```

[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]

                          BEYOND THE TAX CUT:
                         UNLEASHING THE ECONOMY

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                 DOMESTIC MONETARY POLICY, TECHNOLOGY,
                          AND ECONOMIC GROWTH

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 29, 2001

                               __________

       Printed for the use of the Committee on Financial Services

                            Serial No. 107-8

                   U.S. GOVERNMENT PRINTING OFFICE
71-632                     WASHINGTON : 2001

_______________________________________________________________________
 For sale by the Superintendent of Documents, U.S. Government Printing 
                                 Office
 Internet: bookstore.gpo.gov Phone: (202) 512-1800 Fax: (202) 512-2550
               Mail: Stop SSOP, Washington DC 20402-0001

                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Ohio                  JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio           JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York              JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         
SHELLEY MOORE CAPITO, West Virginia  BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio

             Terry Haines, Chief Counsel and Staff Director
               Subcommittee on Domestic Monetary Policy, 
                     Technology and Economic Growth

                   PETER T. KING, New York, Chairman

JAMES A. LEACH, Iowa, Vice Chairman  CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California          BARNEY FRANK, Massachusetts
FRANK D. LUCAS, Oklahoma             GREGORY W. MEEKS, New York
RON PAUL, Texas                      BERNARD SANDERS, Vermont
STEPHEN C. LaTOURETTE, Ohio          JAMES H. MALONEY, Connecticut
DOUG OSE, California                 DARLENE HOOLEY, Oregon
MARK GREEN, Wisconsin                MAX SANDLIN, Texas
CHRISTOPHER SHAYS, Connecticut       CHARLES A. GONZALEZ, Texas
JOHN B. SHADEGG, Arizona             MICHAEL E. CAPUANO, Massachusetts
VITO FOSSELLA, New York              RUBEN HINOJOSA, Texas
FELIX J. GRUCCI, Jr., New York       WILLIAM LACY CLAY, Missouri
MELISSA A. HART, Pennsylvania        MIKE ROSS, Arizona
SHELLEY MOORE CAPITO, West Virginia

                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    March 29, 2001...............................................     1
Appendix
    March 29, 2001...............................................    41

                               WITNESSES
                        Thursday, March 29, 2001

Armey, Hon. Richard, Majority Leader, U.S. House of 
  Representatives................................................     2
Baily, Dr. Martin N., Senior Fellow, Institute for International 
  Economics, Washington, DC......................................    15
Glassman, James K., Resident Fellow, American Enterprise 
  Institute......................................................    12
Kudlow, Lawrence, Chief Executive Officer, Kudlow & Company, LLP.    18
Kvamme, E. Floyd, Co-Chairman of the President's Council of 
  Advisors for Science and Technology............................    10

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................    42
    Maloney, Hon. Carolyn B......................................    44
    Baily, Dr. Martin N..........................................    62
    Glassman, James K............................................    50
    Kudlow, Lawrence (with attachment)...........................    68
    Kvamme, E. Floyd.............................................    46

              Additional Material Submitted for the Record

Glassman, James K.:
    ``The Joy of Debt,'' The Weekly Standard, March 26, 2001.....    58

 
                          BEYOND THE TAX CUT:
                         UNLEASHING THE ECONOMY

                              ----------                              

                        THURSDAY, MARCH 29, 2001

             U.S. House of Representatives,
         Subcommittee on Domestic Monetary Policy, 
                   Technology, and Economic Growth,
                           Committee on Financial Services,
                                                    Washington, DC.
    The subcommittee met, pursuant to call, at 10:00 a.m., in 
room 2128, Rayburn House Office Building, Hon. Peter T. King, 
[chairman of the subcommittee], presiding.
    Present: Chairman King; Representatives Oxley, LaFalce, 
Shays, Grucci, Green, Ose, Paul, Fossella, Hart, C. Maloney of 
New York, Clay, and J. Maloney of Connecticut.
    Also present: Representative Toomey.
    Chairman King. The hearing will come to order.
    It is my personal pleasure to begin the first business of 
this new subcommittee by examining one of the most vital issues 
facing our country--the health of the economy.
    Let me first say that I welcome the distinguished 
Representative, Mr. Armey, and I thank all of you for setting 
aside time in your schedule to share with us your economic 
insights.
    I would also like to congratulate Mr. Kvamme on his newly 
appointed status as President Bush's Co-chair of the 
President's Council of Advisors for Science and Technology. I 
understand that Mr. Kvamme will have to leave early so he can 
get down to the White House. They do have certain priorities, 
so we will certainly respect that.
    The importance of economic growth cannot be overstated, 
particularly at this point in time. There is strong fear and 
skepticism across the Nation as to where our economy is headed. 
Today, it is my hope that we will discuss the many steps 
necessary to put the economy back on track, starting with some 
tax relief.
    In the interest of time we would ask that the Members limit 
their opening remarks today and to put them in the record. I 
also realize that Mr. Armey is under very serious time 
constraints this morning, and I agree with my distinguished 
Ranking Member, Mrs. Maloney, to allow only these limited 
remarks before Mr. Armey gives his remarks.
    Again, I can't stress enough how important the subject 
matter is that we are covering today. We're talking about jobs, 
savings, education, and the list goes on.
    I also want to commend President Bush for taking on this 
problem head on. And, as to the subcommittee, I assure you we 
will do all we can to ensure economic growth.
    I will yield back my time and recognize the distinguished 
Ranking Member, a good friend from New York, Mrs. Maloney.
    Mrs. Maloney. Thank you very much, Mr. Chairman, and I will 
withhold my full statement until after the Majority leader 
testifies.
    Given that this is the first hearing of the new Domestic 
Monetary Policy, Technology, and Economic Growth Subcommittee, 
let me first welcome the Chairman, Peter King, my fellow New 
Yorker. I look forward to 2 interesting years of working 
together and I look forward to today's hearing, and 
particularly I am very eager to hear the Majority leader's 
testimony.
    I yield back the balance of my time. I will submit later my 
opening statement.
    [The prepared statement of Hon. Carolyn B. Maloney can be 
found on page 44 in the appendix.]
    Chairman King. I thank the Ranking Member.
    And now it's my pleasure to introduce the Majority leader 
of the Congress, my good friend from Texas, Mr. Armey.

STATEMENT OF HON. RICHARD ARMEY, MAJORITY LEADER, U.S. HOUSE OF 
                        REPRESENTATIVES

    Mr. Armey. Thank you, Mr. Chairman.
    First of all, let me say, it's a pleasure to be invited, 
particularly on this subject, a subject I've studied throughout 
most of my adult life.
    Let me begin, Mr. Chairman, by pointing out that I believe 
in the separate authority of the Federal Reserve Board. I 
believe that the proper role of the Federal Reserve is to be 
obsessive with inflation and I believe that the current Federal 
Reserve Board does their job quite well in that regard.
    I do believe though that there should be a coincidence 
between the Federal Reserve's monetary policy and the Federal 
Government's fiscal policy. And that coincidence should be born 
out of an accurate understanding of what's going on in the 
economy.
    The current news about the re-evaluation of our last 
quarter's performance and the current indications of this 
quarter's performance cannot be encouraging to the American 
people; and they are, in fact, looking to us to do something 
about it.
    Let me just talk about what it is we can do. The clear 
first fact that is what we can do must almost inevitably be and 
almost perhaps solely be in the area of lowering taxes. The 
incredible tax debate that we're having right now centers 
around the President's tax plan. Everybody realizes and, 
indeed, I believe they realize also at the White House that 
that plan was written at another time under different economic 
circumstances when the Nation was in a different mood about tax 
reduction than what we are today.
    Today, the Nation is concerned about the performance of the 
economy and they are anxious to have a tax reduction and they 
are becoming more critical with respect to the forum in which 
the tax reduction takes place.
    And while I applaud the President's plan, the component 
parts of the President's plan do not, I think, find themselves 
constructive in the most favorable way for economic growth and 
to provide incentives to growth.
    My recommendation is that we change the President's plan in 
such a way as to do what the President has said he would do, 
and that is the commendable part of the position he takes 
today, he's trying to implement what he campaigned on.
    But to go a little bit further, I believe that you can see 
change happening now already. A few weeks ago, some of us were 
talking about retroactivity, and now retroactivity of the 
President's plan seems to have a growing following, and I 
indeed expect more retroactivity in the final analysis than 
what you've seen already in the rate reduction that we've seen.
    But while it is beneficial and is certainly just to do 
things like eliminate the marriage penalty and eliminate death 
taxes, and while death taxes in particular may have some long-
term growth incentives in their elimination, there are things 
that I think we ought to be doing in addition to the marginal 
rate reduction that could speak more quickly to today's more 
immediate concerns. And those would be in the areas of capital 
gains tax reduction to provide further incentive for 
investment. But one thing that is indisputable now by our 
historical experience with reducing capital gains is that it 
does, in fact, incentivize growth in the economy, investment is 
the engine of economic growth.
    And, in particular, Mr. Chairman, since we see the scope of 
your jurisdiction in this subcommittee, relate that to high-
tech world in which we live today. We are going through, in the 
world, driven, I think, very largely in the United States, by 
what I would call the ``electronic revolution.'' We have the 
agricultural revolution, we had the industrial revolution, now 
we are in the electronic revolution and it is a magnificent 
phenomena.
    The high-tech sector of the economy obviously shows us a 
change. When we had our recent concerns about the stock market, 
it showed up in the NASDAQ with the high-tech instruments 
there.
    So when we look at what we can do on the investment side, 
we ought to be sensitive to what we can do to sustain high 
levels of investment in this dynamic sector of the economy, 
this leading sector of the economy.
    Capital gains tax reductions certainly would be good for 
that sector of the economy as it would be for any other sector 
of the economy.
    I think we ought to look, in particular, at some things 
that we might be able to do in the high-tech sector. And one of 
the suggestions I might offer is expensing capital for software 
and perhaps even consider it for hardware simply because its' 
rate of obsolescence is so high. My way of putting it is, that 
every time you have another college dropout, you have another 
new major innovation in the high-tech computerized sector of 
the economy. And that, of course, means that people who would 
want to implement this for the increased productivity they can 
have, have to recapture that cost quickly or they may not dare 
to do so, because it could be obsolete next year.
    The other thing that I think that we have available to us 
is the Portmann-Cardin retirement security legislation. This 
expands IRA opportunities for all Americans. And certainly one 
of the things that it does that you can put under the item of 
justice is give hard-working American, stay-at-home wives, the 
same access to this opportunity for their retirement as wives 
who work outside the home. That is something that just must be 
done.
    The affordability is very important given the nature of our 
economy today, especially, again, in the high-tech sector. 
Those folks move around like college professors and they need 
to take their pensions with them. So I think that's an 
important point.
    One final thing I would like to touch on, there is, today, 
what I'm calling the ``rebate debate.'' Because of the success 
that we have had in holding down spending and generating a 
surplus to the economy, we have in this current fiscal year a 
substantial surplus of some $70 billion. That money can be 
available for a tax rebate right now almost immediately. And 
that is not a bad thing to do.
    Any time you take people's money, that is received by the 
Government, in a sense as a tax overcharge, you can give it 
back, and that would be a good thing to do. And I would be all 
willing to do that. But I do not think we should entertain any 
thought of doing that instead of a larger, more comprehensive 
tax reduction policy such as the President proposed leading 
with a rate reduction and adding some of these other growth 
factors.
    Anybody that would suggest that, I would suggest doing what 
I would call ``rebate and switch.'' And that would be a bad 
effort for us to entertain.
    So what I would suggest on that is we take advantage of 
this surplus that is in this existing fiscal year to enhance 
what we can achieve under the President's plan. That is, 
perhaps, by the way to transfer some of that money to some of 
the out years to make the plan work more smoothly in the out 
years, or indeed to, in fact, increase the retroactivity for 
this year out of this year's money through some mechanism or 
indeed possibly the rebate itself.
    But let us not let this opportunity for immediate rebate 
born out of this fiscal year's surplus detract our attention 
from the larger requirement of providing America with a set of 
new opportunities and incentives to do more in their life.
    Let me put it to you finally in this way, if I were to get 
into a poker game with a thousand dollars and win with this 
thousand dollars, I would certainly celebrate that thousand 
dollars and I have no doubt I would spend it to stimulate the 
economy. But I would make no life changing decisions on that. I 
would like to point out, incidentally, that if I were to lose a 
thousand dollars, my wife would make a life changing decision.
    [Laughter.]
    And that is analogous to the region, certainly we will have 
used it productively on behalf of our families. But it provides 
no incentives for us to make change. As opposed to a tax plan 
that says, for now and into the future you will receive a 
greater take-home pay for your larger efforts. You will receive 
a greater return on your investments to reduce capital gains 
tax. You will be able to take a date to put into technology 
that might be obsolete in a year, because you can afford it at 
this time by expensing. Those are things that really provide 
people the opportunity to take the risks, the innovate, be 
creative, and improve technology.
    We must never underestimate the impact of computerized 
electronic technology in our economy and the impact is 
precisely this. It give us growth to increase productivity and 
that is the only way we can have growth without carrying with 
it the current inflation. And that is the miracle of modern 
electronics in terms of economics and we ought to foster 
investment.
    Thank you.
    Chairman King. Thank you for your testimony.
    I realize that your schedule is very tight this morning, so 
I am going to yield my time to the Chairman of the full 
committee, Mr. Oxley.
    Mr. Oxley. Thank you, Mr. Chairman. And welcome, Mr. 
