S. Hrg. 108-49

THE ADMINISTRATION’S GROWTH

AND JOBS PLAN

HEARING

before the

JOINT ECONOMIC COMMITTEE

CONGRESS OF THE UNITED STATES

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

January 30, 2003

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JOINT ECONOMIC COMMITTEE

[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]

SENATE HOUSE OF REPRESENTATIVES

ROBERT F. BENNETT, Utah, Chairman JIM SAXTON, New Jersey, Vice Chairman

SAM BROWNBACK, Kansas

JEFF SESSIONS, Alabama

JOHN SUNUNU, New Hampshire

LAMAR ALEXANDER, Tennessee

SUSAN M. COLLINS, Maine

JACK REED, Rhode Island

EDWARD M. KENNEDY, Massachusetts

PAUL S. SARBANES, Maryland

JEFF BINGAMAN, New Mexico

DONALD B. MARRON, Executive Director

(ii)
CONTENTS

OPENING STATEMENT OF MEMBER

Senator Robert F. Bennett, Chairman . . . . . . . . . . . . . . . . . . . . . . . . . 1

Representative Pete Stark, Ranking Minority Member ............3

Representative Jim Saxton, Vice Chairman .....................5

Representative Paul Ryan ..................................6

WITNESS

Statement of the Honorable R. Glenn Hubbard, Chairman, Council of

Economic Advisers ....................................8

SUBMISSIONS FOR THE RECORD

Prepared Statement of Senator Robert F. Bennett, Chairman . . . . . . 30

Prepared Statement of Representative Pete Stark, Ranking Minority

Member . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

Prepared Statement of Representative Jim Saxton, Vice Chairman . . 35

Prepared Statement of the Honorable R. Glenn Hubbard, Chairman,

Council of Economic Advisers . . . . . . . . . . . . . . . . . . . . . . . . . . 37

Prepared Statement of Senator Edward M. Kennedy . . . . . . . . . . . . . 52

(iii)
The Administration’s Growth and Jobs Plan

Thursday, January 30, 2003

Congress of the United States

Joint Economic Committee

Washington, D.C.

The Committee met, pursuant to notice, at 10:03 a.m., in Room 628,

Dirksen Senate Office Building, the Honorable Robert F. Bennett,

Chairman of the Committee, presiding.

Present: Senators Bennett, Collins, Sarbanes, and Reed;

Representatives Saxton, Stark, and Ryan.

Staff Present: Donald Marron, Jeff Wrase, Christopher Frenze,

Robert Keleher, Brian Higginbotham, Colleen J. Healy, Dianne Preece,

Wesley Yeo, Wendell Primus, Chad Stone, Frank Sammartino, Diane

Rogers.

OPENING STATEMENT OF ROBERT F. BENNETT, CHAIRMAN

Senator Bennett. The Committee will come to order. We welcome

everyone here to the first hearing of the Joint Economic Committee of the

108th Congress, and I am happy to have the privilege of chairing the

Committee for the next two years. 

I want to begin by thanking Representative Saxton for the fine work

he did as Chairman in the previous Congress, and I look forward to

working with all of the Members of the Committee, on both sides of the

aisle. I hope we can continue this Committee's tradition of working

together in the utmost courtesy and civility, even though I know we will

also continue the tradition of being very firm in our somewhat differing

views of the economy and policy.

We are pleased to have as our distinguished guest Dr. Glenn Hubbard

from the Council of Economic Advisers (CEA). Dr. Hubbard has served

the President ably for the past two years, and we're grateful, Doctor, for

your commitment to public service.

It is fitting that our first hearing features the head of the CEA,

because the Committee and the Council were created together in 1946.

They have worked hand-in-hand over the years to provide timely, and we

hope objective, economic analysis for our respective branches of

government. My staff and I have enjoyed working with the CEA, and I

expect this cooperation will continue.

As Federal Reserve Chairman Alan Greenspan recently testified

before this Committee, the economy is currently going through a soft

patch, and the lack of robust, sustained economic growth has been a

frustration to everyone.

The proper role of the government in alleviating a sluggish economy

and accelerating the nascent recovery is a difficult one, and it sometimes

seems that there are as many different answers, as there are economists.
2

The primary focus of today's hearing is the Bush Administration's

proposal to boost the economy in the near term and at the same time

provide a solid foundation for long-term growth. The proposal would

accelerate tax cuts that Congress has already approved, moving their

effective dates from future years into the present one, while reducing

marginal rates and eliminating the marriage penalty, increasing child tax

credits, and providing families with some relief from the alternative

minimum tax. 

In addition, the proposal would triple the small business expensing

limit for new capital investment, provide states with funds to establish

individual reemployment accounts, and eliminate the double taxation of

dividends.

This tax cut proposal is a bold one, and one that is sure to increase the

budget deficit in the short-run. However, I do not think that the primary

factor in judging the policy ought to be its impact on the near term deficit.

I think one lesson we've learned in the last 30 years, through both

Republican and Democratic Administrations, and Republican and

Democratic Congresses, is that solid economic growth is a wonderful

elixir for budget challenges. 

In my view, the current budget deficit arises primarily because that

solid growth was interrupted at a time when we had dramatic increases in

spending, much of it brought on by the aftermath of the 9/11 tragedy.

