.

Thank you for holding these important hearings, and I look forward to working with the committee on these issues.

Chairman TOOMEY. Thank you, Mr. Edwards.

[Mr. Edwards’ statement may be found in the appendix.]

Chairman TOOMEY. At this time, I would like to welcome and invite Mr. William Beach, the Director for the Center for Data Analysis with The Heritage Foundation. Thank you for being with us

today, Mr. Beach.

STATEMENT OF WILLIAM BEACH, CENTER FOR DATA

ANALYSIS, THE HERITAGE FOUNDATION

Mr. BEACH. Thank you very much.

Mr. Chairman, Congressman Pascrell and members, my name is

William Beach. I am director for the Center for Data Analysis at

The Heritage Foundation. It is indeed a great privilege for me to

be with you this morning to speak on this important topic. These

remarks are my own and not necessarily those of The Heritage

Foundation.

There is increasingly little doubt that the U.S. Economy currently is in recession. The visible and widely noted economic slowdown that began in the spring of 2000 worsened over the summer

and fall. The service and financial sectors joined the manufacturing

sector in contracting during the winter of 2001, and the recession

officially began in March, as indeed Congressman Pascrell has

noted in his remarks.

It is in this context that Congress now is debating the composition of an economic stimulus bill. The events of September 11

doubtless worsened the economic contraction and unnecessarily introduced into the debate proposals to ameliorate harm related to

the terrorist attacks.

Perhaps the debate’s most interesting feature is how it has

helped clarify the economic differences between a demand-based

approach to strengthening economic performance and the supplybased approach. Congressman, I appreciate your remarks very

much in that regard. I suspect this additional clarity is not entirely

evident to everyone involved, even those most closely involved in

7

the debate. The statistical and rhetorical record, however, should

be very useful to future disputants.

What do I mean by additional clarity? While still too early to tell,

the small boost to household disposable income that stems from the

summer’s tax rebate program, a key provision of the tax legislation

signed into law by President Bush on June 7, appears to have had

little effect on consumption expenditures. Not only do opinion surveys show that the households devoted the lion’s share of their rebate checks to debt repayment and savings, new data from the Federal Reserve indicates a spike in savings commensurate with the

size of the rebate and its timing. This additional information on the

effects of tax rebates during economic slowdown reinforces findings

about the disposition of earlier rebate efforts likewise intended to

boost consumption expenditures during economically distressed

times.

This additional evidence of how households will likely spend subsidies and one-off rebates is most welcome to analysts focused on

stimulus measures that work on the deep structure of economic activity on incentives, investment and long-term expectations. It

shows, I believe, the futility of efforts solely or mostly devoted on

raising aggregate demand through spending. And while these lessons are hard for Washington policymakers to learn, the statistical

record being made during this recession likely will guide a higher

proportion of future lawmakers toward the more effective and economically sensible route of tax rate reduction in the future.

Our own work on various economic recovery proposals points to

the greater importance of policy change directed at incentives, investments and long-term economic expectations. On November 9

this year, my colleagues, Mark Wilson and Ralph Rector and Rea

Hederman, and I published an analysis of two leading stimulus

proposals then pending in the United States Senate: a plan by Senator Grassley that reflected President Bush’s recommendations and

a plan associated with the Senate leadership, particularly with

Senators Daschle and Baucus. We used a standard model of the

U.S. Economy, the DRI/WEFA U.S. Macroeconomic Model in wide

use in Fortune 500 companies and throughout the government, to

estimate the economic effects of these two plans; and we also employed the CDA individual income tax model to estimate year by

year changes in the fiscal effects.

In my written testimony, Mr. Chairman, I have outlined Senator

Grassley’s proposal and the proposal of the Senate leadership, I

think which are all well-known to people who have been involved

in this debate, and so I will skip that in my verbal remarks.

Every economic indicator in the DRI/WEFA model points to the

superiority of an approach to economic recovery that depends on reducing the costs of work and investment. For example, over the period fiscal year 2002 through 2006, the Grassley plan produces

seven times more jobs than the Senate leadership plan does,

283,000 per year versus 38,000 per year.

The inflation-adjusted disposal income of an average family of

four would increase by $1,060 per year under the Grassley plan

and by $236 per year under the Senate leadership plan.

8

Indeed, the Grassley plan increases inflation-adjusted consump- tion expenditures by $45 billion, as opposed to the Senate leadership’s plan of $10 billion.

The Grassley proposal, which again closely reflected the plan advanced by the Bush administration, clearly would lessen the depth

of the recession and shorten the time over which the economy

would pass before returning to pre-recession growth levels. One

question, however, remains. Just how much of these economic benefits stem from the acceleration of the individual income tax rates

alone?

To answer that question, we estimated the economic effects of

just the rate reductions using the same model of the economy over

the same period. I am announcing these results for the first time

today.

We found that the rate reductions alone of the Grassley-Bush

plan, which again, Mr. Chairman, accelerated all of the rates from

2004 and 2006 into 2002, account for 59 percent of the gain in national output of the entire Grassley plan, which contained also consumption expenditures; 67 percent of the improvement in employment; 65 percent of the increase in disposable income; and 44 percent of the expansion of investment. Indeed, personal savings

growth attributable to the rate reductions account for 68 percent

of the total change in savings produced by the entire Grassley plan.

While it is possible to point to times in our history when spending programs made a significant difference to employment and output, these moments almost always are associated with extraordinary national mobilizations. Ours is not one of those times, even

though the events of September 11 and since have produced a level

of national resolve not seen since the beginning of World War II.