Majority Leader, to your first appearance, and hope not the 
last, before the new Financial Services Committee. Let me 
commend you for your vision in helping us create this new 
committee. And I think the ability to consolidate all of the 
financial services jurisdiction under one committee was a wise 
decision. And we appreciate your ideas and leadership on this.
    I was driving in this morning and heard the Oakridge Boys 
on----
    Chairman King. Imus.
    Mr. Oxley. Imus; very good.
    [Laughter.]
    You probably heard the same thing. And I thought 
immediately of my friend from Texas and was pleased to have him 
here today. I'm not going to ask questions and I'm going to 
make my opening statement part of the record.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page 42 in the appendix.]
    I just wanted to indicate our appreciation for your 
appearance and your leadership on these economic issues. 
Everybody knows you are an economics professor, and I think 
once an economics professor, always an economics professor.
    I remember a long time ago we were down in Oklahoma and we 
were saying that you became an economist, but your mother 
wanted you to be an accountant but you didn't have the 
personality----
    [Laughter.]
    I've always remembered that for a long time. But we do--I 
know your time is short and we do appreciate your appearance 
here and look forward to working with you on a lot of these 
economic issues that are so important to our country's future.
    Mr. Chairman, I yield back.
    Chairman King. Thank you, Mr. Chairman.
    If I might just comment. I too listened to the Oakridge 
Boys this morning and thought about Chairman Tauzin, who in 
reflection about the construction of this committee in singing 
their song, ``it takes a lot of river to wash these tears 
away.''
    [Laughter.]
    We will pass it on to the gentleman from Louisiana.
    [Laughter.]
    I now recognize the Ranking Member, Mrs. Maloney.
    Mrs. Maloney. And I thank the Chairman for being here and 
for his ideas. You have often come up with ideas that stimulate 
the economy. And I think everybody owes a debt to you for 
coming up with the idea of the base closing commission. 
Congress was stranded and couldn't move, and you came forward 
and solved that problem and moved it forward.
    I want to ask a question about the alternative minimum tax. 
Under current law, the Joint Committee on Taxation estimates 
that over 20 million Americans will fall into the AMT by 2011. 
They also state that the Bush tax cut increases this number to 
35 million--benefits of the Bush plan. The impact is especially 
hard on States that have State income taxes like New York, the 
State that the Chairman and I represent.
    Just today, in the delegation meeting that we were at 
earlier, the Chairman of the Ways and Means for the Democrat--
the Ranking Democrat Member, Mr. Rangel, circulated a letter in 
which he merely stated that the program merely had changed the 
name of tax they paid, not the size, talking about the AMT, the 
tax cut moving more people into it. And I just wondered what 
your comments were on it. Do you acknowledge this problem and 
do you have any plans as to how to solve it?
    Mr. Armey. Let me first of all thank you for raising that 
question. This gives us another opportunity, I think, to 
appreciate the President's openness. Because as we begin to 
look at constructing the President's plan in the tax law, 
Chairman Thomas immediately spotted this problem. And as you 
can see, looking at what was done on the rate reduction bill 
that passed the House a couple of weeks ago to address the 
alternative minimum tax to mitigate against that that you will 
see also in the bill that we have on the floor today where we 
put a hold harmless provision in the bill that prevents 
additional people from being afflicted by the alternative 
minimum tax.
    I think the healthy indicator that you see in both these 
actions by the Chairman as the mark ups come out of his 
committee and to the floor and the applause that he's received, 
the encouragement from the White House is that, yes, we are 
very much aware of that and we are very committed and mitigate 
any impact on that, even to have a renewed look at the 
alternative minimum tax in its total as to whether or not it's 
something that should be continued in tax law.
    So the one, I think, very healthy thing that has come out 
of the President's proposal and our efforts to right it is a 
very--let's say, thorough-going reexamination of the minimum 
tax, how we can mitigate against that and, indeed, its very 
legitimacy. So I think Chairman--or the Ranking Member Rangel 
forgot to raise these issues. I think the committee is 
sensitive to this and I know the Administration is encouraging 
in that effort.
    Mrs. Maloney. Can it aid him to fix the--within the $1.6 
trillion that we're considering in that?
    Mr. Armey. It seems to me that one of the things we would 
have to do--I kind of laughed, I said, my mother always figured 
I'd be in a straightjacket some day, but I never thought it 
would be a $1.6 trillion straightjacket.
    [Laughter.]
    And one of the things that I'm encouraging everybody is, as 
we re-examine our opportunities, let's see the extent to which 
we need that extreme. We might be able to get around that, and, 
indeed, the alternative minimum tax provides, I think, a need 
that's sufficient enough so that any reasonable person that 
wanted it accomplished, the other thing that we can do with 
that tax cut--or maybe going to $1.7 or $1.8 is worth it in 
terms of the good things we can do. So I think we just need--
outside the $1.6 million.
    Mrs. Maloney. You mentioned in here an interesting idea, I 
had really never heard of it before, of expensing capital for 
hardware, acknowledging the great impact that technology has on 
growing our economy. And would you expand that to parents to 
deduct the cost of buying computers?
    When I was growing up, we had to have a pencil when we were 
in school. Now the kids have to have a computer.
    I know that in New York a lot of our high schools and 
middle schools are not even wired for computers. They don't 
even have computers. How in the world can they get a job in 
this new world economy without computers? I think it's an 
important point that you raised about the impact of the new 
technology of growing our economy and the importance of 
recognizing it in business. I think we've got to recognize it 
in education. And I wonder if you have any further comments on 
it?
    Mr. Armey. Well, one has to, I think, always be very 
careful in terms of differentiating in electronics and 
computers where it is, in fact, a business application and 
where it is a recreational application. Because recreational 
opportunities of the modern computerized technology are, of 
course, enormous; so enormous that my wife no longer calls my 
office ``my office'' she calls it ``my play room'' since I put 
a computer in there. So as parents examine that, I think we 
have so many efforts to try to get computers in the hands of 
our young people through the schools and then other efforts. I 
do think we need to differentiate.
    If you're talking about expensing capital, whether it's in 
the form of what kind software or hardware, I think you need to 
keep that notion applied to where it is currently applied in 
business applications.
    Mrs. Maloney. Thank you very much.
    Chairman King. Thank you for your testimony. We realize you 
are to be at another meeting at 10:30. So we want to thank you. 
I just would like to say that the more I hear about your 
mother, the more I really admire her insights.
    [Laughter.]
    Thank you very much for your testimony today and any final 
statement you want to make.
    Mr. Armey. I just want to thank you again for letting me be 
here. And I want to thank you all, in particular, for sparing 
me the tough questions that might have come from Mr. Shays.
    [Laughter.]
    Chairman King. Thank you, Mr. Armey.
    If the next panel will step forward.
    Mr. Shays, would you like to make an opening statement?
    Mr. Shays. No, Mr. Chairman.
    Mr. Grucci.
    Mr. Grucci. No, Mr. Chairman.
    Chairman King. Mr. Ose.
    Mr. Ose. No.
    Chairman King. I recognize the Ranking Member.
    Mrs. Maloney. OK. This morning the subcommittee considers 
the topic, After the Tax Cut: Unleashing Economic Growth. While 
I plan to raise a number of issues, I must comment on tax cut 
stuff--actually on the floor that the Majority is proposing. 
They constitute some of the greatest challenges to sustaining 
economic growth by threatening a return to large deficits and 
higher interest rates.
    One of the Majority's tax cuts is so large based on 
economic assumptions that it varied so greatly that we risk 
deficits if our numbers are only slightly off.
    CBO, whose rosy projections are the voices for the tax 
cuts, indicated that its average error margin in projecting 
budget surpluses or deficits for fiscal year in progress has 
historically been about .5 percent of gross domestic product--
GDP. In the current economy this would be $54 billion in 1 
year. As projecting 5 years out, CBO's average error has been 
3.1 percent of GEP, a sixfold increase--to borrow a Bush catch 
phrase this is truly ``faith-based budgeting.''
    Second, despite the tax surplus the Federal Government is 
enjoying, danger lies just over the horizon. The uncertainty of 
the next 10 years, trumped by the uncertainty of the second ten 
starting in the later half of this decade as the baby boomers 
will begin to retire, drastically increasing our retirement 
commitments. Should we find ourselves facing deficits in 2008 
we will truly be in a dire predicament.
    Third, as we all know, the economy is slowing and the 
President's supposedly $1.6 trillion tax cut, which is actually 
closer to $2.2 trillion with interest not paid on the debt and 
the necessary fixes are included, is not conceived as economic 
stimulus, it was a campaign package that was constructed 2 
years ago to appeal to Republican primary voters.
    It will have little immediate impact, and in fact, 75 
percent of the promised tax cuts comes in the second 5 years. 
The Majority may claim to want to end the marriage penalty, but 
as some of my Democratic colleagues have pointed out on the 
floor, their plan is like a tenth anniversary present.
    These concerns are reflected today in an editorial that is 
in The Washington Post entitled ``Tax Fraud.'' While I could go 
on about this ill-conceived tax package, let me simply say that 
the Democrats support tax cuts and we could easily have 
bipartisan consensus for an historically larger, fair, and 
immediate tax cut that would be supported on bipartisan basis 
and passed in days. Looking beyond the Majority's flawed tax 
cut there is a great deal Congress could do to spur economic 
growth. The Federal Government plays a critical role in 
encouraging research and development in the private sector. 
This is especially important to technology companies that have 
been the engines of economic growth, as the leader just pointed 
out, in the last decade.
    We must also increase our commitment to the education of 
all of our children, especially those in public schools. I do 
not believe that this is accomplished through any program that 
we merely subsidize other schools by taking money out of the 
public school system.
    Finally, I strongly favor, as part of a responsible tax cut 
plan, increasing IRAs and 401(k) contribution limits and 
allowing for pension catch-up contributions. These provisions 
increase savings and catch-up contributions can be especially 
beneficial to women rejoining the workplace later in life.
    I believe the Congress can make major positive 
contributions to economic growth. My only fear that the 
Majority's plan commits almost all of our expected future 
surplus to a long-term tax cut that would do nothing for 
economy now and it would take away our flexibility to deal with 
future economic needs as they arise.
    Let me just close by saying, even the economies only 
projected a 5-year plan and that a 10-year plan really might 
cause problems if there is.
    I thank the Chairman.
    Chairman King. Thank you, madam.
    Mr. Shays.
    Mr. Shays. I would love to make a statement.
    The economy has had a 5-year plan, but then our economy 
went down because it was an economy that was directed by the 
Federal Government. My big fear is that if we don't return some 
of the taxes back to the American people, we are going to start 
to see an economy that is more directed by the Federal 
Government.
    I served on the Budget Committee for 10 years and during 
that time I became more and more convinced of the value of tax 
cuts. We had a President, President Kennedy, who wanted a tax 
cut when we had no surpluses. We had another President who 
wanted a tax cut when we had deficits. We have a President now 
who is saying we should have tax cuts when we have a surplus, 
and the surpluses are quite large.
    In listening to the budget debate for the last 2 days, I 
was struck by the fact that, contrary to what my colleagues on 
the other side of the aisle were arguing, you know, no tax cuts 
pay down the debt, practically everything that came forward was 
just more spending. So the issue is, why would you want to 
continue to spend more money if we could just spend the 
surplus? That is where the difference is. And I would suggest 
with all due respect to my colleagues, the Ranking Member whom 
I agree with, much more than I disagree, cutting taxes a 
quarter of the projected surplus makes eminent sense. Trying to 
speed that up, I agree, would make eminent sense. But we phase 
it in, and if in the future we decide we do not want part of 
that phasing to go in, there is nothing to prevent a future 
Congress from saying, let's not do it.
    I am eager to hear what our colleagues have to say. I'm not 
sure we will agree on everything, but I just learned a lot from 
what all four have said over the past years and I think our 
economy has been better for our listening to them.
    So I am eager to begin this hearing and I thank you, Mr. 
Chairman, for conducting this hearing.
    Chairman King. Thank you Mr. Shays. I will now introduce 
our panel.
    First, Mr. Floyd Kvamme, who we mentioned before, was 
appointed by the White House to the President's Council of 
Advisers for Science and Technology; Mr. James Glassman from 
American Enterprise Institute; and Dr. Martin Baily, Senior 
Fellow, International Institute for Economics. We are expected 
to have Larry Kudlow, who we presume is on the way.
    Mr. Kvamme, we realize that you are going to have to leave 
early and we would just ask you to go on and give your 
testimony.

STATEMENT OF E. FLOYD KVAMME, CO-CHAIRMAN, PRESIDENT'S COUNCIL 
             OF ADVISORS FOR SCIENCE AND TECHNOLOGY

    Mr. Kvamme. Thank you.
    Mr. Chairman, I am pleased and honored to have the 
opportunity to testify before the subcommittee on issues of tax 
policy in capital formation and to submit written statements. 
These hearings could not come at a more propitious time; 
weakening economic performance and a greatly divided stock 
market have significantly inhibited and will even erode the 
ability of our capital markets to allocate the necessary 
resources to fund growth in our economy and maintain our 
international competitiveness.
    I am a general partner at Kleiner Perkins Caufield and 
Byers in Menlo Park, California; we are a high-technology 
venture capital firm, and in that capacity, I serve on the 
boards of directors of some seven high-technology companies. I 
also serve as Chairman of Empower America, a Washington-based 
issue advocacy organization; on the board of the Washington-
based National Venture Capital Association and on the Executive 
Committee of the Technology Network, a network of about 280 
high-tech firms with headquarters in California, but with 
members from across the country.
    My testimony today, while influenced by each of these 
associations, represents, however, my personal view on steps 
that could unleash the economy.