We've seen significant increases in outlays, first for the rebuilding of

New York, then for the war on terror, then for homeland security, and

then for preparations for possible action in Iraq. Singling out the tax cuts

already enacted as the sole cause of the deficit, as some have done, strikes

me as simplistic. Thus, I'm very much interested in how Dr. Hubbard and

his staff believe the President's proposal can get us back on the growth

path in both the short-run, and more importantly, the long- term.

The most ambitious part of the growth package is undoubtedly the

removal of the double taxation of dividends, and I'm sure that many of the

questions today will be about the particulars of this part of the President's

plan. There are many different ways to structure tax reform so as to

eliminate the double taxation of dividends, a pernicious distortion of the

tax code that has been reduced or eliminated in almost all of the other

developed economies. 

I welcome the opportunity to have Dr. Hubbard explain some of the

details of the tax cut and the choices made in constructing the plan.

 We also welcome Dr. Hubbard's thoughts on the current state of the

economy. This morning's GDP report suggests that the economic soft

patch is still with us. We avoided having the fourth quarter dip into

negative territory, so to that extent, this morning's number of a positive

growth of 0.7 percent is good news. Nonetheless, it is substantially less

than we would hope, so to that extent, it is bad news, and it's a

disappointing number.

We need to do what we can to produce more robust and rapid growth

in 2003, as many economists are forecasting we will have, so I will be

interested to learn what Dr. Hubbard has to say and whether or not he
3

shares the enthusiasm that some of the forecasters have and hear his

thoughts on the challenges and risks that face the U.S. economy.

Now with that, I think we will turn to Mr. Stark, who is the de facto

Ranking Member of this Joint Committee, and then we will hear from Mr.

Saxton, who is the Vice Chairman of the Committee. 

After that, I would ask those Members who come to limit whatever

opening statements they might have to five minutes, and then we will go

to – pardon me, opening statements to three minutes – then we will go to

the round of questioning after we hear from Chairman Hubbard, and I

would ask all Members to stay within the traditional five-minute limit.

Mr. Stark, we welcome you to continued service on this Committee

now in your role as Ranking Member, and be happy to hear what opening

statements you might have.

[The prepared statement of Senator Bennett appears in the Submissions

for the Record on page 30.]

OPENING STATEMENT OF REPRESENTATIVE PETE STARK, RANKING MINORITY MEMBER

Representative Stark. Well, thank you, Mr. Chairman, and

congratulations on your prestigious new appointment. Mine, people have

often asked me, what does mean to be the Ranking Member? And I know

it's just like being the parsley on a platter of fish.

(Laughter.)

But I enjoy the privilege and prestige of it and want to thank my

colleague, Mr. Saxton, for his past two years of service to this Committee.

He did a good job, and I know that Chairman Bennett, you will continue

that tradition.

I thank you for having this hearing. All indications are that Dr.

Hubbard was the key architect in this economic plan that's being

presented to us by the Administration, and I'm anxious to hear more about

his ideas and how he would respond to questions and criticism.

Two years after the start of our recession, the economy is still in a

slump. We're not creating jobs. We've got tremendously weak growth in

GDP. Unemployment is at an eight or nine-year high of around 3

percent. And economic growth is miserly if it exists at all.

The economy is not delivering any jobs. We're waiting for business

to start investing and rehiring, and we're hoping that the consumer will

start spending so we don't slip into a deeper recession.

I wish I could say that the President had presented us a plan that

would address the problems in the economy, but he's not. We've mostly

put money into the hands of those who don't need it, and I think we

should have a plan that gets people spending immediately. The President

has proposed to eliminate individual income tax on dividends paid by

corporations and speed up rate cuts to a relatively small number of very

high income taxpayers. 

I see three problems with the President's plan. It doesn't provide

stimulus in the near term, it's fiscally irresponsible, and it's unfair. It's

going to provide maybe $35 billion in the first year, and in a package that
4

costs $674 billion over ten, that seems wrong – the curve just seems to be

drawn improperly there.

He relies almost exclusively on tax cuts, ignoring government

spending which can have a direct and immediate impact on jobs and

incomes. One of the obvious ones would be health care. The President’s

plan doesn't address the question of 40 million Americans without health

insurance, and I think there's no question that spending on health care is

one of the fastest job-creating opportunities in any community. 

There is very little relief for the states, much of the problems of which

have been caused by change in our tax policy. There's no money for child

care and other support that would help single mothers and the millions of

people whose unemployment has not been addressed as their

unemployment benefits are expiring and they're having trouble finding a

job.

The plan drains budget resources, making it in my opinion fiscally

irresponsible, and as I said, those budget resources could be put to better

use. I mentioned Medicare. We could spend the $13 billion that the

President has touted for his Leave No Child Behind proposal. He just

didn't buy them a ticket to get on the bus to come along. So I think

money could be better spent there.

The proposal is unfair. I suspect my tax cut will amount to $40,000

or $50,000. I'm sure Chairman Bennett will get almost $90,000 in his tax

cut, and the average family is going to receive very little, a buck or two.

Senator Bennett. If I may, I only wish that were true.

(Laughter.)

Representative Stark. Well, I just judged that by your excellent

suit.

(Laughter.)

I figured if you could have a suit like that, you must be able to afford

it. 

Representative Saxton. What about my suit?

(Laughter.)

Representative Stark. I know that here's a man of the people like

me, and we won't get much of a tax cut.

(Laughter.)