We have a recession produced by policy errors and aggravated by

hostilities. The errors affected investment and incentives, and they

call forth policy responses that are focused on investment and incentives. The hostilities devastated key elements of our economic

superstructure and distressed the lives of hundreds of thousands of

innocent and productive citizens. Those hostilities call forth responses that are compassionate and generous.

I thank you for the opportunity to appear before your committee.

Chairman TOOMEY. Thank you, Mr. Beach.

[Mr. Beach’s statement may be found in the appendix.]

Chairman TOOMEY. At this time, I would like to recognize the

Senior Fellow from the CATO Institute, Mr. Stephen Moore.

STATEMENT OF STEPHEN MOORE, SENIOR FELLOW, CATO

INSTITUTE

Mr. MOORE. Thank you, Chairman Toomey, for holding these

hearings and for inviting me to testify.

As the previous witnesses have documented, we clearly are in a

recession; and, Mr. Pascrell, you are right that this recession began

long before September 11. In fact, I think when the final figures

come in it will indicate that the recession actually began around

January of this year. So we have now been in a 9-month recession.

Fourth-quarter growth must certainly be negative as well.

We do need an economic stimulus plan. We have lost somewhere in the neighborhood of $300 billion in wealth this year, and the

9

growth path that we were on in the 1990s, the 3 and-a-half percent

growth path, has been reduced to negative 1.1 percent. So clearly

we do need an some type of economic stimulus plan.

Let me just spend a minute, if I may, and talk about why economic growth is important and why is it so critical that we get

back on this 3 and-a-half percent potential output growth that we

have in the United States.

Obviously, economic growth is important, because it leads to

more jobs and higher wages and a better stock market and so on.

But one of the areas where I think you all in Congress don’t think

enough about in terms of why economic growth is so important is

that we cannot keep the budget in balance unless we have economic growth. And if I may just spend a minute referring to my

testimony.

If you look on I think it is the third page of my testimony, we

did an analysis of what would happen with revenues, Mr. Chairman, under three real growth—really output growth paths, 2 percent, 3 percent, and 4 percent, over the next 10 years. And the

point I wanted to highlight to you all is that if we only have 2 percent real growth over the next decade, which I would describe is

a low-growth path, we can’t balance the budget. We will be running

about a trillion dollars in deficits over the next decade if we have

2 percent real growth.

If we have 3 percent real growth, which I would describe as kind of a medium-growth path, we will have about $750 billion in surpluses over the next decade.

And if we have 4 percent real growth, which I believe is very

achievable, Mr. Chairman, with the right set of monetary and fiscal

policies, we would have $2.5 trillion in surpluses.

So the point I am trying to make here is, with respect to the

question whether we can be afford to be cutting taxes in a progrowth way, I would say we can’t afford not do it. We have to do

this if we want to have a strong fiscal environment, which I think

we all agree we need to have.

So what do we do in terms of promoting growth?

I would argue, first of all, that I would agree with both the previous witnesses that we ought to look at accelerating the rate cuts.

When we did that tax cut, Mr. Chairman, back in May, the idea

was we would phase in these tax cuts 2005, 2006 and 2007. We

need the tax cuts now. We are in kind of an economic emergency

right now, and it makes no sense to phase in tax cuts later when

the economic emergency is happening now.

I would argue that we ought to cut the capital gains tax. I think

this would be one of the most important fiscal stimulus provisions

in terms of dramatically having an immediate effect. And here is

where why I think a capital gains cut would have a strong effect.

If you cut the capital gains tax, what you will do is almost instantly raise asset prices in the United States. It has to happen.

Because when you are cutting the capital gains tax, what you are

doing is you are increasing the after-tax rate of return on those assets; and every time we have cut the capital gains tax over the last

30 years it has led to a rally on the stock market.

Now this is being described as a policy to help the rich. But I

think if you look at the statistics now—and that was probably true

10

10 or 20 years ago. A capital gains tax cut would have primarily

benefited rich people in terms of who had capital gains. It is not

so true today. We are truly in a kind of new investor environment

where we right now have about 80 million American households

that own stock.

I would like to make one point in response to something that Mr.

Pascrell said when he said this is a policy to help big business. I

have been working on this policy for the last 15 years, and the

thing that I found striking about this issue about capital gains tax

cuts is big business doesn’t want capital gains tax cuts. If you talk

to people in the Chamber of Commerce they don’t care about capital gains cuts because they realize that those are already big businesses that people already own their stocks. In fact, if you cut the

capital gains tax, people may actually sell stock in some of the big

businesses so they can move into these new emerging technologies

which is so important.

One last point, as you decide what types of tax policies we should

adopt, both in the short-term and the long-term, I just would like

to offer one kind of principle that I think would be a great guiding

principle for both the Republicans and Democrats. We all know we

want to get to a simplified tax system, one-rate system that does

not overtax and double-tax saving and investment. So I would urge

you, as you look at tax policies, ask the question, does this tax

change that we are looking at, will it move us in the direction of

kind of a flat-tax model that doesn’t double tax saving and investment that leads us to a single rate system? Because I think we

would all agree that if we had that type of tax system in place it

would be incredibly bullish for the American economy.

That argues against temporary tax cuts I think because I think

temporary tax cuts only shift the timing of that economic activity.

They do nothing to help the long-term growth rate. And I think it

also argues against targeted tax cuts. I think the best type of tax

cuts are ones that benefit everyone and not just one group over another.

Chairman TOOMEY. Thank you, Mr. Moore, for your testimony.

[Mr. Moore’s statement may be found in the appendix.]