    For more detailed explanation of my testimony here, please 
review the written testimony I have submitted to the 
subcommittee.
    Mr. Chairman, as you know, the venture capital industry has 
been a catalyst for much of our economy's remarkable and 
consistent growth in the past decade. What used to be a 
relatively small community of investors has expanded into a 
nationwide industry. The skills of talented entrepreneurs and 
managers backed by venture professionals has translated into 
successful investments that have greatly increased interest 
among the investing community in this asset class, and has 
provided significant returns to the pension funds, foundations, 
university endowments and other organizations that are our 
limited partners.
    These investments are helping to introduce and integrate 
critical technological innovations that are being applied 
throughout the economy. According to the Federal Reserve Board, 
industry's application of information technology over the past 
decade has vastly increased labor productivity.
    Today, however, we are presented with the challenging 
question of how to keep this level all productivity and 
economic growth growing.
    An important first step to economic growth is already being 
taken. President Bush's tax relief proposal which is advancing 
through Congress is critically important to both the short-term 
and long-term growth. Reductions in marginal tax rates and the 
elimination of both the estate and marriage penalties will 
release much needed capital into the economy and lead to still 
greater productivity. I applaud the steps you and your 
colleagues have taken to enact the President's tax package.
    But I urge you to consider more comprehensive tax and 
regulatory relief efforts focused on sustained economic growth 
in security. Below, I offer some specific ideas.
    The number one priority of emerging growth companies is, 
and always has been, sufficient and efficient access to 
capital. Congress has taken important steps in the recent past 
to help in this area, most recently in 1997 when it lowered the 
capital gains tax rate. But our industry believes that further 
efforts to lower the tax rate are necessary. The U.S. investors 
face capital gains tax rates on both short- and long-term 
gains, which are among the highest in the industrial world. The 
U.S. long-term rate of 20 percent compares to an average of 
14.8 percent overseas while top short-term rates in the U.S. 
compared to an average of 18.4 percent international average. 
Closing these differentials will significantly enhance the 
incentives within our country to buy, hold, and sell equity 
instruments for individuals and corporations.
    Interestingly, if the past is any predictor of the future, 
every time the capital gains rate has been reduced, revenues 
from taxation of capital gains have increased. Thus, capital 
gains reductions will broaden the President's tax cut proposals 
while raising the after-tax return on capital, making it more 
attractive for people to invest in startup companies.
    In contrast to this focus on capital formation, the idea of 
a $60 billion cash tax rebate check unconnected to more 
comprehensive reform aimed at temporarily bolstering consumer 
spending is circulated.
    But as Larry Kudlow will probably point out, consumption 
expenditures are the strongest part of today's economy. In the 
current quarter, real consumer spending could, in fact, 
increase by 3.25 percent.
    In stark contrast stands investment spending, in the form 
of diminished stock market purchases and business equipment 
expenditures, which has declined, significantly pulling down 
the entire economy. As a result, we should focus on increasing 
capital investments as a means of restoring our economy to 
health. Far preferable to any kind of stand-alone rebate would 
be for Congress to provide a front-loaded acceleration of 
January 1, of the across-the-board marginal tax rate reductions 
proposed by the President.
    On a smaller but more immediate scale, small business 
access to capital can also be enhanced through the specific 
regulatory clarification that will fully implement legislation 
Congress passed several years ago such as Section 1045 of the 
IRS code as governing partnerships. For a more thorough 
explanation, please see my written testimony.
    In addition, Congress and the President should act to 
encourage savings by increasing limits, as the Ranking Member 
just mentioned, of lifting the caps on IRAs, Roth IRAs and 
401(K) plans. On regulations Congress should remain ever 
vigilant to guard against the growing morass that is 
encroaching on the high-tech and biotech industries such as 
rules on communications technology and export licenses.
    Excessive regulation of any particular industry increases 
investment risks and thereby lowers the industry's access to 
adequate capital.
    Remember that the American high-tech industry leads the 
world in virtually every area of competence and produces nearly 
half of its revenue from export sales to further benefit of the 
American economy. To my knowledge, there's no such thing as a 
high-growth regulated industry. Continued leadership for 
American companies could be threatened if regulations restrict 
the freedom of action that the industry has enjoyed to date.
    Thus, policies that promote free trade, efficient stock 
markets, effective patent and copyright protection, tax 
treatment allows the expensive software immediately, makes 
permanent the R&D tax credit and removes obstacles to broadband 
deployment and workforce development through strong support of 
improving our education system, an area that we look forward to 
working very closely with the President and Congress would all 
be helpful.
    The President's plan, along with these pro-growth tax 
initiatives and a cooperative monetary policy will help 
stimulate the economy. Then the Administration and Congress 
should forge ahead to reform Social Security into a payroll-
tax-financed worker investment and personal retirement account 
program by allowing workers to invest a portion of their 
payroll taxes into personal accounts.
    Again, I am honored and pleased to be before your 
subcommittee to discuss these vitally important issues. 
Although there's much work still to be gone to implement the 
President's tax relief package, I commend you for your 
leadership in beginning the discussion of the next steps to be 
taken in order to enhance our economy's growth and efficiency. 
Thank you.
    [The prepared statement of E. Floyd Kvamme can be found on 
page 46 in the appendix.]
    Chairman King. Thank you Mr. Kvamme.
    I also want to welcome the other Members who took all the 
trouble to make it down here. I appreciate the effort they went 
through to get here. And we have votes coming up.
    What I would like to do is we will probably be leaving here 
in about 7 or 8 minutes and then come back.
    Mr. Glassman, if you want to begin your testimony, we will 
perhaps finish your testimony before we leave to vote. Then we 
will come back.

   STATEMENT OF JAMES K. GLASSMAN, RESIDENT FELLOW, AMERICAN 
                      ENTERPRISE INSTITUTE

    Mr. Glassman. Thank you, Mr. Chairman.
    Mr. Chairman, Representative Maloney, Members of the 
subcommittee, the message I bring you today is that the U.S. 
economy has slowed and that tax cuts and monetary easing are 
necessary, but not sufficient to restore the rate of growth we 
experienced in the late 1990s. What is critical is that changes 
are made in regulatory policy to encourage what I call the 
liberation of supply, the resurgence of output. I will give 
brief recommendations on how this could be accomplished.
    First, however, I want to congratulate my friend, Floyd 
Kvamme, and say that it is an honor to be invited to testify 
here on this important matter especially in the company of such 
a distinguished group of economists including the Majority 
leader who just left.
    You know, it was Ronald Reagan who said that economists are 
people who see something work in practice and wonder if the 
would work in theory. And what has worked in practice over the 
last two decades is the U.S. economy. We have far exceeded the 
record for the longest expansion in U.S. history. Since World 
War II we have had nine recessions, but only one since 1982, 
and that, by historic standards, was shallow and brief, but it 
still hurt. Recessions, even slowdowns, are extremely painful 
to real people.
    Today, we may have already entered into the tenth post-war 
recession; at the very least, the economy has slowed 
significantly.
    Let me just briefly review the causes of the slowdown, the 
reasons for the economic boom that we have seen, and some 
recommendations on unleashing the economy once again. Here are 
the major culprits as far as the slowdown is concerned:
    Number one, Fed rate hikes. The Federal Reserve began to 
raise interest rates in June of 1999 with little sign of 
inflation. As far as I'm concerned, I believe it was a mistake.
    Second, the tripling of oil prices. Eight of the nine post-
war recessions, including the last four, have been preceded by 
an oil shock. It is the rising price of oil plus tighter Fed 
policy that tends to cause recessions, and this double whammy 
is present today, as well.
    Third, the drag of high taxes and a gigantic surplus. 
Federal tax revenues as a percentage of gross domestic product 
last year were 20.6 percent--a level exceeded only twice in 
U.S. history, and that during World War II.
    The surplus itself is a reflection of these high revenues 
flowing into Washington. Cash that could have been used for 
consumption or new private investments is instead being used to 
retire the bonds of investors who typically use the proceeds to 
buy more bonds. Retiring debt--especially with debt at such low 
levels as a percentage of GDP is no way to spur the economy. 
And I respectfully refer the subcommittee to my article, ``The 
Joy of Debt'' in the March 26 issue of The Weekly Standard.
    Fourth, the end of the high-tech enterprise zone. The past 
year, especially, has seen increased Government intervention in 
the economy, especially in the high-tech sector as well as 
Federal and State mismanagement of the planned deregulation of 
telecommunications. A year ago, I argued that this change in 
political approach to high tech threatened a ``regulatory 
recession.'' We may be in it.
    It is no coincidence that high-tech stock prices began 
their 60 percent slide at almost the exact moment that the 
Justice Department asked a Federal court to break up Microsoft 
Corporation, the software company that is credited with 
igniting the computer revolution in the early 1980s.
    But before getting to the question of what should be done 
to reverse the slowdown, let me just examine very quickly why 
the economy has boomed up to now. Business cycles work in 
fairly predictable ways. Prosperity causes demand to rise, it 
bumps up against supply, constraints of production and labor, 
prices rise, the Fed comes in and whacks down this inflation 
with higher interest rates, the economy slows, and frequently 
goes into recession and then we have the same thing all over 
again.
    But for most of the 1980s and 1990s, that did not happen. 
We had strong growth--at times, twice the average with really 
very low inflation.
    Why?
    The reason is that the U.S. has been undergoing what I call 
a ``liberation of supply.'' When demand rose, it did not bump 
up against supply constraints.
    Why?
    Let me just briefly cite four reasons:
    One, the spread of free trade, both in goods and in people 
through immigration.
    Second, lower tax rates and better regulatory policies that 
really began in the Carter and the Reagan years.
    Third, better monetary policy.
    And, fourth, Mr. Kvamme referred to this, the high-tech 
revolution. The advent of inexpensive, powerful network 
computers, has boosted productivity to about twice the historic 
average. Very simply, productivity means more output for the 
same input--that is, more supply.
    But lately this liberation of supply has stalled, new 
bottlenecks and shortages have developed and steps need to be 
taken. Two of them, obvious ones, are already being taken.
    First, the Federal Reserve has cut interest rates and will 
continue to do so. Second, Congress has begun action on 
President Bush's plan to cut taxes a total of $1.6 trillion 
over 10 years. And while the hearing is titled ``Beyond The Tax 
Cut,'' I heard a lot of talk about taxes and I'm going to put 
in my two cents' worth. I want to emphasize the importance of 
significant tax relief, rather than a quickie short-term cut 
that will do nothing to stimulate the economy, in fact, it will 
probably be counterproductive.
    I would also just like to associate myself with the 
comments of the Majority leader about expensing software and 
hardware. The single step that would give the economy the 
biggest boost would be to accelerate depreciation or allow 
expensing of capital investment. You get an immediate boost and 
a very big one. But we need more, specifically these few 
things:
    Number one, the U.S. must formulate a clear energy policy 
that concentrates on encouraging supply. Currently, supply is 
being severely restricted by excessive environmental barriers 
to increase exploration for energy and by policies such as 
``new source review,'' that discourage the renovation of old 
refineries and utility plants and the building of new ones. 
This is especially hurting the high-tech economy in California.
    Second, the antitrust policy of later years of the Clinton 
Administration should be changed to take into account the 
realities of high technology.
    Third, the bottlenecks that are restricting the spread of 
broadband technology must be forced open. The main problem is 
the lack of enforcement of the main piece of regulatory 
legislation, the Telecommunications Act of 1996.
    And finally, wireless, too, is being hurt by lack of 
supply. Regulators should get out of the business of allocating 
bandwidth to the politically powerful and instead let market 
forces determine who gets space on the spectrum.
    The U.S. economy has shown that, when supply is liberated, 
growth rates of 4 or 5 percent--roughly double the post-World 
War II average are possible without inflation. With tax cuts, 
interest rate cuts, and a supply oriented energy policy and 
sensible regulations, we can revive a prosperity that will 
improve the lives of even more Americans than the boom of the 
1980s and 1990s.
    Thank you, Mr. Chairman.
    [The prepared statement of James K. Glassman can be found 
on page 50 in the appendix.]
    Chairman King. Thank you, Mr. Glassman. We have to recess 
to vote. Probably we will resume at about 11:15.
    Mr. Kvamme, I realize you're going to have to leave. There 
is no sense holding you around until the vote. I know Members 
have questions for you. If it is OK with you, we will ask them 
to submit those questions to you in writing and perhaps you can 
give us the answers.
    Mr. Kvamme. Again, I apologize for that. But I would be 
very happy to, Mr. Chairman.
    Chairman King. Thank you, sir.
    And also, Mr. Glassman, your article, ``The Joy of Debt,'' 
without objection, I will have this inserted into the record.
    Mr. Glassman. Thank you, Mr. Chairman.
    [The article referred to can be found on page 58 in the 
appendix.]
    Chairman King. We will resume about 11:15.
    [Recess]
    Chairman King. The hearing will come to order.
    I appreciate your patience and tolerance. Hopefully that 
was the last vote for a while and we will be able to continue 
with the hearing.
    Our next witness was already introduced, and we look 
forward to his testimony, Dr. Martin Baily.

STATEMENT OF DR. MARTIN N. BAILY, SENIOR FELLOW, INSTITUTE FOR 
            INTERNATIONAL ECONOMICS, WASHINGTON, DC

    Dr. Baily. Thank you. Chairman King, Ranking Member 
Maloney, and Members of the subcommittee, I appreciate this 
opportunity to be able to talk to you about the economy and 
some of the policies that might be affected in helping this 
economy move forward.