Really, I would like to see, as our leader on the House side, Nancy

Pelosi, and the leader Mr. Daschle, on the Senate side, have talked about

a plan that provides perhaps $140 or $150 billion in the first year, and

hopefully would put people back to work immediately. I know that's

where our differences will come, and I look forward to seeing whether

and how we can put that money immediately to work. 

I suspect that every community in every Congressional District in the

country has on its shelf a public works project that would put people

immediately to work. Highways in Wisconsin, I might suggest, Mr.

Ryan. Schools in New Jersey. In Utah every community has an

important project, immediately putting people to work, immediately

providing something useful in our communities, I think that's where we

should direct our money or education as you choose.
5

I'd like to see us go back to the eighties when we saw deficits balloon,

but there was a difference. President Reagan recognized that the tax cut

that he passed in 1981 was excessive, and he scaled it back. Perhaps

that's what we should think about now, and I look forward to your

testimony, Dr. Hubbard, and how it addresses those concerns.

[The prepared statement of Representative Stark appears in the

Submissions for the Record on page 32.]

Senator Bennett. Mr. Saxton, again we thank you for your service

and your period as Chairman, and I'll do my best to try to rise up to your

level of excellence. 

OPENING STATEMENT OF REPRESENTATIVE JIM SAXTON, VICE CHAIRMAN

Representative Saxton. Well, Senator Bennett, Mr. Chairman, I

congratulate you on assuming the responsibilities and the pleasures of

being the Chairman of this Committee. I believe very firmly that this

Committee has served a very useful purpose over the last decades, and

have enjoyed very much chairing it both during the 105th and the 107th

Congress and working with Pete Stark and yourself and others. 

And in particular, let me just say what a pleasure it is to welcome

Chairman Hubbard back before the Committee again. People like

Chairman Hubbard and Alan Greenspan, who come before the

Committee, have been a great help in helping us to understand, while we

don't always agree, to understand the Administration's position, and today

we'll be looking forward to Dr. Hubbard's insights, which will be helpful

I'm sure once again.

Let me just say that a review of the data shows that the economy has

not yet fully rebounded from the slowdown that began in the middle of

2000. Although GDP growth was about 3 percent during the first three

quarters of the year, it lagged in the fourth quarter. Consumption has held

up quite well until the last quarter, but weakness in business investment

continues to be a feature of the slowdown. Employment has also been

weak, with manufacturing employment, for example, falling for 29

consecutive months since the summer of the year 2000.

The President has proposed to accelerate already scheduled tax

reductions in individual marginal income tax rates and the marriage

penalty, provide a dividend exclusion for individuals, and expand

expensing of investment for small businesses, among a variety of other

things.

During 2001, many economists noted the timeliness of the first

installment of tax relief, given the fact that the economy had slipped into

a recession. The current concerns about the pace of the economic

expansion indicate that accelerated tax relief now would also be

appropriate. The end of double taxation of dividends would also reduce

the bias against savings and investment in the tax code, and enhance the

prospects of economic growth over the long run.

Unfortunately, opponents of the President's tax proposal have

misrepresented it as skewed toward the affluent. However, this argument

is typically based on incomplete information taken out of context. As I

have pointed out before, disclosure of the shares of taxes paid by each
6

income group before and after a tax relief plan goes into effect is usually

not made by such critics. Such information would demonstrate that the

proposition of tax relief is mostly driven by shares of taxes paid before

tax relief becomes effective, and usually subsequent changes in total tax

shares are quite small.

Another issue related to evaluating the impact of tax relief is income

mobility. Over ten years ago, this Committee asked the Treasury

Department to provide an analysis of mobility of tax filers over an

extended period of time. In the last Congress, I requested an updated

examination of this critically important issue, as such information would

be valuable to policymakers now in determining what happens to various

people in various income categories as they move from one quintile to the

next.

There are those who persist in viewing the U.S. economy as a sort of

caste system in which people are cemented into a particular income class

forever. It's simply not so. Data on income mobility demonstrate a much

more flexible and dynamic reality characterized by fairly high degrees of

income mobility. That is a key element in our economic system.

Once again, Chairman Hubbard, I want to just take this opportunity

to thank you for being here with us once again, and we look forward to

your testimony.

[The prepared statement of Representative Saxton appears in the

Submissions for the Record on page 35.]

Senator Bennett. Thank you very much, Mr. Saxton. Mr. Ryan, we

welcome you to the Committee, and look forward to your participation.

Do you have some opening comments for us?

OPENING STATEMENT OF REPRESENTATIVE RYAN

Representative Ryan. I do. Thank you, Mr. Chairman. It's not

often that a junior Member gets to engage in opening statements. In the

House, they usually just do the Chairman and the Ranking Member, so

I'm going to have to take advantage of this opportunity.

Senator Bennett. Keep your eye on the clock.

Representative Ryan. Yes, I will.

(Laughter.)

Thank you. I'd like to make just three quick points. You're going to

hear this kind of rhetoric back and forth for quite some time. On the

demand side of the economy, it's very common that the other side of the

aisle will talk about sort of the Keynesian demand-side stimulus. If that

is what we're interested in doing, I would argue that is not what the

economy needs right now.

The Bush plan has more of it. If you take a look at the Democrat

plan, it's $300 once. You get a check one month for one year. The Bush

plan, 92 million Americans get $1,100, not this year, but every year

thereafter. So even if you're of the opinion that this economy needs

demand-side stimulus, there's more of it in the Bush plan.