Chairman TOOMEY. At this time, I would like to recognize a man

who comes to us from the small business world itself. As I look

over Mr. Lauster’s resume, it is an impressive resume with a number of impressive and distinguished projects in architecture, which

is his profession. I would like to welcome you and thank you very

much for joining us, Mr. Charles Lauster from New York.

STATEMENT OF CHARLES M. LAUSTER, LAUSTER & RADU

ARCHITECTS, P.C., NEW YORK, NY

Mr. LAUSTER. Thank you, Chairman Toomey.

I am indeed an architect. My partner and I have run a small

firm of 12 people in New York City since 1983. Over the years we

have seen a number of economic ups and downs and one war. We

have never seen circumstances, however, quite like the ones we are

seeing today—a recession, a war and a Nation holding its breath.

Stimulus for small business is certainly needed, but it has to be the

right stimulus. I would like to discuss those options that the FedVerDate 11-MAY-2000 06:23 Mar 19, 2002 Jkt 078012 PO 00000 Frm 00014 Fmt 6633 Sfmt 6602 E:\HR\OC\B012A.XXX pfrm11 PsN: B012A
11

eral Government could take that would help businesses like mine

and comment on those that would do no good at all for us.

What do I mean by small business? First, a firm that is 300 people or less. Most small businesses are much smaller, but even at

several 100 the management can know the names or at least of all

or at least most of the workers and thus has some personal relation

with its staff. In terms of operations, such as accounting, human

resources, advertising, a firm of 10 people and a firm of 300 are

much more similar than either of them is to a company of 10,000.

Second, the business is not publicly traded. Capital is the key

problem for small business. Meeting payrolls, running equipment,

paying the rent—cash flow is what keeps most small businesses

small. This is not to say that small businesses are poor. Most are

quite successful. However, capitalization almost always comes out

of the owners’ pockets. You may have had a great year, but if the

receivables were high for 6 months, it was probably a year of

scrambling for cash.

So what can the Federal Government do to stimulate small business? There is a lot of discussion of cutting tax rates further. This

makes sense to small business if it puts substantially more money

in the hands of masses of consumers, the main market for small

businesses. Big cuts for higher bracket taxpayers puts money into

investments and not into the markets small business needs. There

is a down side to simple rate cuts. As Federal, State and local governments cut their revenues, they cut services in capital projects.

Government is an important customer for local small businesses

and deficits means lost contracts. It also means the environment in

which we do business deteriorates.

Again, the issue is capital. Big business has the money and the

clout to make world fit its needs. If it doesn’t like the world it is

in, it moves. Small business lives in the world it has got. Crime,

poor schools, inadequate mass transit make it harder and more expensive to do business, and there is nothing we can do about it as

individual businesses. We rely on good quality of life as provided

by government. That means adequate tax revenue.

For these reasons, capital gains cuts and the cut in the alternate

minimum tax are largely harmful to small business. While we gain

little from these cuts, the lost revenue means lost quality of life for

our businesses and our lives. The AMT cut was especially galling

to small business. No struggling small business is getting taxes

back.

Focused stimulus can address real small business needs. Small

business loans, tax credits for hiring, support of local efforts to provide manufacturing space and empowerment zones are programs

that have worked and can serve as examples for new legislation.

These sorts of efforts get contracts and money directly to small

businesses, especially if aimed at areas that are particularly hard

hit.

Right now, lower Manhattan is hard hit. The City is struggling

to retain businesses, to keep small businesses from closing their

doors and to rebuild. There are a lot of good ideas that Mayor

Giuliani and others are advocating. Relocation assistance within

the city, employee tax credits and special grants to businesses that

stay in the recovery zone are a few of them. Simple rate cuts will

12

do nothing to help us in this regard. In fact, to the extent that the

cuts reduced the City’s revenue, our suffering will only increase.

To sum up, stimulus aimed directly at small business can help.

Stimulus that meets big business needs will not necessarily help

small business much. The differences in scale and practice are simply too great. Tax cuts at the highest brackets, capital gains cuts

and the AMT cuts are no help at all. Government does not need

to stimulate small businesses that have lots of capital already.

Stimulus that creates access to capital and markets that assist in

providing employee benefits and that broaden the horizon of business opportunities can make a real difference.

Small business is helping America fight the recession and thereby the terrorists who sought our ruin. A wide stimulus package can

give small business a helping hand without weakening the country.

We will all breathe easier.

Thank you very much.

Chairman TOOMEY. Thank you very much for your testimony.

[Mr. Lauster’s statement may be found in the appendix.]

Chairman TOOMEY. Thank you all for joining us this morning

and providing this testimony.

I would like to begin with a series of questions, and I would like

to begin with Mr. Beach. My first question for you goes to the heart

of this debate in some ways as to the appropriate economic stimulus. Some are arguing for taking measures that would enhance

consumer spending, rebate checks, sending out checks to people

who didn’t receive them in the past, for instance, versus others who

argue that it is all about encouraging investment. And I was wondering if you could comment on this, if you are familiar with the

recent economic statistics.

It is my understanding that over the course of 2001, during the

period during which the economy has slowed down and actually

gone into negative growth, that consumer spending is holding quite

well. In fact, consumer spending is not in and of itself in a recession but that investment has declined dramatically. Is that accurate? Is that your view? Is that empirical fact? Is that your theory?

Could you just comment on what the real problem is, based on your

understanding of what the empirical data suggests?

Mr. BEACH. Chairman Toomey, you are correct in your impression of what the data has shown. The data could be revised, but

we don’t expect a substantial revision. The data does indicate a

strength in consumer spending, which is remarkable, to say the

least.