    Let me just note, as speakers have mentioned, that we 
really have had an extraordinary period in our recent economic 
history. This has been perhaps the longest and strongest 
expansion of U.S. economic history. And a point that Jim 
Glassman made, let us not be too theoretical here, let's look 
at what worked in practice. The policies that were in place in 
the 1990s have contributed to and helped us achieve this 
extraordinary and unusual expansion.
    One of the particularly striking things about this period 
is what happened to productivity growth. Productivity growth 
was very rapid after World War II for about 20 years, 
unfortunately, then it began to slow down in 1973. The time 
period is fairly short, but it does now seem, starting in 1995 
and going through 2000, that the rate of productivity growth in 
the U.S. economy doubled or slightly more than doubled.
    That is a transformation. It affects living standards, it 
affects family incomes, it keeps inflation down, it is a key to 
strong economic performance. We need to make sure that whatever 
we do we do not undermine that strong productivity performance.
    Much of this performance was driven by new technologies, 
but those don't raise productivity unless you have the right 
environment.
    Clearly, the economy started to slow in 2000. In part this 
was a response to actions by policymakers, and the Fed in 
particular, that the economy was running too fast and with a 
very tight labor market, that it needed to slow down. The 
resulting slowdown has been more abrupt than we wanted, and 
there are certainly areas of economic weakness that are evident 
here. But let us remember that even now the strong fundamentals 
remain, we have low unemployment and moderate inflation once 
the energy problem is under control. There is a good chance, 
not a certainty, but a very good chance that we will avoid a 
recession, but there will be pretty slow growth through much of 
a this year. After that, we're going to get a resumption of 
normal solid growth, even if we make no changes in tax policy 
at this point.
    In terms of dealing with the current weakness, the evidence 
of history is pretty clear that monetary policy is the most 
effective way to avoid a recession or if we actually go into a 
recession to come back out of recession. And indeed the Fed has 
acted quickly to lower interest rates and to try get us back on 
track. Monetary policy takes a while to work and it may be 
uncomfortable while we go through this current period of 
slowdown, but let's give that, the right medicine, a chance to 
work first.
    With respect to a tax stimulus package, past history 
suggests that manipulating taxes in order to save our economy 
is relatively ineffective and can be counterproductive. I'm 
certainly not the only one who thinks that. John Taylor, who is 
a distinguished economist, who is either now a member of this 
Bush Administration or will be soon, wrote a piece last year 
evaluating the role of fiscal stabilization policy and 
concluded that it generally is not very effective. And there 
are a number of reasons for that included in my testimony.
    More importantly though, we need to keep in place the 
policies that have contributed to the outstanding economic 
performance of recent years. The policy of fiscal discipline as 
we shifted from deficits to surpluses has paid off quite 
handsomely in the performance that I mentioned. And in order to 
keep that fiscal discipline, we need to have realistic 
estimates on what discretionary spending is going to be. We 
need to be realistic, based on past actions, as to how much 
discretionary policy we're going to have and how much Americans 
want in terms of the programs that they are looking for.
    The next aspect of fiscal discipline is that it creates 
surpluses that give us the opportunity to start dealing with 
the challenges of Social Security and Medicare. The long run 
fiscal position that the United States faces as we look into 
the century is not nearly as rosy as the current fiscal 
position. One way, for example, to deal with Social Security 
over the long run would be gradually to shift to a fully funded 
system so that as people paid in they built up an investment 
account and then they receive their retirement part back as 
they retire. We do not have that currently. We have a pay-as-
you-go system.
    In order to get from where we are now to where perhaps we 
would like to be, we're going to need a substantial amount of 
transition funding. And the surpluses, the ones over and above 
the Social Security surplus, give us that opportunity to do 
something about meaningful Social Security and potentially 
Medicare reform.
    I would also like to draw attention to the international 
part of this. The U.S. is running a very large trade and 
current account deficit. We are borrowing nearly $500 billion a 
year. We have accumulated $2 trillion of net indebtedness.
    The U.S. has have benefitted greatly from our ability to 
tap into global capital markets. That has helped us with our 
investment, it has helped our productivity, it has helped to 
strengthen this economy.
    One of the concerns of this hearing is access to capital. 
We need to realize that we cannot keep borrowing at such a rate 
from overseas. There are natural forces as the debt builds up, 
a reduced willingness of foreigners to lend to us, that will 
make it difficult for continued very high borrowing.
    In order to reduce the current account deficit, we need to 
increase national saving in our economy. Private saving is 
likely to rise moving forward. It's been so low in part because 
the stock market has been so strong. People haven't felt the 
need to save as long as their houses and stock portfolios have 
gone up so much. But as we have now had a flattening or decline 
in the stock market, we probably won't get the same 
astronomical gains going forward as we have had in the past. So 
I would expect private savings to rise.
    But we need to reinforce that by making sure we also have 
budget surpluses which are a contribution to national saving in 
order to turn around that situation.
    Rapid economic growth over the long run requires investing 
in the future. This helps productivity, which increases wages 
and family incomes. It also helps the budget surplus, which can 
get into a virtuous cycle as stronger economic growth improves 
the situation.
    I am opposed to any large or long-term tax cut which would 
undermine the surplus. The surplus is needed to increase 
national saving and as a way to deal with the demographic 
challenge. The Social Security trust fund is scheduled to be 
depleted in 2038. There are not going to be Social Security 
surpluses going forward.
    The tax stimulus package currently proposed would have only 
a modest effect on the current short-term weakness. Any tax cut 
that is designed as a stimulus should come into effect quickly 
and should be targeted to lower income families that need help 
in a softer economy. But whatever the pros and cons of a 
moderate tax cut or rebate to stimulate the economy, a large 
long-term tax cut that phases in gradually over the coming 
years is the wrong approach to deal with a temporary economic 
slowdown.
    Something which came up in today's discussion has to do 
with falling investment. There has been a sharp fall in 
investment, but the main reason is that investment got ahead of 
itself in 2000. The economic growth was so strong, the 
telephone companies were out there investing, building more 
capacity than was really needed. There was perhaps more 
investment in high-tech than was justified by the fundamentals. 
That's the reason for slowing investment. Investment should 
resume as economic growth picks up.
    Finally, the latest jump in consumer confidence is welcome, 
but I think a lot of American families are still pretty 
nervous. And one of the reasons they are nervous is they are 
worried about what is going to happen to them if they lose 
their jobs. They're afraid that they can't pay their bills, 
they might end up potentially in bankruptcy. They're afraid 
that their health insurance is going to evaporate.
    So, this would be an appropriate time to review some of the 
Federal programs like unemployment insurance, and programs that 
help people without health insurance. If we strengthened some 
of those programs, it would help improve consumer confidence.
    Thank you very much.
    [The prepared statement of Dr. Martin N. Baily can be found 
on page 62 in the appendix.]
    Chairman King. Thank you, Dr. Baily.
    Our next witness is a man who feels so strongly about this 
issue he braved the choppy skies and risked lightening and wind 
to come down here this morning, Larry Kudlow, an old friend. 
Mr. Kudlow.

STATEMENT OF LAWRENCE KUDLOW, CHIEF EXECUTIVE OFFICER, KUDLOW & 
                          COMPANY, LLP

    Mr. Kudlow. Thank you, Mr. Chairman and greetings to the 
panel. My own Congresswoman, Mrs. Maloney, greetings, Mr. 
Shays.
    I just want to make a few points that I hope have not been 
made by my other fellow panelists. First of all, the Federal 
Reserve cannot do it alone. We have had a pretty significant 
reduction of the Fed's policy rates, the Fed funds rate, and 
the discount rate so far this year. They have knocked the funds 
rate down by one 150 basis points, as you know, and similarly 
the discount rate.
    But the reality is, the stock market and the economy are 
still very much in the doldrums. And I want to put on the table 
the possible point for future discussion and that is, what 
really matters in the current economic setting with respect to 
the monetary policy, is not the level of the Federal funds 
rate, it is the volume of high-powered liquidity that the 
Central Bank injects into the economy. You know, this cycle was 
never plagued by the problem of rising inflation and rising 
interest rates.
    Interest rate movements have been remarkably benign. I know 
they went up a little bit in 1998 and the first part of 1999, 
but, you know, as someone who cut his teeth in the profession 
in the 1970s, this is nothing. And I'm glad the Fed fund rate 
jumped from 6.5 to 5. And I believe personally when this cycle 
is over it will probably get to around 3.5 or so.
    But, more important than the level of raise is the volume 
of high-powered cash that ejects to fund the economy. And there 
are two ways to measure that. One is the measure known as the 
monetary base, the other one is a subset of that measure which 
is adjusted bank reserves. And neither one has shown much 
stimulus in the economy so far. I just want to note that.
    So we are in this strange position where the Fed is 
bringing down its policy rate, but there has been only the 
slightest improvement in general liquidity conditions. And this 
is a subject that is unfortunately quite technical and quite 
complex, but I can't begin to tell you how important it is.
    I'm in agreement with Martin Baily, you can't do it alone, 
but I surely agree the Fed is going to be a major player. I 
don't think tax cuts will do it alone either. I think we need a 
shift in macro-policies toward lower tax rates and easier 
money, frankly.
    So far we've gotten neither. And, therefore, it is not 
surprising that the stock market continues to decline. I 
characterize this--promises, promises, but what have you done 
for me lately? The answer is, virtually nothing.
    Just to add another point to this Fed story, there was some 
increase in the monetary base in the month of January when the 
Fed first began to cut rates. You may recall the stock market 
did have a temporary rebound. But since then, the base has 
actually leveled off--a level base. And actually declined in 
its growth rate.
    So, for the past 2 months the base growth has only been 1.6 
percent; at an annual rate, that's a very meager rate. And 
another measure which takes the currency component out of the 
base is called adjusted bank reserves, which for the Fed--is 
the old term ``non-borrowed reserves'' essentially. Non-
borrowed reserves have been essentially falling right now. 
They're falling. They're not rising.
    So, my point is from the standpoint of the monetary side, a 
drop in interest rates is merely a reflection of the decline of 
economic activity. It does not include any particular monetary 
stimulus. And I speak here hopefully empirically and in a non-
partisan way for those people who believe that the Fed should 
get the economy moving and I personally believe there's a good 
deal of truth in that point. The fact is, they are not getting 
the economy moving. They need to take a much more aggressive 
posture with respect to controlling the high-powered cash flows 
that they control. So that's point number one.
    In the fiscal area, I found myself much more in agreement 
with Mr. Glassman than with Mr. Baily. And I want to make a 
couple of points on how I see the problem right now. Because 
we've had a very deep stock market plunge, which I believe 
today is more important than main street kitchens, than GEP, 
since there's over 100 million Americans who are invested in 
the market, the vast majority for long-term retirement 
purposes.
    The stock market plunge has caused a significant increase 
in the cost of capital. There are many ways to show that, but 
let me just choose what I think is a fairly obvious one in the 
parlance of the--using the S&P 500 as broad as the most 
representative index of stocks. About a year ago, in March of 
2000, at the S&P was pretty close to its peak, the price 
earnings multiple was roughly 33. The prices were roughly 33 
times expected earnings.
    Now, translating that into capital costs is very simple, 
just invert the measure and you get earnings divided by price, 
which gives you a bond yield. And at 33 times earnings, the 
bond equivalent is 3 percent. Take one over the PE multiple and 
divide. This is not a Republican point, this is not a 
Democratic point, this is really a corporate finance point.
    Now today, with the stock market down about, in rough 
terms, 25 percent the S&P, the price earnings multiple has 
fallen to something around 22 times earnings. And those are 22 
times last year's earnings.
    So the earnings yield has increased to 4.5 percent. I hope 
I haven't lost you already. But the point I want to make is, 
the earnings yield is one important measurement cost of equity 
capital. The increase from 3 percent a year ago to 4.5 percent 
currently is a roughly 50 percent rise. That's a very 
significant increase in the cost of equity money. And that is 
one of the most difficult consequences of the plunge in the 
stock market. It is now much more expensive for everyone to 
finance through equity fund. And I think we would all agree, we 
would rather American companies, both large and small, use more 
equity than debt.
    So, with that in mind, I am concerned that fiscal policy, 
particularly tax policy, must help relieve the cost of capital 
increase which has occurred. And traditionally one can look at 
this as the interest rate cost of capital and the tax cost of 
capital. Although I want to underscore what Jim Glassman 
mentioned, essentially the regulatory cost of capital, which is 
an important point, but I'm going to leave that to his 
expertise.
    Traditional corporate finance is on the interest cost of 
capital and the tax cost of capital. They're both very 
important. And so the kind of tax changes that I would 
recommend, the kinds of tax reforms I recommend would go to 
reducing the cost of capital. And that leads me to two very 
simple proposals:
    One is the reduction in income tax rates, and, in 
particular, as unfashionable as my sentence is going the be, it 
is in this sense more important to reduce the top rates than 
the bottom rates. My view is, all rates should be reduced. But 
in strictly economic terms, with respect to the tax cost of 
capital, the upper income rates are really tax rates on 
capital, because that's the group that does the saving in our 
economy, and we save to invest.
    Investment required saving. Once you get into the middle 
and lower brackets, there is virtually no saving and in the 
lowest brackets there is substantially negative saving.
    So if one wants to promote economic growth, which is, I 
think, in many ways a different issue than various social-
related issues; if one wants to reduce the tax cost of capital, 
then one would go to lowering the tax rate.
    The other tax that, of course, comes to mind, and I'm not 
shocky with people know my--capital gains tax rate. Capital 
gains is the even more direct tax on capital. And so my 
recommendation, Mr. Chairman, to deal with this economic slump 
is to have immediate and retroactive reduction in marginal tax 
rates on income and capital gains. Those are not the only tax 
reforms that would be helpful. But, in an immediate sense, I 
believe they would--and I use this word advisably--``provide 
some shock therapy'' to the stock market plunge; which, in some 
respects is feeding on itself right now.