On the issue of what's the best for the states. This one I grapple with

quite often. My Governor is facing a $4 billion biennial deficit. It's a big

problem in our municipalities. And I would argue that people going back

to work paying taxes helps not only the Federal Government, but it
7

actually helps the states and the municipalities, because their tax revenues

will increase. So economic growth is the ball that we need to keep our

eyes on. That is the best thing for the states, given that more government

spending is not the solution to our economic problems.

The basic three components of the definition of Gross Domestic

Product(GDP) are consumption, investment, and government spending.

Consumption, relatively speaking, has done quite well. It's the reason

why, arguably, we had positive economic growth last year. Now it went

down a little bit in the last quarter, and I think our GDP statistics as of

this morning for the fourth quarter are about 0.7. So clearly, our economy

needs growing and needs helping.

Government spending. We're at an all-time high. We're spending

more in the Federal Government than we ever have before in the history

of this country, essentially. So the idea that more government spending

will fix our economic problems belies the facts. If government spending

was the answer to growing our economy, we wouldn't have economic

problems today. We wouldn't be coming out of a recession slowly.

So the problem with the economy and the problem with what is

hurting Gross Domestic Product is investment. Investment is declining.

Investment has been declining for eight consecutive quarters. We may

see some signs of recovery on the investment side, and that is why,

appropriately so, the basic components of this tax plan is focused on

reviving investment.

And one of the most hostile aspects to investment is the tax code. We

have basically two functions in government – this is my opinion – that

we can do to help grow the economy: Monetary policy, which the Fed

Chairman is almost out of bullets on that one, and tax policy. And of the

areas in tax policy where we really hurt investment, it is how we double

and triple tax capital. And one of the most obnoxious provisions in our

tax code that double taxes capital formation, that puts a higher price on

investment, is the way we double tax dividends. Because the effective tax

rate on dividends in so many ways exceeds 60 percent.

And so when we see a huge problem in the double taxation of

dividends and how it raises the price of investment, it goes in saying that

as we reduce this double taxation on capital, as we reduce that tax, we

reduce the price of investment, and we can help investment flourish,

grow, and that in turn helps businesses expand and create jobs. That will

help the states. That will help the Federal Government. But more

importantly, that will help all of our constituents who are hard at work

looking for jobs.

With that, I conclude. Thank you, Chairman.

Senator Bennett. Thank you very much. Well, Dr. Hubbard, you've

heard the kind of argument that probably is going to go on, but we turn

to you for some light and understanding and background on the

President's proposal. And once again, we thank you for your being here

today, and we thank you for your commitment to public service.
8

OPENING STATEMENT OF DR. R. GLENN HUBBARD,

CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS

Dr. Hubbard. Well, thank you very much, Mr. Chairman and Mr.

Stark and Members of the Committee. I'd like to begin, Mr. Chairman,

by thanking you and of course Mr. Saxton as well for the ongoing

privilege CEA has of working with the Committee. 

In pretty short order we'll also be delivering to you the President's

economic report and look forward to discussing that with you as well.

I really just want to touch on three themes in my oral remarks for you,

Mr. Chairman, and really key in on a picture for each. One to talk about

the golden goose, second to talk about the problem, and third to talk about

some benefits of what the President's proposing.

Senator Bennett. If I may interrupt you, with unanimous consent,

your formal statement will be included in the record.

Dr. Hubbard. Thank you. Thank you, Mr. Chairman. I wanted to

start out with the story that we've all got to keep our eye on that I just

alluded to as the golden goose. Over the long term, what determines all

of our living standards is our nation's productivity growth. And we have

some good news here in the long term that we have seen an acceleration

in productivity growth in the United States. 

This is good news not just over time for the United States, it's actually

a statement about how well America is doing vis-a-vis our trading

partners who have not received the same kind of increase in productivity

growth. That reflects in very large part the flexibility of the private sector

in the United States, and attempts by public policy to make sure that we

have the right environment for productivity growth. So in the long term,

that's what we have to focus on.

In the short term, as came up in the opening remarks, the economy is

in a soft patch. The data that we just received this morning indicated that

real GDP growth for the fourth quarter was very modest, a positive

number, but very modest, .7 percent, well under what we believe the

economy's potential growth to be.

Within that, we believe that investment has played the lion's share of

the story. I would like to turn if I could to the second chart. If you think

about the economic situation in the current recovery, the household has

been the star, both during the downturn and in the upturn that we have.

Investment is the problem. What this picture does is show you how

investment behaves both during a recession, on the left side of the chart,

and in the recovery, on the right side of the chart, the solid line being a

typical recession over the postwar periods. So the typical recession.

We'd had good times before. Investment is very cyclical. A decline and

then a quick recovery. 

The most recent recession is not typical of the post-war period. It was

a period in which the economy had accumulated too much capital. That

is, we overestimated the profitability of capital in the economy. We're all

familiar with new economy stories, overvaluation in the equity markets

and so on. So we had – the red line meaning the current recovery and

recession – we had more investment, and then we had a much sharper

decline. So investment really does remain the problem.
9

We believe in the Administration that not only is investment a key to

understanding the current outlook – I think the data make that obvious –

it is a key to understanding what to do about it.