It is apparent that the United States’ economy continues to attract consumption from abroad. It continues to elicit good consumption spending from households. And though in the last several

months and I think particularly after September 11 consumers

have begun to cut back in their spending as they are hesitant to

get involved with travel and any spending that involves that part

of the industry, it is still the case that the consumer confidence

hasn’t fallen as much as we have seen in previous recessions, particularly if you have a recession starting in March.

But you are also right in saying that the source of this recession

is in the investment. I say in my written remarks and I didn’t say

in my oral remarks that my view of what caused this recession is

13

really a series of policy errors that started actually back in 1997

as the Federal Reserve began to pump additional supplies of money

and credit into the economy to prepare it to enable it to be liquid

for the Y2K conversions, an enormous expansion in 1998 and 1999

of supplies of money and credit, some of which was no doubt used

by small and large businesses to convert but was also used to create a whole new range of businesses, some of which had markets

and many of which did not.

As the bubble began to burst, the Federal Reserve had another

thing it was doing. It was actually raising rates to stop the inflationary pressures that were going on. Well, of course this created

new tax burdens, and tax burdens rose almost to a point of 2 percent of GDP. So we had a combination of policy errors all related

to investment.

I think the deep structure is there for a lot of policy changes. We

need to cut the costs of capital, reduce the required rates of return

for long-term investment in order to bring back that part of the

economy.

Chairman TOOMEY. Thank you.

Moving on, I would like to follow up on a comment that Mr.

Moore made. You emphasized the vital importance of economic

growth. There are the obvious reasons, the benefit to all the people

who live and work in America, but also the Government’s perspective, the increase in revenue. And I think certainly most of us will

agree with the merits of encouraging as much economic growth as

possible. The question is, can we reasonably expect that to result

from the prescription that you recommend? And to that I would ask

again, is there empirical evidence? What is the correlation historically, globally, for greater economic freedom, economic freer trade

and particularly lower taxes and prosperity? Is there a demonstrable correlation that we can point to that suggests empirically

that when you have lower taxes you have greater growth?

Mr. MOORE. There is. And I would add just one thing to Bill

Beach’s comment about the economy, which is he is exactly right

in terms of his explanation of what happened to the monetary policy. Something else was going on at that time, too, in the late

1990s that surprised a lot of people, especially when I tell Members

of Congress about this. Between 1995 and the year 2000, the average Federal tax rate went from 17 percent of GDP up to about 21

percent of GDP. That was a huge increase. It was about a 3 anda-half percent increase in GDP that was being taken in Federal

taxes.

When I tell that to people in government, they say, how can that

possibly be the case? We haven’t raised any taxes in the last 4 or

5 years.

What was happening over that period, as people were making

higher incomes, they were being pushed into higher tax brackets,

something we described as this real income bracket creep.

The reason I mention that, if you look throughout the last 30 or

40 years, the post World War II period, if you track that Federal

tax burden, any time it gets above about the 20 percent level, it

is sort of a siren alarm that we may have a recession. In fact, many

of the deepest recessions that we have had since World War II

have been correlated with that tax burden ratcheting up. In fact,

14

the most recent example being the severe mini depression we had

in the 1978 to 1982 period where taxes rose very dramatically because of both real and inflation-induced bracket creep.

So, clearly, the kind of historical evidence indicates that many

times—not always, but many times when you get that tax burden

up above that 20 percent level, you have got to bring them back

down.

By the way, the normal of the post World War II period is about

18 percent, and if you take into account the Bush tax cut, that will

bring us down to about 19 and-a-half percent of GDP. I think that

is a little too high. We need to have a stimulus.

Just quickly in answer to your question about how economic

growth affects—if you look at international comparisons, it is not

only true that countries that have economic freedom are richer— in fact, economic freedom is generally lower taxes, small centralized government, freer trade policies, all these kinds of protection

of private property rights which is very important to economic

growth. But you also find countries that have these economic policies are countries that tend to be healthier. They tend to have

longer life expectancies and so on.

So I do believe an economic stimulus plan now is necessary, if

it is designed towards investment. And I think Bill Beach is exactly

right. It is an investment drought that has really caused this economy to contract, not a consumption drought.

Chairman TOOMEY. Thank you very much.

I have run over my time, but I do have another question, and I

will ask, can I do that now? Fine.

Mr. Edwards, I wanted to ask you to comment specifically about

the corporate AMT. It strikes me that certainly this has been a

much-aligned feature of the House-passed stimulus package. It has

always struck me that the AMT is itself an extraordinary obsession

of the absurdity of our Tax Code.

We basically say, if you follow the rules perfectly and do exactly

what the law says and we don’t like the consequence, we will make

you redo it and pay more in taxes. As part of that, my understanding is that, in a manner of speaking, a corporation that pays

the AMT has historically been given a credit to reduce future tax

burden and that credit is carried on the balance sheet of a corporation and we would require that that be manifested that way. So

elimination of the corporate AMT gets rid of an absurd feature of

our Tax Code, but it requires that this credit be allowed to be

cashed in because it is part of the very future. Perhaps you could

clarify that and explain whether that is accurate or whether you

have a different perspective.

Mr. EDWARDS. No. That is right. The modern version of the AMT

was enacted in 1986. And basically the 1986 act really went overboard in trying to make sure every last company in the country

paid some taxes. So they really broadened the general base, but in

addition they threw on this parallel AMT tax system. What they

did is they said any year that a company pays AMT, the amount

that AMT was greater than the regular tax, they are allowed to

take it as a credit in future years. So in current law, companies are

taking about 3 or 4 billion dollars of credit every year against prior

AMT payments made. So in the House bill, in a sense there would

15

be nothing—there would be no big change from the current law.