    You know, we are long past the point where normal 
discounted earnings follows a future market value. Make any 
sense? If earnings could fall by 10 percent in 2001, but if you 
discount those earnings by a 4 percent treasury bill rate, then 
the S&P 500 is at least 25 to 30 percent on the value right 
now, that's all very interesting, but the market keeps 
falling--forecasting, notwithstanding the market keeps falling. 
So I have concluded that we need some shock therapy to jar the 
quiescent animal spirit or investor spirits and create a better 
atmosphere. And I think reduction in tax rates on capital would 
be the best short-run policy.
    I'm going to make two or three other quick points. In 
addition to the rising cost of capital, the market plunge has 
also generated significant increases of risk premiums on 
capital. Now that, in some respects, is very much related to 
capital costs.
    One can see these risk premiums by the widening credit 
quality spread between lower-rated corporate bonds and higher-
rated corporate bonds, and, of course, Treasuries, which are 
risk free.
    As Mr. Kvamme has indicated in his testimony, there has 
been a general drying up of venture capital flows and there has 
been a general pull back in the initial public offerings marked 
``VIP'' only. Those are all additional pieces of evidence that 
risk capital premiums have significantly increased. So I think 
we need to take some tax measures and some monetary measures to 
jolt the market attitude and to, if you will, create some shock 
therapy.
    As far as the economic outlook goes, I really believe for 
those people who want an immediate tax cut on consumption, I 
mean, I'm obviously sympathetic to the idea of an immediate tax 
cut, but I must tell you, consumption is not the problem right 
now. Consumption is not as healthy. Personal spending, personal 
consumption expenditures, which is the largest category in the 
national income accounts, are not as strongly growing as they 
were a year ago. But, really, they are still positive. Up about 
close to 4 percent in the fourth quarter, and I guess they'll 
be up 3 percent or so in the first quarter.
    Retail sales are rising, albeit more slowly. Automobile 
sales are still at a high level. The analysts have pointed out, 
I think Mr. Greenspan has pointed this out, incomes are still 
growing however the slowdown and so forth.
    Where the real weakness is occurring in the actual data is 
on the investment side of the income potential accounts. In 
particular, industrial production has fallen 5 straight months. 
A sixth month of that could qualify as a recession indicator. 
And factory orders and shipments continue to decline. We got 
more bad news on that yesterday. There is an overhang of 
inventories across the board. And gross domestic investment 
declined in the fourth quarter and is set, in my judgment, to 
fall again in the first quarter.
    So we have an investment side recession. We have a capital 
cost problem. We have an investment risk premium problem. And I 
would argue that to generate long-run health of the economy we 
should be looking at the supply or investment or capital sides 
of the calculation, not the consumption side.
    And, yes, I am a Wall Streeter and, yes, there is, 
therefore, some preoccupation with the stock market. But I must 
tell you, what has happened in the stock market is not 
something to be just sloughed off, oh, it will recover, it will 
recover. I remain an optimist in the long run, but I can tell 
you, the stock market plunge is taking its toll on the economy, 
on sinking investment spirits, and on the risk-taker. And to 
expand the productivity revolution that Martin Baily discussed, 
a point with which I completely agree with him--completely--we 
need more capital. It is in many ways our most valuable 
resource. It is capital that makes labor productive.
    Thank you.
    [The prepared statement of Lawrence Kudlow can be found on 
page 68 in the appendix.]
    Chairman King. Thank you, Mr. Kudlow.
    Over the next several weeks and months we are going the 
have very intensive debate in Congress about the President's 
tax policy and whether or not it should be expanded, whether or 
not it should be restricted. And my concern has been that there 
appears to be a distortion of certain basic facts. For instance 
there almost seems to be a--taken as gospel--that the Reagan 
tax cuts of the 1980s did not work; it hurt the economy, 
interest rates went up. My understanding of the Reagan tax cuts 
is that interest rates--dramatically cut, 18 million jobs were 
created, inflation were dramatically cut, 4 million Americans 
came out of poverty during that time. It was the longest 
peacetime expansion we had.
    We have, over the last 19 years, had one brief recession. 
And yet, both the media and among certainly many members in the 
opposition party there's talk that these tax cuts did not work. 
You can go back to the Kennedy tax cuts. There was no surplus 
either. Those tax cuts worked.
    So I would like to ask, what we can learn from the Reagan 
tax cuts and how they are applicable to today, and how real are 
the fears that if the economy does take a bit of a downturn, or 
if there is a brief deficit that somehow this is going to ruin 
our economy for years to come. So I would just ask the three of 
you, I guess in order, Mr. Glassman, Mr. Baily, Mr. Kudlow, the 
order in which you testified.
    Mr. Glassman. Well, Mr. Chairman, I agree with what you 
said. The Reagan tax cut certainly worked. Imagine today if we 
confronted top rates of 70 percent on so-called ``unearned 
income.'' This was the disdain with which policymakers viewed 
investing. They called it ``unearned income.'' The top rate on 
earned income was 50 percent. The Reagan cuts essentially 
``liberated''--a term I used in my testimony--investment and to 
some extent worked. And, indeed, while deficits rose, although 
they did not rise because of these tax cuts, interest rates 
fell. The economy boomed. The contrast between the 1980s and 
the 1970s could not be more stark.
    So, yes, marginal tax rate cuts work. Unfortunately, they 
did go back up over the last 10 or 20 years. Well, we still had 
rates considerably low. So I think that the Bush tax cuts, 
which concentrate on marginal rate reductions are a good idea 
and they are certainly a step in the right direction.
    Chairman King. Mr. Baily.
    Dr. Baily. Just briefly. The late 1970s and the early 1980s 
was a very difficult period. There was very high inflation, 
double-digit inflation. There was then a very deep recession in 
1982. Following that, there was certainly strong economic 
growth as the economy came out of that very deep recession. 
Much of that growth was recovery from the recession and then 
there was some reasonably solid growth after that, in part, 
because a lot of people were coming into the labor force. My 
concern about the Reagan tax cuts--by the way, I think 70 
percent margin tax rates are too high--was they were too large, 
they were based on an unrealistic view of how much expenditure 
was going to be cut and so there were very large deficits. 
Those did increase interest rates relative to what would have 
occurred otherwise.
    They disrupted financial markets, the international 
exchange markets and we ended up with a big trade deficit, so 
we actually were borrowing overseas to cover those deficits, 
which is not what we are doing now. We are borrowing overseas 
today to cover private investment. Then we were borrowing to 
cover Federal deficits.
    And the other thing to keep in mind is that productivity is 
really a key to whether you can keep expansions going or 
whether limits are going to arise. Productivity slowed after 
1973 and it really did not accelerate in the 1980s. It stayed 
at a very mediocre pace. The idea that large tax cuts would 
liberate higher productivity. That did not happen.
    Chairman King. Mr. Kudlow.
    Mr. Kudlow. I'll just sign on to what Mr. Glassman 
mentioned in aggregate terms. I will make a wee bit of a 
follow-up to my friend, Martin Baily, that in my view, and I 
guess I was there in OMB counting numbers, some days were 
better than others in those days. The single biggest source of 
the cyclical budget deficit was the rapid deceleration of 
inflation, which we did not build into our numbers, because 
when Jerry Jordan and Craig Roberts and--Jerry and I said, if 
the Fed could get inflation down in a year or two, no one in 
Washington agreed with us.
    People hauled out their Phillips curves and told us this 
will take 8 or 10 years. You probably could never get inflation 
down. It was rising upward to 12 to 15 percent on the CBI. And, 
Mr. Voelcker, who was a very heroic Fed chairman, if unpopular, 
he was heroic, took the inflation rate down from the 12 to 15 
percent peak to 2 to 3 percent inside of about 18 to 24 months.
    And anyone who knows how the budget works knows that 
revenues are estimated from the rate of rise in nominal GDP, 
which is representative of national income. And the rate of 
rise in nominal GDP was collapsed in the early 1980s. So the 
inflation sponsored revenue increases that we had lived on for 
the prior 10 or 12 years evaporated and they did so in an 18- 
to 24-month period. That was the single biggest source of the 
deficit.
    I actually, with all respect in looking at the numbers, 
would note that although the Congress may have spent too much, 
``aggregate spending,'' totals from the Congress in the 1980s 
were not significantly different from the aggregate spending 
totals provided by the Reagan Administration.
    The priorities were different. But the aggregates were 
remarkably similar. And so I have never taken the view that 
deficits were caused by too much spending. Indeed, the Federal 
share of GDP began to fall in the 1980s and it intensified in 
the 1990s, a good thing. But my point is, it was rapid, rapid 
disinflation. And it wasn't--we had to do it, whatever, that's 
what happened.
    The second point is, we had trade deficits for 20 years. 
The best way to cure a trade deficit is a recession. The only 
time we went close to trade surplus was 1990-91, which was our 
last recession. And I don't agree with Martin, foreign capital 
has been flowing into the United States for 20 years, because 
we've had the highest investment rate of return. And that's one 
of the reasons our productivity rates are so high.
    And I'll just add, Mr. Chairman, I have never seen 
empirical evidence, I have never seen empirical evidence 
whether it's regression analysis or any other statistical means 
that proves a relationship between deficits and interest rates 
or debt and interest rates for the U.S. economy. For other 
economies, particularly in Latin America and Asia, yes. For the 
U.S. economy I've never seen it. And I gave a paper to this 
effect at the American Enterprises 2 or 3 weeks ago.
    Chairman King. Mrs. Maloney.
    Mrs. Maloney. Thank you, Mr. Chairman and I would like to 
welcome all of our panelists, particularly Mr. Larry Kudlow who 
is from the great State of New York and actually a neighbor on 
93rd Street.
    Mr. Kudlow. In your district.
    Mrs. Maloney. Absolutely. And, Mr. Glassman, it's so 
wonderful to meet you in person and not your website or one of 
your many TV appearances.
    And I would particularly like to welcome Dr. Martin Baily 
from the Institute for International Economics. Dr. Baily 
served as Chairman of President Clinton's Council of Economic 
Advisors. I truly believe that one of the reasons that we had 
the economic successes during the Clinton Administration, 8 
years of sustained economic growth, was the high level of 
people who served, particularly in the financial services area 
with Rubin, Summers and Dr. Baily at CEA. So I welcome you and 
I thank you for coming. I do appreciate it.
    I would first of all like to ask Dr. Baily to respond to 
Mr. Kudlow's remarks about the so-called ``tax cost of 
capital'' that we need shock therapy to reduce rates and 
capital gains in the economy. And also his comment that 
deficits are not caused by spending, but by other factors and 
that the way to cure a trade deficit is through a recession. I 
would just like to hear your counterpoints on that.
    Dr. Baily. Cost of capital, the second one was?
    Mrs. Maloney. His statement that deficits are not caused by 
too much spending.
    Mr. Kudlow. Deficits in the 1980s.
    Dr. Baily. Well, the price-earnings ratio in the stock 
market is one element in the cost of capital. What I would do 
is put this somewhat more into a historical perspective. We had 
had a tremendous run up in the stock market. If you look back 
historically the price-earnings ratio might have been around 12 
and then it got up to 33 and now it is back down a little bit. 
You may recall that Chairman Greenspan talked about 
``irrational exuberance'' in the stock market. I think the Dow 
was around 6000 at that time. So we just had an enormous 
increase in the stock market which went beyond any good 
estimates of what earnings growth was likely to be to sustain 
it. So there has been a correction. I'm not going to forecast 
where the market is going to go in the future, but I think we 
have seen a correction, a necessary correction to get a little 
bit more realism into the market. And the market is still very 
strong in terms of its overall level. I would not regard it as 
providing a significant barrier to investment.
    The problem with investment right now is the overinvestment 
that took place in the boom. Companies now need to get back on 
track as we restore growth; which I think we can do.
    As to the deficits in the 1980s, it's a matter of 
arithmetic. A deficit is the difference between what we take in 
and what we spend. So it can be affected by both sides of that 
equation.
    What happened in the 1980s was that we promised that there 
were going to be bigger cuts in spending or that spending was 
going to be controlled, in a way that did not happen. For good 
reason. A lot of programs people want to have in place.
    Another thing I mentioned about the 1980s is that although 
there were significant cuts in income tax rates, there were 
increases in payroll tax rates, so that a lot of people at that 
time did not experience a tax cut. And looking forward, as I 
mentioned in my testimony, the share of discretionary spending 
in GDP has been going down. It went down significantly from FY 
1992 to FY 2000. Given the need for a strong defense, given the 
kind of investment programs in technology that are helpful to 
growth into the private sector, you have to take a realistic 
look at how much further squeeze there is likely to be on 
spending. Then think of the tax cut in that context and what we 
can sustain and still keep the surpluses going.
    I don't know what to say about this recession reducing the 
trade deficit. Technically it does. If everyone stopped 
spending then they would stop buying from overseas. But I don't 
think Larry Kudlow believes we should induce recessions to cure 
the trade deficit. What we need to do is to find a way to make 
sure that we sustain the level of national savings. We can do 
this by increasing private saving and maintaining public 
saving. This would bring more of a match between what we 
produce and what we spend. That's the way to reduce the trade 
and foreign account deficit.
    Chairman King. The gentleman's time has expired.
    The Chairman of the full committee, Mr. Oxley.
    Mr. Oxley. Thank you. Mr. Chairman, let me welcome our 
distinguished witnesses whom I've followed for a number of 
years and appreciate their contribution to the debate. Let me 
begin.