In thinking about the downside risks to the economy that were on the

President's mind, a key one was the prospect of a delayed investment

recovery. Most of the private sector forecasts that are relatively

optimistic assume a very timely investment recovery. And I think that is

still a reasonable scenario in the economy. 

However, I must tell you, as I talk to business executives around the

country and quiz economists on the uncertainty in their forecast, I remain

very worried about the timing of the investment recovery. That is in large

part because business people have assigned very high hurdle rates or bars

to jump over for new investment projects, and I think that is a key risk

that our economy faces.

There of course is also a risk on the consumer side. We have seen a

substantial deterioration in household wealth with declining equity

markets that's been offset in part by positive news on the housing front,

but on balance, the household sector has lost wealth, and that lost wealth

may affect consumption through household's increases in saving to

rebuild.

With these risks to the short-term outlook in mind, the President

advanced a very bold proposal to enhance long-term growth while

providing near-term support against these downside risks. You all know

the elements of the President's proposal, but I think what's important is

the mapping of those elements to the downside risks.

So let me start with what I identified as the diagnosis or the problem

that the President saw and was trying to fix, first on supporting

investment. There are at least three ways in the package of proposals that

the President submitted that we have a very pro-investment shift in

policy. One obviously is the elimination of the double tax on corporate

income, and I'll come back to this.

Second is raising the expensing limits for small business, a very

dramatic reduction in the cost of capital for small business owners. And

third, the advanced reductions in marginal tax rates. Remember that a

great many small businesses pay tax at individual rates. So this isn't just

a matter of putting money in people's pockets, it's a matter of lowering the

cost of capital for investment and for job creation in small businesses.

We believe that the most immediate effect of ending the double

taxation of corporate income, which we believe is a very important part

of the President's proposal, is to lower the cost of capital faced by firms

in equity markets. This proposal is often discussed as to who gets

dividends. I would submit to you while that's a dimension of the

problem, it is not the most interesting. The most interesting is the

dramatic effect of this proposal on the cost of capital for business

investment.

We've estimated at the Council, depending on assumptions you make

on the type of equipment, the way in which it's financed, costs of capital

would fall by between 10 and 25 percent. For those who would say that

this is not a short-term measure, let me restate it in the language that's
10

familiar in stimulus debates – investment tax credits. The elimination of

the double taxation of corporate income would be equivalent to an

investment tax credit of between 4 and 7 percent. Gentlemen, that is a

very, very big tax cut for investment.

In addition to the economic efficiency gains which economists talk

about, which were very much on the President's mind, I think it's

important to acknowledge the very important benefits in terms of

corporate governance. By switching to a tax system that does not reward

financial engineering, that does not reward leverage and possibly

excessive retention of earnings, there is a major improvement in

transparency in corporate America. 

The President's goal in addition to the gains in investment was that

business people should be making business decisions based on their

business judgment, not on the tax code. And when the American people

as the owners of companies look at earnings, they have a right to know

that those earnings are transparent and accurate.

In addition to the double tax, as I mentioned before, the President's

proposals to dramatically increase expensing are very much pro-capital

accumulation. 

I also identified consumption in the diagnosis. Here the President's

tax cut is dramatic. The change in calendar year liability for 2003 is

almost $100 billion. The Treasury believes conservatively it can get $60

billion out the door. As was observed in the opening remarks, that is the

down payment on a long-term tax cut. We expect that to have quite a

significant effect on spending.

A typical family of four with two earners making $39,000 would

receive $1,100 in relief under the President's plan. 

Again, the fact that this is a long-term tax cut is very, very important.

Temporary tax changes have very modest effects on spending, if that is

indeed their goal.

The President of course has been keenly attuned to job growth. We

all know that in addition to the recession's atypical feature in investment

of jobs have not recovered as fast as a typical recovery would have them.

In addition to the pro-growth features of the President's plan, he has also

recommended $3.6 billion in block grant funding for personal

reemployment accounts, which are designed to help individuals master

their own training initiatives and get back to work more quickly.

Now how will this affect the economy? First let me tell you a story,

and then I'll show you a picture. We tend to think in Washington

sometimes about the very short run, and I'll talk with you about that. But

it is important to understand again that what we're trying to do is also

things that raise our economy's capacity to grow. And in that respect, the

elimination of the double taxation of dividends is particularly important.

In economics, we know that who writes the check to the IRS has very

little to do with who actually bears the burden of the tax. In the case of

the double taxation of dividends in a growing economy, much of the

burden of the tax is borne by workers, all of us, in our wages and

incomes. Why is that so? The double tax decreases capital accumulation.

That's less for each of us to work with in our jobs. Ultimately that lowers
11

our productivity and our wages. The President's proposal sets that in

reverse and is very much aimed at raising wages and incomes, not just

dividend payouts.

In terms of effects on the national saving and budget balance, we

believe that what the President has suggested does not significantly

worsen the government's fiscal position. There are two elements in the

current debate over deficits that I think are very important. Both have to

do with what do you do about them. The first is spending restraint, which

the President has spoken of and will be evident in the budget as it comes

to you next week. And the second is the promotion of economic growth.

I like to think in terms of a fiscal anchor. What could I look at to tell

me over the next several years where we're headed in fiscal policy. To

me as an economist, things like the debt-to-GDP ratio or thinking as a

household or business would, debt service burden, say debt service over

spending. Both of those, including the President's proposal, will be

showing a downward trend over the next decade.