Companies can already take these credits.

Chairman TOOMEY. Can I interrupt and ask you, would it be accurate to view that credit as equivalent to an interest-free loan

that the company has made to the Federal Government?

Mr. EDWARDS. That is a good way of looking at it. I mean—a lot

of the things in the corporate income tax are all timing. The Federal Government wants to get the money early. Companies want to

delay it and pay it later. Accelerated depreciation is a good example of that.

I think there is a good compromise that we can work out that,

by repealing the AMT itself, the Federal Government doesn’t lose

any money. Because the last few years companies have been paying

about 3 or 4 billion dollars in new AMT and taking about 3 or 4

billion dollars of credit. The net effect has been zero. But when you

repeal it, you have got about $25 billion of built-up AMTs that we

have to figure out what to do with. And I think a fair compromise

would be to allow companies to take those built-up credits in current law maybe over 4, 5 years.

Chairman TOOMEY. Thank you very much.

Mr. Pascrell, thank you for your cooperation, and I am happy to

recognize you.

Mr. PASCRELL. Mr. Moore—by the way, all of your testimony I

found to be very interesting, and it is just too bad it doesn’t have

a wider audience, but that is the nature of the beast. I almost conclude that maybe this discussion should be brought to the Ways

and Means Committee, because I thought you know that we are

here to discuss small business.

But since you brought the subject up, you know, in your discussions, you mentioned about comparing tax rates. I have seen calculations that indicate that the effective tax rate is lower today

than it was in 1985. You disagree with that, Mr. Moore?

Mr. MOORE. Well, depends on who you are talking about. The effective tax rate on investment actually has risen over the last 15

years or so. So I would disagree with the idea. And it also depends

on whether you are talking about just Federal tax rates or you are

talking Federal, State or local all together.

Mr. PASCRELL. Federal taxes.

Mr. MOORE. Federal taxes have actually been somewhat stable,

slightly higher than they were in the mid 1980s.

Mr. PASCRELL. Any attempt to indicate, in defense of your arguments or support of your arguments, that the tax rate is higher

now in terms of in relationship to the GDP is absolutely fallacious,

do you agree?

Mr. MOORE. If you look at what has happened over the last 4

years, the Federal tax burden went from about 18 percent of GDP

to about 21 percent of GDP. That is a fairly large increase over a

4, 5 year period. We are at an abnormally high level of Federal

taxes or percent of GDP right now. Not the highest ever, but fairly

close to being at peak levels.

Mr. PASCRELL. If we accelerate the tax cuts, which you are advocating, how much more of a deficit are we going to produce over

the next 10 years?

Mr. MOORE. You know, that is a really difficult question.

16

Mr. PASCRELL. How much of a deficit are you going to produce

over the next 5 years?

Mr. MOORE. My sort of rule of thumb on tax rate reductions is

that you are going to roughly recapture about one-third of the static revenue loss. So if you are talking about a tax reduction that

would be—let us say it is $100 billion a year, you are going to re- capture about one-third of that or $33 billion in higher economic

growth from the lower tax rates.

Mr. MOORE. So you will probably have some negative effect. But

the point I was making about why economic growth is so important

is that if we are right about how tax rate reductions help economic

growth, then we can actually have increased revenues, not less.

If you look at my testimony, Mr. Pascrell, what you will find, for

example, in the 1980s, when we did very dramatic reductions in

tax rates, you know, the top tax rate went from 70 percent in 1980

down to 28 percent by the end of the 1980s, and yet over that period we almost doubled Federal tax revenues. And it was also—— Mr. PASCRELL. What did we do to the deficit?

Mr. MOORE. Well, the deficit went way up, but it was mostly—— Mr. PASCRELL. Well, that is the point. You want to rush over

that point all the time. You even rush over it in your testimony

and—you know, with all due respect.

Mr. MOORE. But it was because—— Mr. PASCRELL. The deficit is something we can’t—it is something

we cannot dismiss. It is not a phantom deficit. It had a lot to do

with interest rates. You talk about the consumer. You talk about

the average Joe out there. The consumer had to face the high rates

due to, much of it, not all of it, to those deficits that you just wave

your hand on.

Mr. MOORE. Well, but, Mr. Pascrell—— Mr. PASCRELL. You don’t support deficit spending, do you?

Mr. MOORE. No, I don’t. I——

Mr. PASCRELL. You don’t support deficit government, do you?

Mr. MOORE. Not at all, but actually if you look at the 1980s——

Mr. PASCRELL. But that is what we had in the 1980s, and you

keep on pointing back that that is the time when things were wonderful.

Mr. MOORE. Well, it was. We had very strong economic growth

in the 1980s. By the way, we had lower interest rates, not higher

interest rates. In fact, when I got out of college in 1981, the mortgage interest rate was 20 percent. So interest rates fell very dramatically in the 1980s. But one of the interesting things about the

1980s is that you did have a very big military buildup in the 1980s,

I mean, and that was in large part a—— Mr. PASCRELL. It was needed.

Mr. MOORE. It was needed, and it was one of the causes of the

deficits. And yet I would say that those deficits were not inappropriate, at a time when you are trying to dig out of a big economic

hole that we were in and win a war, and we are in a similar kind

of situation to that right now.

Mr. PASCRELL. Mr. Chairman, I think Mr. Moore is very—is

being very, very honest to his beliefs, but I do believe that his beliefs move towards the deficit spending being simply the fallout

from specific economic policies, and I would really question, really

17

question it. I mean, I would like to debate you and discuss with you

about the deficits and the effect that it has had on many aspects

of this government.