    Mr. Kudlow, you mentioned that consumer spending tends to 
or continues to be relatively robust, if I don't misquote you 
or misstate it, and yet most economists tell us that two-thirds 
of our economic growth is consumer spending. If that is the 
case and we still have this robust consumer spending, then why 
are you telling us that the economy continues to falter?
    Mr. Kudlow. Well, because consumer spending is almost 
always roughly two-third of GDP, whether the economy is rising 
or falling. That's just the way the arithmetic works. At the 
margin, however, it is highly unusual for consumer spending to 
lead a downturn. It is almost always--the downturns are almost 
always found in the investment side of the accounts, either 
inventories or production or gross domestic investment. That's 
what causes swings in business cycles.
    Now, we have had periods, particularly in the late 1970s, 
early 1980s, when the inflation rate was so high that almost 
definitionally, logically, real consumer spending fell and it 
had as much to do with the gigantic boost of inflation as it 
did the actual drop in the volume of sales. And, actually, 
right now there's a little risk here depending on how one 
measures it.
    In recent months, the last 3 months, the increase in retail 
sales, which is a smaller component of consumer expenditures, 
that increase is just barely keeping up with the inflation 
rates--CPI. It's mostly energy and natural gas-related. But, 
yeah, that's the reason. PCE just, you know, is always whether 
the economy is up or down. It very seldom turns negative. When 
it does we are in a heap of trouble.
    Mr. Oxley. Let me ask Mr. Glassman if he agrees with that 
general viewpoint?
    Mr. Glassman. I do Mr. Chairman.
    Mr. Oxley. And, Dr. Baily?
    Dr. Baily. You made a valid point, which is that 
consumption is a big part of the economy and since it's 
continuing to grow, that's an optimistic sign that we should be 
able to get through this period without recession, even though 
there is a risk of recession.
    Mr. Oxley. I've heard many people opine on the question of 
whether, in fact, the stock market is really the economy and 
I've heard a number of people say, that indeed the stock market 
is not the economy. Let me ask you Mr. Kudlow, that is the old 
adage that the market is predicted viable the last three 
recessions, don't you concur that the stock market is totally 
separated from the economy?
    Mr. Kudlow. No.
    Mr. Oxley. Well, let me ask Mr. Glassman, do you agree with 
that?
    Mr. Glassman. That the stock market is separated from the 
economy?
    Mr. Oxley. Yeah.
    Mr. Glassman. No, not at all. In fact, the stock market 
frequently tells us what the economy is going to do next But 
there are major feedbacks, and I think this is what Larry was 
saying, that when people feel that their wealth has declined as 
a result of a sharp decline in the stock market, even if they 
don't plan to use their 401K plan for another 20 years, they 
cut back and it's not good for the economy. There are 
definitely feedbacks.
    Mr. Oxley. Well so far as though we haven't seen that.
    Mr. Kudlow. Oh, yes, we have, we've seen it. We've seen a 
slowdown, it's just not a feedback on consumption. It's a very 
nominal fee. I never bought into the consumption wealth, stock 
market wealth view that Mr. Greenspan has.
    Mr. Oxley. You never bought into the wealth effect concept?
    Mr. Kudlow. Which Mr. Greenspan himself has recently 
abandoned. My point is the accepted point, different point. In 
corporate finance terms movements in the stock market affect 
the cost of capital and the returns to capital, and that runs 
right through entire investment process.
    In other words, the market is integrated to the economy, 
because people in business, men and women in business, have to 
make basic capital decisions, to invest or not to invest and 
I--buying stock in their own companies. And they do that, in 
large measure, based on capital cost which can be looked at in 
terms of interest rates as well as taxes. There's a tax cost of 
capital and an interest cost of capital.
    What we've had in the last 12 months is a plunge in the 
market, an increase in capital costs and we've had a 
significant slowdown of investment spending in the economy. So 
there's your link, it runs on the investment sides, not just 
the consumption or down side.
    Mr. Oxley. Thank you. My time has expired. Thank you, Mr. 
Chairman.
    Chairman King. Thank you Mr. Chairman.
    The gentlemen from California, Mr. Ose.
    Mr. Ose. Thank you, Mr. Chairman.
    Dr. Baily, I want to explore something. Looking at your 
written testimony under the summary.
    Dr. Baily. Yes.
    Mr. Ose. Down at the bottom you talk about a tax stimulus 
package for a very large, long-term tax cut. The first point is 
that the tax package is likely to have a modest effect on 
current short-term weakness, and then your second point is that 
a very large long-term tax cut that phases in gradually over 
the coming years is the wrong approach to deal with a temporary 
economic slowdown.
    My question is, if we reversed the hypothesis--that is that 
a tax increase package is likely to have only a modest effect 
on the current short-term accounting, how long of a lag do you 
envision in that impact? Is it 6 months, is it alleviated in 18 
months?
    Dr. Baily. We're talking about a short-term, immediate 
package?
    Mr. Ose. That's my first question, yes. If a tax stimulus 
package is only going to have a modest effect, how long before 
we get to that effect?
    Dr. Baily. If it went into affect immediately, I would 
expect its' impact to be fairly quick. Of course, people have 
to feel it in their after-tax incomes, so you have to get it 
through Congress and signed. If it were a tax rebate then 
people would get it right away. If it's a reduction in rates, 
then it would take a while before people would actually feel it 
in their household after-tax income. But the impact would 
certainly be 6 months or so.
    Mr. Ose. Would that be the same in your comment about the 
very long, large, long-term tax cut is the wrong approach to 
deal with temporary economic explosion. Is it your point that a 
very large, long-term tax cut should be oriented toward a very 
long-term economic prosperity?
    Dr. Baily. That's correct. And that long-term tax policy 
should be geared toward maintaining economic prosperity. We 
obviously have disagreement here. Many of the witnesses or 
Members of the subcommittee believe that the tax cuts are a way 
to get prosperity.
    The argument that I am making in this testimony is that 
running surpluses and maintaining fiscal discipline is the best 
way to continue the prosperity. Either way, leaving aside that 
difference, the setting of long-term tax rates should be based 
on the goal of long-term prosperity.
    Mr. Ose. So your point is that, it takes almost a 
triangulated approach between fiscal policy, monetary policy 
and tax policy to make the economy right?
    Dr. Baily. Yes.
    Mr. Ose. Well, we passed a tax cut here in the House and 
the Senate last August and the President vetoed it. Can you 
give me some indication as to why he said that we don't need it 
and now 6 months later we're clearly in an economic downturn?
    Dr. Baily. Well, it was a large tax package, it was long 
term and the President believed--and his economic advisors 
believed--that this would undermine the fiscal discipline which 
we felt had brought us the very strong prosperity or 
contributed to it. The private sector obviously is the prime 
mover there. That was the reason that the tax package was 
rejected by the President.
    He also had some concerns about the distributional effects 
of that tax cut. He felt that if you were going to have a tax 
cut it should be that more of the tax relief should go to 
lower-income families.
    Mr. Ose. If I might follow up on that. I know by that time 
Mr. Rubin had left the cabinet. I'm curious. Did the President 
or anybody ever visit with Mr. Rubin about his perspective on 
that proposal?
    Dr. Baily. Well, I was not party to private meetings, but I 
know he respects Mr. Rubin's opinion and I imagine he continued 
to consult with Mr. Rubin. But I have no personal knowledge of 
that.
    Mr. Ose. Thank you, Mr. Chairman.
    Chairman King. The gentlemen from Connecticut, Mr. Shays.
    Mr. Shays. Thank you. I appreciate you holding this 
hearing. This is fascinating stuff. It's fun to be on the 
Budget Committee and look at these issues a little differently. 
But let me first tell you from my budget experience, I thought 
that one of the reasons we eliminated rapid--was that we wanted 
Government to get off the spending at least during the 1970s 
and the 1960s, so to say that the 1980s wasn't any different to 
me, it was, that's the shame of it, it was supposed to be 
different. And I just make that observation.
    But my first question is this, there must be different 
types of investment spending, because I have trouble Larry, Mr. 
Kudlow, with the concept that inventory has been down, you 
know, that's the area of focus, excuse me, inventory has been 
up, spending of inventory has been down. The reason why 
spending of inventory went down was that there was no consumer 
spending eating up that inventory.
    Mr. Kudlow. Actually, most of the weakness on that side is 
from business, decline in business spending of the inventory.
    Mr. Shays. No, this is not----
    Mr. Kudlow. And when I refer to investment, Chris, or Mr. 
Shays, I'm talking about investment in structures and 
equipment. Yes, we're having an inventory correction, but I 
kind of pushed that aside. We get inventory pressures from time 
to time, so I'm not----
    Mr. Shays. Mr. Glassman, your article is fascinating. One 
of the interesting things about that, I got excited when we 
coupled Social Security--the debt reduction, because it was 
based on just spending. And also, we only had three options, 
basically, we condition spend it, or we can provide a tax cut, 
or we can pay down debt. Those are the three basic areas that I 
see my ability in Government. And so I guess the question I am 
asking is, has it been a healthy way for us to cut down 
spending, by suggesting some of this surplus go to get out of 
debt, and so isn't it a question of how much debt we could 
have?
    Mr. Glassman. Well, I think the objective is defensively to 
stop spending. The best way to do is by stopping the flow of 
tax revenues into Washington through a tax cut. I think that's 
a much better way to do it than retiring the debt.
    Mr. Shays. But we all are trying to be somewhat practical 
here, I mean, its my choice then that we go this way, do you 
agree that having a tax cut, may be even larger. Once we got to 
that point the choices in the last 3 days and in debate was 
spending more on a tax cut and there is a lot of interest in 
spending. I mean, we're right about the caps----
    Mr. Glassman. I agree. And spending more, first of all, I 
want to say I think Martin and I were--and certainly Larry, 
more than I--were among the few who saw these surpluses 
developing 4 or 5 years ago. And my great fear was exactly 
what's happened over the last couple of years, which is, it has 
spurred Congress to bigger spending increases in the last few 
years than we've had since the 1970s. How to stop that?
    I think really the only way to do that is through a tax 
cut.
    Think about this: the Congressional Budget Office, in the 
January 31 report, says that by 2006 we are going to have paid 
off all the debt that we can pay off. It will all be gone, and 
then we are going to start what the CBO calls ``uncommitted 
funds.'' They had to actually invent a term for this, which is 
money flowing into Washington that can't go to pay off the 
debt, because it's already paid off.
    Mr. Shays. It's going to be spent at this moment, my 
concern is----
    Mr. Glassman. Exactly. It is going to be spent and so we 
need to reduce that flow and, by the way, it would also help 
the economy to reduce that flow through a tax cut.
    Mr. Kudlow. I mean, if debt retirement were going to stop 
spending----
    Mr. Shays. You need to get closer to the mike. But make it 
short, if you could.
    Mr. Kudlow. If debt retirement was the path to lower 
spending, then it would have been the path to lower spending. 
But it hasn't been. We've been retiring debt--spending more.
    Mr. Shays. Let me just say, if we were not retiring debt we 
would be spending more. I mean that is the challenge.
    Mr. Kudlow. Maybe, I mean maybe. All I'm saying is----
    Mr. Shays. Well in my 13 years here, you know, I just see 
it's too darned easy. And my Republican colleagues are willing 
to spend as much my Democrat colleagues.
    Mr. Kudlow. Well, all I'm saying is that we have been 
retiring debt in the last couple of fiscal years and as an 
experiment we have not, this is not spending increases. That's 
all I'm saying.
    We're not spending all of it. We are retiring debt at a 
rate of $1 billion per businesses day. It's quite amazing. But 
if we were not getting that money flowing into Washington, then 
there would not be any conditional spending and there would not 
be as much debt retirement.
    Mr. Shays. We're going to have a few more rounds, yes?
    Thank you.
    Chairman King. Mr. Grucci.
    Mr. Grucci. Thank you, Mr. Chairman.
    First let me acknowledge some of the students that are here 
from the eastern end of the first congressional district. 
Welcome and I hope you're find this enlightening, because I 
certainly am.
    Mr. Kudlow, you have testified that capital gains reduction 
is helpful to the economy. And if you do believe that and I 
happen to agree with that same philosophy, if you do agree with 
that and you have stated that you do believe that it does work, 
to what level should it be lowered or should it be eliminated 
completely? And if it is eliminated or lowered, to what impact 
do you see that having on the economy, the projections, the 
surpluses that are materializing or for us to keep on course 
through our current tax plan, budget that was outlined so far?
    Mr. Kudlow. You know, there are two Presidents who have 
resided over significant reductions in capital gains. One is 
Ronald Reagan and the other is Bill Clinton, and they both 
enjoyed tremendous economic success through the process. And 
both times the revenues generated from capital gains went up. I 
have a chart in my testimony on the Clinton capital gain 
effect. So I think we have a lot of evidence, it's a good 
thing.
    Now, you asked what the right rate is, I'm not sure I have 
all that listed. We're talking about a general tax reform and 
simplification plan, which is something I devoutly desire. It 
might be possible to eliminate cap gains or perhaps drop it to 
something around 5 or 10 percent. It is currently, as you know, 
20.
    I don't know, I think right now dropping it from 20 to 15 
would be an enormous help to the deteriorating investor 
spirits. It would aid the return on capital, it would help 
offset the higher cost of capital. All of which I think are the 
biggest issues right now from the economics spectrum.
    Mr. Grucci. Thank you. If I have time left, Mr. Chairman, 
I'd appreciate the other panelists' position on that same 
question.