Let me conclude with the third picture if I might. The President is

clearly aimed at improving the prospects for recovery. That's not just in

GDP, that's in all of our jobs and our incomes, and for long-term growth.

The diagnosis of business investment provides the light to the policy.

In this chart, we looked at the percentage difference from our baseline

forecast for what the President has proposed, so we believe that we could

get just under a percentage point higher GDP growth in 2003. This is

cumulative in the level of GDP, so adding another .8 to that, we're getting

1.7 percent higher in '04, 1.8 in '05, and continuing increases in the level

of GDP helping American workers going back to that first picture to

sustain their potential.

If I might, Mr. Chairman, in ending my remarks make a comment

about the budget as well. These changes in GDP, the level of GDP, are

permanent. That means of course that the higher incomes each year

translate into higher revenues each year. In thinking about the President's

proposals, most of these are front-loaded. That is, they are the rate cut

accelerations, the long-term piece being the dividends. And I would urge

you as you contemplate that proposal in purely budget terms to compare

the economic benefits with the proposal's cost.

Thank you very much, Mr. Chairman.

[The prepared statement of Dr. Hubbard appears in the Submissions for

the Record on page 37.]

Senator Bennett. Thank you, Dr. Hubbard. Before you take that

chart down, let me be sure I understand it. The growth rate, the annual

growth rate in 2002 with the numbers we got this morning, comes out at

about 2.7 percent?

Dr. Hubbard. Correct.

Senator Bennett. 2.75. Is this saying that the .9 goes on top of the

2.75?

Dr. Hubbard. The .9 is relative to our internal forecast for 2003,

which will be part of the President's budget. So they'll be released to you

on Monday. So relative to our forecast, we believe that we could get an

extra nine-tenths of a percent GDP growth. 
12

Senator Bennett. Well, yes. But specifically, so that the noneconomist can understand it. If we are at 2.75 now, you are forecasting

that we will be at 3.65 next year? 

Dr. Hubbard. If the baseline were 2.75, you would add that to the

baseline. So this is a very, very large change. The economy's potential

growth is something like 3 percent is a way of scaling it for you.

Senator Bennett. Okay. But again, so that I can get it, 2.75, that's

what this morning's numbers are saying this year will be? And you're

saying with an 0.9 as the growth effect of this package, that next year

would then, simple math, would be 3.65 next year?

Dr. Hubbard. Well, not quite. It would be adding to whatever the

forecast is for next year, but that's quite close. So, yes, that's the

increment. That's the extra GDP that our economy gets.

Senator Bennett. Okay. So if in fact we are 3.65 next year, that's a

very good year.

Dr. Hubbard. That would be a very good year indeed, Senator.

Keep in mind, there are a number of downside risks to the economy

which made us do that, and all forecasts are uncertain, but we believe that

even with that uncertainty, this extra will help us get to the numbers

you've suggested.

Senator Bennett. I understand uncertainty. But if we then take 2.75

as our base and we add 1.7, you're up in very, very tall cotton at that point

in 2004.

Dr. Hubbard. A little too tall a cotton.

Senator Bennett. Yes. That's why I want to get the --

Dr. Hubbard. This is the level of GDP. If I might just get up.

Senator Bennett. Yes. Let us be sure we understand this.

Dr. Hubbard. Basically saying in the first year, the calendar year

we're in, we would expect an improvement in growth of this amount. We

would expect a further improvement in growth next year. But of course,

this part of the level goes up. So this is saying the level of GDP is higher

in the first year. It's higher in the second year because this part

accumulates plus additional growth. 

Senator Bennett. No, I understand that. I understand that. The blue

chip forecasts for next year are for 2.7 annualized rate in the first quarter,

3.2 in the second quarter, 3.8 in the third quarter, and – pardon me, 3.6

in the third quarter, and 3.8 in the fourth quarter, which would come in

around 3 percent for the year. 

Dr. Hubbard. Two things if I might about those forecasts. Of

course that's a consensus that's part of a wide range.

Senator Bennett. I understand that.

Dr. Hubbard. Our own view is that's a bit a optimistic. And second,

those forecasts build in already some assumptions about fiscal stimulus.

They are making a guess as to – 

Senator Bennett. Yes. I understand. But this is the numbers game

that we get on television. I was briefly on television this morning, and

they wanted a quick single answer, and I told them there is no quick

single answer, which they take as a politician's answer. 
13

But I'm trying to understand your chart here. And frankly, if I don't

understand your chart, I think a lot of folks are not going to understand

your chart. So what are you saying about 2003 with this chart with a hard

number of 0.9 percent growth package effect?

Dr. Hubbard. Well, again, let's talk about the level of GDP. If GDP

were $10 trillion for the U.S. economy, that would suggest an extra $90

billion in '03, an extra $170 billion in '04, an extra $180 billion in '05 and

so on and so on.

Senator Bennett. Okay. I understand that. But can we put it into

the number that always gets used to determine whether we're in a

recession or not? The number that says that you either have positive

growth or negative growth, and this year that number they're saying over

the whole year, looking back, we had a positive growth of 2.75 percent.

Now on that number, what – you say the forecast numbers that I've

given you are overly optimistic. Can you give us a number that you think

will be accurate for 2003, with all of the caveats surrounding forecasts

and the ability to change? We understand all of that. But if in fact the 3

percent plus number coming of this year's of 2.75 is a little optimistic in

your view, do you have a number? Or is it a fool's errand to try to come

up with a number? And if that's the case, I'll accept that as an answer too.