I just want to ask one more question of Mr. Beach.

Chairman TOOMEY. Sure.

Mr. PASCRELL. We are in a dramatically different time right now

than we were 10 months ago, 5 years ago. We realize that we are

fighting this war, and it is going to have a tremendous effect

abroad and at home. We have increased our intelligence apparatus.

We have attempted to begin the process of education—it is costly—

in terms of getting people to understand who we are as Americans

and what we value. There is a tremendous stimulant package. If

we do the things that Governor Ridge has asked us to do of protecting ourselves, in terms of bolstering specific targeted military,

in terms of expanding intelligence and protecting our waterways

and our water, protecting our food supplies, bioterrorism, if we do

all of those things, somebody is going to have to spend money to

do that. That is a stimulus unto itself. The numbers have ranged

from 25 to $50 billion. Aren’t we saying that we—might not we say

we could do two things at the same time? Stimulate the economy

and protect ourselves? Or is that over simplistic?

Mr. BEACH. Not at all, Congressman, not at all. In fact the proposals that we have examined, and I think we have examined all

of the proposals from both parties and indeed from some that were

not even in a party, have combined an increase in homeland defense and the issues of infrastructure, which you quite properly

raise, with what we would call true stimulus packages that go to

the deep structure of the economy. The interesting thing about

what we are finding is that many of the proposals for homeland defense go to preparing borders better, to maintain the security of the

United States around its lakes and waterways and its highway systems, and the effect in that area of government spending will be

stimulating. There will be more employment in Wichita, Kansas or

El Paso, Texas.

But when we look at the entire economy, those measures, as

much needed as they are, simply don’t produce the employment

and consumption and output changes, which a set of relatively simple moves do, and that is the rate reductions, particularly on labor.

I am not particularly concerned on the capital side, because so

many small businesses of course file their taxes through the 1040,

and anything you are doing on rates there will help them. The

overall effect of just the rate reductions, producing consumption expenditure growth and investment growth are truly remarkable,

clearly indicating that the problem in this recession is in fact on

the investment side.

So I would say, yes, let us have a stimulus package, a defense

package that combines all of that spending, but let us not think in

this particular episode that we are going to have the same effect

on the economy that Franklin Delano Roosevelt, Republicans and

Democrats, had in 1939, 1940 and 1941 as we prepared ourselves

for war through massive government spending on the defense side.

Mr. PASCRELL. Thank you. Thank you, Mr. Chairman.

Chairman TOOMEY. Thank you. The gentleman from Ohio.

18

Mr. CHABOT. Thank you, Mr. Toomey. I share Mr. Pascrell’s concern about deficit spending, and I am very much opposed to it. I

would note that there was Democratic control of the House of Representatives for, like, 40 years up to 1994. I know that until—we

had approximately 30 years of deficit spending up until the budget

year of 1998, and it is my understanding that the budget years— basically we had the balanced budget agreement in 1997. We have

had surpluses in the budget years 1998, 1999, 2000, 2001. It is my

understanding that if you add up the surpluses of those 4 years,

it is approximately $600 billion of surpluses that we have had.

Now, I know a lot of my liberal colleagues—because of concern

next year, it looks like we may very well have deficit spending

again next year, which I am very much opposed to, but there are

those projecting it.

Now, some of my liberal colleagues are blaming that projected

deficit on President Bush’s tax cuts. It is my understanding that of the $595 billion of surpluses we have had over the past 4 budget

years, that 94 percent of that went to reduce the debt that we built

up in this Nation over those years when we didn’t have balanced

budgets, and only 6 percent of that surplus has gone for tax relief,

only 6 percent.

Now, one could—one might say, well, you know, is that actually—you know, are those numbers accurate, because a lot of

money went for additional spending, too? But the fact is if you

spent the money, then, you know it isn’t considered in the surpluses; and we did spend, in my view, far too much money.

This is kind of a longwinded question, but based upon that statement, those who would blame the deficits next year on the Bush

tax cut, I would be interested to hear what the panel would have

to say about that argument, which I personally disagree with that

argument, but I would like to hear what the panel might have to

say about that.

Mr. BEACH. Well, Congressman, if I could just weigh in, we need

to keep in mind that the key elements of the Bush tax cut are not

implemented until several years from now, and so we have to be

patient before we make that argument. If we are eager to make the

argument that the Bush tax cut is the source of deficits, we have

to wait until the Bush tax cut is implemented. And next year we

do get the first of the rate reductions in a very large way, but

2004——

Mr. CHABOT. Let me follow up before you go on. Some of it went

back in the form of the rebates.

Mr. BEACH. That’s right.

Mr. CHABOT. And I assume that is where the 6 percent figure is

coming from, although I am not sure of that, and I would be happy

to be enlightened by the panel.

Mr. BEACH. It is my understanding that that is where that number is coming from as well, and we have to be careful that we offset

the economic growth attributable to the rebates and attributable to

rate reductions before we make the argument. So we have to be

balanced. We have to be fair.

The third thing I would like to say about this is that the Congress is currently considering an extraordinary growth in agricultural subsidies, and there are other challenges that the Congress

19

faces on the spending side. The projections that Mr. Daniels and

others have made of deficits include an estimation, including our

estimates, of what Congress is likely to do on the spending side.

So we have to bring both sides of the ledger in when we began to

think about deficits.

And then finally, the work that we are doing and I think others

on this table have done indicates that there is a tenuous case at

best between modest deficits and interest rate changes. The monetary handles that the Federal Reserve has at its disposal can accommodate small deficits in the neighborhood of probably less than

50 billion a year through the monetary means that Chairman

Greenspan talks to you about all the time.