    Mr. Glassman. Well, let me just add another perspective to 
this, and that is that one of the problems with a high capital 
gains tax rate, that's what we have right now, is that it 
misallocates capital. People tend to hold onto their 
investments, even when they are not good investments, because 
they do not want to take--they don't want to be hit by the 
capital gains taxes. And I think that's one of the problems we 
ran into in what a lot of people consider a tech bubble. People 
have built up gigantic gains in stocks that they probably had 
come to realize were not necessarily very solid companies. And 
without really being able to get out of those stocks without 
being penalized by a high capital gains rate, moving that money 
into probably better uses for that capital. So that's one of 
the big problems that capital gains, high capital rates cost 
us.
    Mr. Grucci. Thank you.
    Dr. Baily.
    Dr. Baily. A moderate tax on capital gains is appropriate. 
It's fairly easy, well, not fairly easy, it's certainly 
possible for many people to shift whether they receive income 
as general income that's subject to the ordinary income tax, or 
whether they receive it as capital gains. If there is no 
capital gains tax at all, there's a danger that this becomes a 
way of avoiding taxes altogether. I would suggest that we have 
a reasonable capital gains tax rate.
    The rate that's in place now--during this period there has 
been a tremendous investment boom. There has been almost too 
much money floating out to people with fairly vague business 
plans. The capital gains tax that we had in place in this 
period has certainly not been associated with a particular 
shortage of capital.
    Mr. Kudlow. But the only--if I could just----
    Mr. Grucci. Sure.
    Mr. Kudlow. As a tax reform as someone that has long 
advocated flat tax type reform, my criteria is that income be 
taxed only once. And when you get into capital gains and other 
forms of saving and investment taxation, there is multiple 
taxation and that renders the system a lot.
    Mr. Grucci. I must say, I share your opinion on taxes--for 
the American people.
    Thank you, Mr. Chairman, I yield back the remainder of my 
time.
    Chairman King. Thank you, Mr. Grucci.
    Ms. Hart--I'm sorry, Dr. Paul.
    Dr. Paul. Thank you, Mr. Chairman. I want to direct my 
questions and comments to Mr. Glassman and Mr. Kudlow. But 
basically I think I'm in agreement with much of what you say, 
because I'm a strong proponent that we ought to get taxes down, 
the sooner the better, the more the better. I also think that 
we ought to cut spending and cut regulations all to help the 
economy. And the more the better. I wanted to make just a 
comment about the surplus, where I have some slight 
disagreement. I don't really want to dwell on that as I do 
think that we should be concerned about the obligation of the 
Federal Government and that has not been shrinking.
    The only thing that shrinks is the marketable debt. So we 
have a tremendous obligation, whether it's considered debt or 
whether it's considered the national debt, the official 
national debt actually hasn't shrunk. And those numbers may 
well change in a recession, because at the peak of the market 
our assumptions are wrong, but we have more revenues than we 
think. At the bottom it's the opposite, we have a lot less than 
we assume. So I think that is a future problem.
    But I want to talk more about and get you to comment on 
monetary policy and interest rates. Because you seem to accept 
the definition that most everybody here accepts as the 
definition of inflation. That is, if you look at CBI and the 
CBI doesn't go up, there's no inflation. And I disagree with 
that. Because from the Austrian viewpoint, you look at the 
money supply. And the money supply is increasing significantly.
    If you look at MZM right now, which is the best measurement 
of the money that's available for spending, it is currently 
going up at a 28 percent rate. So there's a lot of money there, 
and that to me is inflation. And even to argue that we have no 
inflation by the CPI and the PPI, we can look to--which you 
admit we have rising prices, services are going up rather 
quickly, medical fees are going up, education costs are going 
up, the cost of housing is going up and something nobody wants 
to put into the cost of living are taxes. So these are all 
going up.
    So I think there's tremendous inflation and an Austrian 
economist would also include the inflated prices in the stock 
market. And when you have excess credit floating out there, 
people do dumb things. They develop overcapacity and 
malinvestment, and they ``over-speculate.''
    So instead of arguing that we lack capital, and lack money, 
I would say the opposite is true. We've had way too much.
    Greenspan expressed a concern in 1996 about the stock 
market, and since that time he increased the money supply by 50 
percent and M3 went up over $2 trillion. And, again, the attack 
on the Fed for not addressing this quickly enough and 
forcefully enough, we failed to remember that raising interest 
rates aren't always that harmful immediately.
    In 1994 to 1995 he raised interest rates 7 times. We didn't 
have a recession. Nobody was hollering and screaming. But right 
now he raised them and the market is ready to correct from all 
the inflation. So I would say that it's a serious mistake not 
to recognize that it's the mischief of the Fed that's causing 
it--which you might agree with--but you're saying, ``Well, what 
we need is more money.'' Under capitalism, capital comes from 
savings. But we have no savings. We say, ``Oh, no, the stock 
market is up and that's life savings.'' Well, does that mean 
that we lost $4 trillion worth of savings in the last year? 
It's because we have no savings.
    And I don't see how you can solve the problem of inflation 
with more inflation. It seems like the only debate that goes on 
here is how wide the spigot should be. Should it be coming 
faster or slower? And when you come up with the inevitable 
slump that always comes from the inflated monetary system, the 
money supply, then the only answer is, well, you didn't inflate 
fast enough, or you turned it off too soon.
    I would ask you to comment on those remarks.
    Mr. Kudlow. Well, you covered a lot of ground, Congressman. 
Let's see, I'll try to--I used to be a fairly devout reader 
of--and, as I recall, he measured the value of money based on 
commodity indexes and gold, both of which have been generally 
falling in the last 20 years. I think that's about right. We've 
been in a disinflationary environment bordering on deflation. 
So that's my basic comment.
    Technically I think you're confusing money supply with 
money demand. People are front loading their money into 
institutional and retail money market funds. That's a classic 
signal of the lack of confidence in the market and the economy. 
So as a result, MZM is rising rapidly. But that's a function of 
the increased demand for cash and typically in an atmosphere of 
declining interest rates, the opportunity--cash has come down 
quite a bit. It is not a healthy economic sign. The only money 
the Fed controls is the money they create, which is bank 
reserves and that continues to decline, and that's a 
deflationary signal. And I would hope that this subcommittee 
would explore these issues, because I believe Federal Reserve 
policy needs to come under much greater scrutiny.
    Dr. Paul. My time has expired.
    Chairman King. Thank you, Dr. Paul, for your questions and 
for being an honorary panelist.
    Ms. Hart.
    Ms. Hart. Thank you, Mr. Chairman. I actually don't have 
any questions for the panel, but I do want to thank them for 
coming here and discussing this issue as we continue to debate 
these issues as the actual full Congress.
    Chairman King. I thank the gentlelady.
    Do you have time for one more round? There are some more 
questions that I would like to ask.
    I would just to ask on question. Addressing the whole, what 
I call ``class warfare'' about how too much money--that the tax 
cut plan cuts too much for the top level. My understanding is 
that when Reagan came in, in 1970, the top rate was 70 percent, 
now it's 39. It went down further at one time. Still it's gone 
from 70 to 39, and yet the people at that top rate in 1980 were 
paying 18 percent of total revenues, now they're paying 30 
percent of total revenues, which seems to indicate that as we 
reduce the rate at the higher level they actually end up paying 
more.
    Now, maybe I have that backward, and I really would ask 
that you clarify that, or is that accurate?
    Mr. Glassman. Mr. Chairman, that is exactly accurate. The 
thing I would just add about the top bracket, it's very 
important to understand is that the majority of businesses in 
American are sole proprietorships or partnerships. So they are 
taxed, most of the ones that are doing half decently, at that 
top rate. So we are not just talking about rich individuals, we 
are talking about most half-decent sized American businesses.
    Chairman King. Now, these are Sub-chapter S companies?
    Mr. Glassman. Right. So we are talking about Sub-chapter S 
corporations, partnerships and sole proprietorship, and LLPs. 
So that is the majority of American business. That's the rate 
that they're being taxed at, 39.6.
    If you take the rate down a little bit, you'll have a big 
impact on those folks who tend to be very entrepreneurial, it 
will increase the flow of capital to those businesses and it 
will increase investment and work. So its very important.
    But your original point is very well taken. It is also, of 
course, one of the political difficulties of cutting marginal 
rates. The top 1 percent of earners pays 34 percent of the 
Federal income taxes.
    So any time you're going to have anything that's close to 
an across-the-board tax cut, obviously people who pay most of 
the taxes are going to get the biggest benefit in terms of 
absolute dollars. Not in terms of percentage. In fact, the Bush 
tax cut gives the biggest percentage cuts to people in the 
lower brackets.
    Mr. Kudlow. I just think that--I'm sorry.
    Chairman King. Go on, Mr. Kudlow.
    Mr. Kudlow. I just want to make an--you know, I think--the 
bottom rate is consumption and the top rate is capital. I mean, 
that's really how our system works.
    Mr. Shays. Say that again?
    Mr. Kudlow. he bottom rate is consumption and the top rate 
is capital. That's really how it works. And, you know, I think 
you've got some political forces who want to ease the tax rate 
on the consumption and others want to ease the tax rate on 
capital or investment. You know, you can do both. That's what 
the beauty of across-the-board rate reduction is. It just 
occurs to me. I mean, Martin Baily was talking about, you know, 
if you pass a tax cut it will take effect on the economy pretty 
quickly. And it just strikes me that two things happened here 
and they merged together as some of the arguments.
    Number one, if you lower tax rates across the board, the 
IRS will make the adjustment to the polling rates, and in this 
case it's a downward adjustment. Well, that includes cash flow. 
So in that sense it's consumption oriented. But it also changes 
the incentive system, because the extra dollar will be taxed at 
a lower rate, which provides for greater reward for work effort 
and investment capital decisions. So both work together. You 
also get the benefit of dropping investment costs. But my point 
is, supply siders argue the rate reduction, because it affects 
behavior through a better reward system. Well, I think we need 
that after the Fed has eviscerated the stock market. You know, 
it's time for some rewards. But, also, if people are 
concerned--fine, because their cash flows as Jim Glassman 
indicated, their cash flows will benefit. It's win/win. But if 
we choose one or the other, I think you're leaving the realm of 
economic policy and you're going to the realm of social policy. 
That's what I think. And, you know, I think right now we need 
economic recovery policy, not social policy.
    Chairman King. Dr. Baily.
    Dr. Baily. If I could just make a quick comment. We want 
people to be successful and those who are successful make 
money. That's great for America. And, as we said, many of them 
are in small businesses, some of them are large businesses. The 
reason the proportion of tax revenue paid by people in the top 
brackets has risen is that the economy has done so well. There 
are more people moving up into higher brackets. Also, there has 
been some widening of the income distribution. Certainly as you 
look at taxable income, the distribution has widened. Many of 
the benefits of this very strong expansion have gone to people 
in the upper income brackets and they have then paid the tax 
rates that apply to that group.
    We were just talking about the availability of capital. 
Most of the capital that is generated in our economy comes from 
retained earnings of corporations. Corporations do pay taxes, 
although the proportion of revenue coming from corporate taxes 
has gone down. The availability of capital for investment is 
largely generated by internal funds from companies or may be 
subject to the capital gains tax rate which is lower.
    Chairman King. Thank you.
    Mrs. Maloney.
    Mrs. Maloney. Dr. Baily and the rest of the panel, many of 
my colleagues are comparing the Bush tax cut plan to the 
Kennedy-Johnson tax cut of 1964. The Kennedy-Johnson plan cut 
the highest tax rates from 91 percent to 70 percent, thereby 
tripling the benefit of each dollar an individual earned. The 
highest bracket decrease proposed by the Majority would go from 
39.6 percent to 33 percent. While this overwhelmingly skews the 
benefits of the overall package to the wealthiest taxpayers, at 
the same time there's only an 11 percent less tax burden for 
those taxpayers. Is this plan truly comparable to the Kennedy-
Johnson tax cut, would you say, or--and would you add, would a 
reduction in the estate tax be an effective economic stimulus? 
Dr. Baily and then Mr. Glassman and Mr. Kudlow, your comments.
    Dr. Baily. One can exaggerate the similarities with the 
Kennedy tax cut. I agree with the point that you made that 91 
percent is a pretty absurd rate of tax. It was actually 
appropriate to cut that rate; 70 percent was still pretty high. 
Once you get up to 91 percent, you're going to get some 
distortions. Bringing that rate down is a very appropriate 
thing to do.
    The parallel being made is that tax revenues rose after the 
tax cuts were enacted. This was because the economy had been in 
a recession in the early 1960s--there was a double-dip 
recession--and as it recovered, there was high growth in the 
economy. It may well be also, going from 91 to 70 percent, that 
there were effects on the incentive side. Most of what happened 
was the cyclical strength, which then went too far as 
expenditures on the Vietnam War increased and the economy 
became overheated.
    The tax rate reductions that are being proposed now, to the 
extent they have incentive effects, those would be 
substantially smaller. But on the overall point: We should set 
our tax rates with an eye to what's the reasonable burden that 
people should pay relative to what the level of spending that 
has to be financed. The incentive effects, most careful 
analysis suggests, are fairly small to making moderate 
adjustments in tax rates.
    Mr. Glassman. I'm not sure if the implication of your 
question is that the Bush tax cuts are too small. I would 
probably agree with that. Certainly the Kennedy----
    Mrs. Maloney. I think he answered it pretty clearly. Would 
you say a reduction in the estate tax, do you feel that would 
be an effective economic stimulus?
    Mr. Glassman. It's not on the top of my list. In other 
words, I don't think the estate tax has a big economic effect. 