Dr. Hubbard. Well, we certainly have a number that will be

presented Monday in the President's budget, so I don't want to get out

ahead of that.

Senator Bennett. Okay.

Dr. Hubbard. But I think what the President was concerned about

was not just the expectation, which is what blue chip consensus forecasts

or our own forecasts or any other forecast is, but also the downside risks

there. I think it's very unlikely that the U.S. economy will enter a

recession, again, if by that you mean a couple of quarters of negative

GDP growth, I think that's unlikely in almost any scenario.

Senator Bennett. Okay. All right. Well, let me go to one of the

other things you said and then I'll move along, or allow the other

Members of the Committee to move along. 

But I think it's a very important point that needs to be emphasized

over and over and over again that you touched on in passing, but I want

to pull it out and highlight it. And that is the tax cuts, the reductions in

marginal rates, do not go exclusively to wealthy individuals. We are not

talking about Michael Jordan and Donald Trump and Ted Turner here.

For many of the tax returns that will fall into the top marginal rate,

indeed for most of the tax returns that will fall into the top marginal rate,

they will show K-1 income. Now I've asked the question around here

ever since I got here as a Senator, does anybody know what a K-1 is? I

won't ask for a show of hands, because it's always a little embarrassing

because I've discovered that most of my colleagues have no idea what a

K-1 is. They know what W-2 is, but they assume that all income that

shows up on an individual's 1040 is W-2 income or investment income,

and they don't know what a K-1 is. 

So to explain to those out in television land who may not know, a K-1

is the tax form you fill out when you have a partnership, a small business,
14

or an S Corporation, where the earnings of the business entity, the

company, pass through onto your personal tax form. I've had very direct

experience with this. 

Mr. Stark refers to my tax return. When we were running the

company that I was the head of prior to coming to the Senate, we were an

S Corporation, which meant that the earnings of the company passed

through onto my personal tax return. Now these earnings were not exact,

but let me use these numbers that will be illustrative.

I was being paid a salary as the CEO of that company of $120,000 a

year. My tax return showed income of a million dollars. Where did the

other $880,000 come from? It came from the company. Now I

immediately had to give back to the company all of that money, except

the amount of money they allowed me to keep to pay my taxes on that

money. Actually, it was a detriment to me, because all of the deductions

and exemptions that would be available to me at $120,000 immediately

disappeared when the IRS saw that I was earning a million dollars a year.

That was K-1 income, not W-2 income.

Now it just so happened that while I was running that company it was

the decade of greed, at least as it was depicted by some people. The top

marginal tax rate was 28 percent. That meant the earnings of the

company that flowed through my tax return were taxed at 28 percent

instead of 36 percent, or in today's atmosphere, after the Clinton tax

increases of 1993, 42 percent. And I can tell you that the difference

between paying taxes at a federal rate of 28 percent and paying taxes at

the federal rate of 42 percent represented the difference between survival

and failure for that company.

Again, it's not Michael Jordan or Ted Turner or Donald Trump. The

majority of tax returns that show income in the top marginal rate are small

businesses or partnerships that are passing through onto the individual

return company income. So when you make the statement in your

presentation that the acceleration of the reduction in the top marginal rate

will significantly improve small business and create new jobs, you are

exactly right. 

I will agree that Michael Jordan doesn't need a tax cut. I will agree

that Ted Turner doesn't need a tax cut. But small businesses whose

owners are showing the income of the business on their individual tax

returns significantly do need a tax cut, and it may be the difference, as I

say, between survival and nonsurvival. As I say, we grew our company

from four full-time employees, which is what it had when I joined them

in the middle of decade of greed. That company was formed in 1984.

Today there are over 4,000 employees, all of them paying income taxes.

The growth of the company was financed entirely with internally

generated money that we were able to hold onto with the difference

between 42 percent, today's rate, and 28 percent, the rate during the

Reagan years. It was not an insignificant matter, and it was not a matter

of fairness. It was a matter of economic growth.

All right. I apologize. With that speech, I will yield now.

Dr. Hubbard. Could I actually comment, Senator?

Senator Bennett. Yes, you can respond.
15

Dr. Hubbard. I think you touched on two very important points, one

on distribution even in the way that term is often used in Washington.

The distribution table before and after the President's plan looks very

similar. I.e., as you suggested, a lot of the benefits go to lower and

moderate income families. 

Your point on small business is incredibly on point. Because if you

go to data say from the Survey of Consumer Finances, the Federal

Reserve Board's data, about half of the households in the top 1 percent are

almost exclusive small business owners, and people who are partial

owners swell that number to closer to three-fourths of very high income

taxpayers. So this is very much a business issue, and I thank you for

making that point. 

Senator Bennett. Mr. Stark?

Representative Stark. Thank you, Mr. Chairman. Thank you, Dr.

Hubbard. Can you tell us or estimate for us on the same basis,

particularly for next year, your estimate of how many new jobs the

President's proposal will create. Do you have that information? 

Dr. Hubbard. We've estimated for – just looking at the years you

have here, for the 2003, a little over a half a million jobs, close to 900,000

jobs in the next year.

Representative Stark. So for a total of 1.4 million?

Dr. Hubbard. In the first two years, yes.