Mr. MOORE. Mr. Chabot, you asked the question about what happened to the surplus, and that is going to be a question throughout

the next year that people are going to be asking, and basically the

story I think is this. Clearly a lot of it was spent. This year you

are looking at appropriations bills that will be up 8 or 9 percent,

which is enormous, given that we are virtually at a zero inflation

environment. So those are all real increases in spending in almost

every area, and Bill Beach is right, one of the areas where you are

saying the biggest spending increase is in the agriculture area. So a lot of it was spent. You had the $40 billion tax—I think it

was about 40 billion on the tax rebates? What was it? 40 billion,

which I would argue—Bill and I may disagree a little bit on this.

I see no economic benefit whatsoever from tax rebates. In fact, I

think tax rebates are probably the worst way to cut taxes, because

they have no economic incentive effects whatsoever.

The other part, though, and this is the essence of what my testimony is about, the major reason you are possibly facing now a future of deficits again, and it swamps all of these other effects, is

that we have gone from a 3.5 percent real GDP growth path to a

negative growth path. And until you get that economy back up to

2, hopefully 3 to 4 percent growth, you are going to be—it is like

a dog chasing your tail. You are never going to be able to produce

enough revenues to balance the budget. And that is why, for example, Mr. Pascrell, we may disagree about what policies are best for

economic growth, but hopefully the one thing we can all agree on

is that unless we—that we have to pursue like a laser beam those

growth policies, because, you know, you are going to be having

these excruciating hearings over the next couple of years unless we

get growth back up, and that is the primary explanation for why

that surplus is shrinking so quickly.

Mr. CHABOT. Thank you.

Mr. EDWARDS. Can I make a very quick comment to follow up on

something that Steve mentioned? In terms of the effect of the deficit, I think everyone believes that the Federal Government should

not run large deficits just because of a basic honesty in Government argument. It shouldn’t spend more than we take in. But economically, there is less and less relationship between the Federal

deficit and effects on the economy, and the reason why that is, is

capital markets these days are global. I came across a figure the

other day from the IMF that shows the world debt markets, corporate and government debt around the world, are valued now at

about $25 trillion. The U.S. Federal debt is a small drop in the

20

bucket for that. Interest rates are set worldwide. There is less and

less relationship between what we do with the Federal Government

books here and interest rates on the United States, which are set

globally.

Chairman TOOMEY. If everyone has time, I would like to have another round of questions. Did you want to follow up?

Mr. PASCRELL. I want to follow up with Mr. Edwards.

Chairman TOOMEY. Go ahead.

Mr. PASCRELL. If I may.

Chairman TOOMEY. Sure.

Mr. PASCRELL. You know how much comes out of every dollar to

pay off the interest of the day. This is a large portion, and what

we did—and the Congressman was absolutely correct—since we got

here in 1997, we insisted that we have caps on spending, although

of course they dissolved; both sides are guilty. But we wanted to

reduce the amount of money that we have to take out of every tax

dollar in order to pay the interest on the debt. I think that is critical. I think it is—regardless that it is part of a huge global financial situation, but the fact that we were able to do it for 4 years

bodes well for the future.

Now, we were in deficit—going back to the original point, we

were in deficit in terms of the stimulus package and some spending, all sides responsible, in June. And I can prove that. And we

were hanging to the situation that has been exacerbated since the

tragedy of September 11th. I believe that we should agree on those

facts and move forward so that we get a stimulus package that is

going to be effectively put to use immediately and not 2 or 3 years

from now, and that helps the small business person.

That is why we are here, so that that small business person is

the immediate recipient of the benefits that we think are necessary. I think that is critical. I think that is important, because

we have been thinking corporate. We have been thinking global in

that sense, and I think that it doesn’t serve the majority of folks

who have small businesses in this country. Haven’t, Mr. Chairman,

we been listening to these folks that have come before the general

committee, small businesses that are hurting out there before September the 11th, after September the 11th? I think we need to respond to those needs. They are real needs.

Chairman TOOMEY. Well, I would like to follow up on this topic,

too, and as a former small business owner myself, I was always

very conscious of the percent of my operating budget that was

going to debt service, and some have suggested that if we lower

taxes, we may have at least in the short term a larger deficit and

large deficits lead to high interest rates and that is very harmful

for small businesses, as well as many others. But from what I have

seen, at least in the post-war era, there is virtually no correlation

whatsoever between the size of the Federal budget deficit and the

level of interest rates. Am I wrong? Is there a correlation? Is there

not a correlation?

Mr. EDWARDS. No. As I indicated, there is less and less relationship. I mean, you can graph interest rates in the Federal deficit

over the last couple of decades, and there is very little relationship.

Interest rates are set by things like inflation expectations and that

sort of thing and——

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Chairman TOOMEY. So this isn’t a question of empirical fact. This

isn’t—the theory, you can look at the data; you know what interest

rates were historically. You know how big the deficit was in any

given year, and you can confirm that there simply is not a correlation anymore.

Mr. PASCRELL. Mr. Chairman, that is in utter contradiction to

what Mr. Greenspan has been saying for the last 4 years, maybe

one of the reasons why he thought he acted too early or too late

in reducing interest rates. But that is contradicting basically what

we—one of the foundations we have been moving on, and, you

know, that is fine. I mean, there is no god—there is only one God,

and there are no gods——

Mr. MOORE. He is not the God.