It has some. The main effect is a lot of money flowing to 
lawyers and accountants so that people can set up a system 
where they don't end up paying the tax. It's very inefficient--
one of the many inefficiencies in the tax code.
    Mr. Kudlow. It's in the second tier of my wish list.
    Mrs. Maloney. What effect do you think cutting the estate 
tax would have on the economy? Do you think it would be an 
economic stimulus?
    Mr. Kudlow. Yes. I think it's pro capital formation, 
absolutely. I think the measuring those effects, however, are 
not easy, because so many people today don't pay because of 
what Jim said, you've got the diversion of accounting and legal 
financial planning industry, which is there precisely to set 
up, I might add, highly successful avoidance schemes.
    I just wanted to mention on the question you asked Dr. 
Baily, you and I have gone back and forth on this for many 
years, lower marginal tax rates are lower marginal tax rates. 
And what President Kennedy proposed is, in terms of structure, 
identical to what President Reagan later did and what President 
Bush is doing. And I might add what President Clinton did in 
the mid-1990s. Income distributions are different, inflation 
rates are different, tax brackets and so forth are all 
different. But lower marginal rates are lower marginal rates. 
And Coolidge, Kennedy, and Reagan and Clinton did it in the 
20th Century. Every time economic growth followed.
    Mrs. Maloney. But after the Reagan tax cuts, Mr. Dole came 
forward and had to increase taxes, because the deficit was 
going up and was reacting to cuts that were too much.
    Mr. Kudlow. The deficit went down.
    Mrs. Maloney. And possibly we would have Republicans having 
to raise taxes if this $1.6 or $2.2 trillion goes through.
    Mr. Kudlow. Well, you and I might disagree about the 
history of the 1980s.
    Mrs. Maloney. Did Mr. Dole raise taxes roughly $300 million 
after the Reagan tax cuts?
    Mr. Kudlow. We did not change income tax rates. That's the 
important point. Income tax rates were lowered in the 1981 
bill, implemented over a 3-year period and they were never 
raised. No.
    Mrs. Maloney. Well, where did the Dole tax increase come 
from?
    Mr. Kudlow. The Dole program, and I don't want to single 
out Senator Dole, he didn't have that much power in those days, 
no Senator does. But the fact is, payroll taxes were raised and 
some shifting about in the original corporate tax cut is 
changed. In other words, the safe--releasing was repealed and 
certain depreciation reform was repealed. The individual income 
tax rates, which were brought down, were never raised. And I 
might add, from the full implementation, which was January 1st, 
1983, each and every year individual income tax receipts rose. 
The non-payroll individual income tax receipts rose every year.
    Mrs. Maloney. My time is up.
    Chairman King. Mr. Shays.
    Mr. Shays. Mr. Greenspan said that he supported a trigger 
for surprising--tax cut and I don't want to--he said what about 
spending? He said, well, he would support a trigger on 
entitlements.
    Is there logic to actually--I don't support a trigger, but 
if you had one, couldn't I do the inverse and basically say, 
you've got a great surplus that we need to accelerate the tax 
cut? And if I did that, what would be the negative?
    Mr. Kudlow. Well, I mean, that's an interesting model, 
actually. I had considered that. There probably is merit to 
that. Because I think the lower tax rates, if we're going to 
get better here on the probe and that's actually going to throw 
up higher surpluses which permit a greater tax reform in the 
next decade.
    Mr. Shays. Mr. Glassman.
    Mr. Glassman. I agree with what Larry said. I mean, I'm not 
for a trigger, that's for sure. I think it limits your 
flexibility among many other things, but, if you had one, 
that's not a bad idea.
    Mr. Shays. Dr. Baily.
    Dr. Baily. I'm not too enthusiastic about triggers. The 
concern about a trigger would be that if the economy were 
perhaps beginning to overheat at some future point, it might at 
that point be throwing off larger surpluses. That's part of the 
automatic stabilizer mechanism that helps to prevent that 
overheating. So if you were to trigger greater tax cuts, this 
would be the wrong policy. Similarly, if the economy would go 
into a deep recession, the surpluses would disappear. I don't 
think that would be a good time to increase taxes.
    Mr. Shays. I realize this isn't the Ways and Means 
Committee, but if I asked, in terms of the most important as it 
relates to taxes, stimulus, fairness, inefficiency or--to get 
it off the table, get the money off the table.
    Mr. Kudlow. Stimulus.
    Mr. Glassman. I think I would go for number four first. I 
would say get the money off the table, and then I guess I would 
say stimulus and then efficiency and fairness is a five.
    Mr. Shays. Fairness is the easiest one for us to argue for 
our constituents, so I'm sorry.
    [Laughter.]
    Mr. Shays. Dr. Baily.
    Dr. Baily. I would think efficiency and fairness would be 
the two I like.
    Mr. Shays. I will yield back. Thank you.
    Chairman King. Dr. Paul.
    Dr. Paul. Thank you.
    I think a good marginal tax rate ought to be about 10 
percent. Any person who has to pay more than that--10 percent, 
let's give them 10 percent and then let's work on it. But, of 
course, that involves a spending problem. I want to get back to 
money policy and deflation. I was looking at Mr. Kudlow's chart 
that he gave us, and it shows that the monetary base, the 
reserves monetary base was rising at a 17 percent rate a year 
ago and it evened out and now is at 4 percent. So I would not 
call that deflation. And the rapid rise a year ago, so we have 
a lot of cash floating out there.
    To me, deflation is what happened in the 1930s. The supply 
shrinks, the purchasing power of a dollar goes up. By all 
measurements the supply is going up, the purchasing power of 
our dollar is going down. And commenting again on the panacea 
that everybody looks to that all we have to do is get the lower 
rates and we're going to solve our problem. Just like the seven 
increases in rates in 1994-95 did not give us a recession, 
sometimes the lowering of the rates won't do what they did the 
last time.
    For instance, interest rates are 0 percent in Japan because 
we're not getting a stimulus. As a matter of fact, after the 
depression got going we took interest rates very, very low and 
it was the old story about pushing on a string, it doesn't 
always work. So I do think that this concept of money and 
market policy is still very, very important, because I believe 
it's the mistakes made previously that gives us this mandatory 
correction, to me that just makes the bubble that much bigger.
    But I do want to follow up on a comment Mr. Kudlow made on 
the indicator of the gold price. And I think that the gold 
price could give us a good indication of what was happening, 
except that the gold price is not controlled by the 
marketplace. In the 1960s, we maintained the gold price at $35 
an ounce by dumping gold. Therefore, the gold price was no 
indication at all about what was to come in the 1970s. Finally 
they quit dumping the gold on the market.
    Today, gold is being dumped on the market in a different 
way. Central banks are loaning that gold, that gets dumped on 
the market. And some of those funds are used to buy Treasury 
bills, it props up the dollar at the same time it drives the 
price of gold down. Britain and other countries have literally 
sold hundreds of tons of gold into the market. So I would ask 
whether or not you think this is really a good number to 
follow, a good price to follow, indicating what the market is 
telling us.
    Mr. Kudlow. Well, I wouldn't bet the ranch on any one 
indicator. But gold holds up pretty well over time. As I 
mentioned, in the last 20 years, the weight of the direction of 
gold trends has been deflationary, not inflationary.
    I agree with your other point on interest rates. I 
mentioned that in my opening remarks, interest rates don't tell 
you much about monetary policy.
    However, if you examine that chart I'm glad I got somebody 
to take note of that monetary based chart. Going from 16 
percent growth over a 12-month change to minus 2.5 is one of 
the biggest swings in post-war monetary history. And, by the 
way, going on the other side, going from 5 to 6 percent of 16 
was an inflationary swing in 1998 and 1999. But going from 16.5 
to minus 2.5 in 12 months ended in December 2000. That's 
exactly what we're paying for in this economy. And to say that 
base growth now has jumped a little bit back to 3, 4 percent, I 
don't think the Fed's job is nearly done. And I think somebody 
with a higher paid rate in mind need to evaluate how this all 
developed, because when the monetary authorities come before 
Congress, they do not talk about this.
    Dr. Paul. I think this makes my case that no Fed official, 
bureaucrat nor politician knows how to manage the money 
supply--they're incapable of doing it. And I think these swings 
indicates it. And we have probably too much faith in an 
individual knowing, well, what is the proper interest rate, 
what is the proper money supply believing that they know how to 
turn the spigot on and off. I contend that it's something not 
known and that this has to be decided by the marketplace, but 
we have given up on the market for one half of our economy, and 
that's the money system. And that dictates everything. So we 
are central planners through the control of money supply and 
interest rates, so we are much more into central planning and 
Greenspan is the biggest central planner. So when things go 
well, he's a saint and when they go badly, you know, he's the 
devil.
    Mr. Kudlow. Well, I have made some of the same points, 
Congressman. But I will say this, since we have a Fed and the 
Fed is vested with the authority of open market operations, we 
need to look at what they're doing.
    For some reason, and I'm a keen student of the testimonies 
of central bankers before Congress, for some reason, no one 
goes down this road; no one looks at these issues. Members talk 
about taxes, the budgets, and deficits, and debts and triggers 
and all the rest of it, but there's never any discussion about 
money, which is after all what the Fed controls. And, as you 
know, there's only one interest rate the Fed controls. Well, 
I'm sorry, two. They control the discount rate and then they 
mostly control every other interest rate in the economy is not 
controlled by the Fed. But what they do control is the creation 
of bank reserves. And I wish you would look at that.
    Mrs. Maloney. That's subject matter for another hearing.
    Dr. Baily. Can I make a quick comment on that? Let me first 
of all correct an impression that I may have given in thinking 
that the Fed does it all. That's not my view. The Fed leans 
against the wind. There are natural forces in the economy that 
give rise to ups and downs. Recovery begins as inventories are 
reduced.
    And the other comment is on the change in the financial 
system. The changes taking place in the financial system, and 
the deregulation of the banking system, have made the money 
supply a much less useful measure and that's why most people 
look primarily to the effect of interest rates.
    Chairman King. I would like to thank the entire panel for 
their testimony. Again, as the debate goes forward, I would 
hope that everyone would look at the your comments today, your 
testimony which added immeasurably to the debate. And so I just 
want to thank you for your time and being here.
    I just want to note some Members may have additional 
questions for the panel that they may submit in writing. 
Without objection the hearing record will remain open for 30 
days for Members to submit questions to the witnesses and place 
the responses in the record.
    The hearing is adjourned.
    [Whereupon, at 12:45 p.m., the hearing was adjourned.]

                            A P P E N D I X

                             March 29, 2001

[GRAPHIC] [TIFF OMITTED] T1632.001

[GRAPHIC] [TIFF OMITTED] T1632.002

[GRAPHIC] [TIFF OMITTED] T1632.003

[GRAPHIC] [TIFF OMITTED] T1632.004

[GRAPHIC] [TIFF OMITTED] T1632.005

[GRAPHIC] [TIFF OMITTED] T1632.006

[GRAPHIC] [TIFF OMITTED] T1632.007

[GRAPHIC] [TIFF OMITTED] T1632.008

[GRAPHIC] [TIFF OMITTED] T1632.009

[GRAPHIC] [TIFF OMITTED] T1632.010

[GRAPHIC] [TIFF OMITTED] T1632.011

[GRAPHIC] [TIFF OMITTED] T1632.012

[GRAPHIC] [TIFF OMITTED] T1632.013

[GRAPHIC] [TIFF OMITTED] T1632.014

[GRAPHIC] [TIFF OMITTED] T1632.015

[GRAPHIC] [TIFF OMITTED] T1632.016

[GRAPHIC] [TIFF OMITTED] T1632.017

[GRAPHIC] [TIFF OMITTED] T1632.018

[GRAPHIC] [TIFF OMITTED] T1632.019

[GRAPHIC] [TIFF OMITTED] T1632.020

[GRAPHIC] [TIFF OMITTED] T1632.021

[GRAPHIC] [TIFF OMITTED] T1632.022

[GRAPHIC] [TIFF OMITTED] T1632.023

[GRAPHIC] [TIFF OMITTED] T1632.024

[GRAPHIC] [TIFF OMITTED] T1632.025

[GRAPHIC] [TIFF OMITTED] T1632.026

[GRAPHIC] [TIFF OMITTED] T1632.027

[GRAPHIC] [TIFF OMITTED] T1632.028

[GRAPHIC] [TIFF OMITTED] T1632.029

[GRAPHIC] [TIFF OMITTED] T1632.030

[GRAPHIC] [TIFF OMITTED] T1632.031

[GRAPHIC] [TIFF OMITTED] T1632.032

[GRAPHIC] [TIFF OMITTED] T1632.033

[GRAPHIC] [TIFF OMITTED] T1632.034

[GRAPHIC] [TIFF OMITTED] T1632.035

[GRAPHIC] [TIFF OMITTED] T1632.036

[GRAPHIC] [TIFF OMITTED] T1632.037

[GRAPHIC] [TIFF OMITTED] T1632.038

[GRAPHIC] [TIFF OMITTED] T1632.039

[GRAPHIC] [TIFF OMITTED] T1632.040

[GRAPHIC] [TIFF OMITTED] T1632.041

[GRAPHIC] [TIFF OMITTED] T1632.042

[GRAPHIC] [TIFF OMITTED] T1632.043

[GRAPHIC] [TIFF OMITTED] T1632.044

[GRAPHIC] [TIFF OMITTED] T1632.045

[GRAPHIC] [TIFF OMITTED] T1632.046

[GRAPHIC] [TIFF OMITTED] T1632.047


```