Chairman TOOMEY. Let me just respond quickly, and then I will

yield to Mr. Moore. But I am simply making a point about objective

historical fact, and if someone can show me the data that suggests

that there is a historical correlation, then I will admit that I am

then completely wrong, but I am saying that in—certainly in recent

decades, there is no correlation, and I just don’t think that is really

disputable.

Mr. MOORE. Well, actually there is a correlation. It is actually

government spending which is causing—there is a crowding-out effect of government, and it is not from the borrowing. It is from the

government spending. And government spending can be financed in

three ways, through higher taxes, through monetary policy or

through running deficits. And what the evidence seems to indicate

is that, you know, higher taxes also lead to a crowding-out effect.

And so we should really be concentrating on the total size of the

government spending.

One other interesting aspect about this, by the way, though, is

not only in the 1980s did we have high interest rates and falling—

I mean, high deficits and falling interest rates, but if you look at

Japan today, Japan has the lowest interest rates in sort of recorded

history, and yet they are running gigantic budget deficits. So it is

just hard to find any relationship between deficits, and despite

what God says about this.

Chairman TOOMEY. And that actually leads me right to the next

topic which I wanted to ask Mr. Beach. Japan is an interesting example, not only because of their extremely low interest rates, but

my understanding is that they have had an unprecedented wave of

successive Federal Government, if you will, spending programs.

And to those who suggest that, well, won’t Federal spending, which

has increased dramatically, won’t that solve the problem, again,

empirically, the evidence in Japan certainly doesn’t suggest that.

But is that a valid comparison? Is that useful to look at the decade

of the 1990s in Japan?

Mr. BEACH. I think it is useful to look at large industrialized

countries’ recent history and see what pattern they have gone

through. It is instructive, Mr. Chairman. Japan has got a very interesting problem. The average householder in Japan is so

unconfident in the future that they are withholding their consumption. Prices fall and they withhold it even further. They say, well,

I am going to wait to buy that refrigerator or that car or something

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of that nature, and the government has tried one spending stimulus aggregate demand policy change after another.

Finally, after now 10 years—and today we will learn whether

they are officially in their third recession of this decade—there is

a set of proposals to actually cut taxes, and we are hopeful that

that will now lighten the load on householders and stimulate that

economy.

This deficit question is extraordinarily important, however, and

we need to be real serious about it. I am a former small business

person myself, so I have a great interest in these matters, but in

fact if we were in a deficit in June, and I think that that is probably right, then we have a hard time explaining why we have had

a succession month after month of major interest rates falling. You

see, it is not so much the deficit that is the matter. It is the expectation of the future. The Japanese householder says, the future

looks grim in Japan, I will behave in a rational way and withhold

my economic investments and consumption. And that is what a lot

of the people do in this country as well. If they think that the Federal Government is out of control, that its spending is too high, its

taxes are on the way up, well, then interest rates are going to rise

but not because of a deficit but because of a belief in the future.

Chairman TOOMEY. Thank you, and I will yield to Mr. Pascrell

to ask the final question of the hearing.

Mr. PASCRELL. Thank you, Mr. Chairman. You know, in the

1980s we looked to Japan as the model.

Mr. BEACH. Wrongly.

Mr. PASCRELL. Well, we did. This is a fact of life. I didn’t make

it up on the way to the office this morning. You know, I don’t have

any problems supporting the government spending money, and I

want to get Mr. Lauster’s reaction and response to this. I don’t

have any problems, where needed, targeting money, unemployment

insurance. It is government spending. Health benefits, a lot of folks

are out of jobs. We stabilized the airlines. We did nothing for the

110,000 employees laid off. Bridge loans, increasing them, so we

put off paying the tax—the loan back, I don’t have any problems

with that. When we look through the history of the 20th century,

a lot of recessions, a lot of depressions, we saw government wisely

spending money. I mean, it is not an either/or situation. It doesn’t

have to be. None of us should try to make it that.

And, you know, Mr. Lauster, you are like many other small business voices. You have heard back and forth here different philosophical bents. What do you think?

Mr. LAUSTER. Well, a lot of this discussion has been certainly

outside of my zone of competence.

Mr. PASCRELL. Well, join us.

Mr. LAUSTER. The truth is I think most of us in business believe

that the economy, you know, is like the sea. It is this powerful

force, and that while you may be an aircraft carrier on the sea, you

don’t really control it. The Federal Government has an effect, that

is clear. But I think most of us in business believe that the economy really has strong fundamentals, weak fundamentals, and it

will do what it will do, and the Federal Government, through interest rates, fiscal policy, can exacerbate or help people, but it really

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isn’t going to control the economy. The economy is really a force of

nature.

Consequently, my sense is that, especially from a small business

perspective, my business perspective, when people in areas are suffering unduly, like workers who are losing, you know, their jobs

and all of the companies that were referred to before by the chairman, these are people who will get back on their feet, but they are

currently taking, as I said before, a hit. To the extent that the government can cushion them till they get back on their feet, that is

really important. It is important to their morale. It is important to

the prosperity of those communities, those communities that have

large plants that shut down, small businesses that sell groceries,

that sell all sorts of things, those businesses are going to suffer tremendously.

So you have a regional problem that comes from an individual/

corporation’s rational decision to cut back. To the extent that the

government can cushion that kind of thing, it does a great job. I

personally am dubious that the government really controls the

economy as a whole. I believe that is beyond the power of Washington, but I think it can make life better for people and, hence,

stabilize businesses and communities throughout the country.

Mr. PASCRELL. I thank you for all being here.

Chairman TOOMEY. Thank you very much. The hearing is adjourned.

[Whereupon, at 11:21 a.m., the subcommittee was adjourned.]

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