Representative Stark. Have you looked at either of the Democratic

proposals, and can you estimate how many jobs you think that would

create?

Dr. Hubbard. We've not estimated the number of jobs, Mr. Stark.

I think it would be unlikely to be very stimulative, because these involve

temporary tax changes, and our judgment would be there would be a very

small effect on GDP and hence a very small effect on jobs.

Representative Stark. What do you estimate the effect on GDP

would be for the Democrats' plan?

Dr. Hubbard. Well, a good rule – I don't know which of the many

plans you're speaking of, but a good rule of thumb would be that

temporary tax changes would have only a third to a half the spending

effect of a permanent tax change, so you could scale it from there.

Representative Stark. You say it would only be a third of what you

have on the chart. It would be about three-tenths of a percent in 2003?

Dr. Hubbard. Well, again, I'm not sure what plan you're referring

to. But for a given size tax cut, the temporary tax change would only be

a third to a half as effective.

Representative Stark. I guess there's some significant differences.

I think most people would agree what's wrong with the economy and

what the risks are. We don't have enough business investment.

Businesses lack confidence, or certainty, or both. The consumer has been

carrying the load. And a lot of that has been in the real estate market,

which I'd like to come back to in a minute if I can. 

When economic conditions are so uncertain and the job market is so

weak, we don't know how long we can keep going. The only good news

as you showed us earlier is that productivity has been holding up. And
16

you suggest that our long-term prospects are good even without the

President's proposed tax cuts. So the problem seems to be mainly

short-term, if we accept your scenario. 

So why aren’t policies aimed at maintaining consumption and helping

out strapped state and local governments, exactly the right policy? The

long-range economic growth predictions look fine. Why would large tax

cuts that go to high income taxpayers, likely to save the economy more

tax cuts targeted on middle and lower income taxpayers who are ready

to spend those monies. We'll create jobs right away and we'll have more

spending? What am I missing something here.

Dr. Hubbard. Well, I think what the President is trying to do, Mr.

Stark, is to connect the tax relief to what we believe the problem to be,

which is shoring up the consumer and investment, as you just correctly

noted. Temporary tax changes have a small effect. If your goal is to

shore up consumption, you've picked the wrong thing to do it. You might

as well save your bullets if that's your answer.

As for spending projects, say public works projects, we know that

Japan tried over a decade a series of fiscal stimuli on spending that fails

to improve an economy's capacity to grow. You correctly identify of

course that states have significant fiscal crises. Many of those are

structural problems that aren't well addressed by one-time effects.

What the Federal Government can best do for states is to improve the

environment for growth. We've looked state-by-state at the response of

state income to changes in overall income and state revenue in response

to changes in overall income, and believe states could gain from that as

much as $6 billion. I realize that is much less than the shortfall, but we

believe that is the appropriate role for the Federal Government.

Representative Stark. Let me ask you this. Mr. Zandi of

economy.com says that the Democratic proposal would add 600,000 more

jobs than the President's plan. I presume you disagree with that?

Dr. Hubbard. Well, again, I'm not sure what you mean by the

Democrats' plan. If you mean the temporary tax changes that have been

talked about, I think that would just be fanciful – 

Representative Stark. Let's say putting $150 billion rather than $35

or $50 billion up front in the – 

Dr. Hubbard. It depends very much, Mr. Stark, on how you use the

$150 billion. Temporary tax changes have fairly modest effects. The

President again has a calendar year liability change of $100 billion. The

plans originally I guess that Congresswoman Pelosi had floated would

have had very similar cash out the door in 2003 compared to what the

President had, but again, being temporary, would have had a very small

effect.

Representative Stark. Let's go to the real estate issue for a moment.

You managed to suggest years ago that increasing the deficit would also

increase interest rates. They're suggesting perhaps that that doesn't hold

anymore, so it depends on whether I'm talking to the professor or the head

of the economic advisers as to who you believe. 

But let's assume for a moment that interest rates increase. Wouldn't

that have a very serious effect primarily on the housing market, the
17

single-family housing market, which seems to -- the bubble there seems

to be expanding and not bursting? Perhaps not. Perhaps you can explain

why that's growing, Wal-Mart isn't and Caldwell Banker is. I gather we're

having more housing starts. And I'm happy, but I'm nervous. In other

words, if you have unemployment and if that spreads or it doesn't

increase, and interest rates go up, eventually you won't be able to sell that

house if you move. I see a danger there. Tell me it isn't there and you'll

make me very happy. But perhaps you can shed some light on that.

Dr. Hubbard. I think you have correctly identified the importance

of housing and housing wealth for consumers. And I think current

housing prices do reflect fundamentals in large part. One, as you just

noted, we have the lowest interest rates in a generation, so the user cost,

if you will, of owning a home is very low. And a variety of demographic

considerations have put wind in the sails of the housing market, all true.

Changes in the stock of government debt do of course affect interest

rates, but very, very modestly. In this year's economic report of the

President, we'll talk about model-based calculations based on work

widely accepted in the economics profession, a change in the stock of

government debt on the order of $200 billion might affect yields by 3 to

5 basis points.

Now if you ask yourself why aren't the effects larger, look at your

intuition from current events. We have seen very large changes in

projected fiscal situations and very low interest rates. I'm just telling you

many, many, many factors determine interest rates.

Representative Stark. Thank you.

Senator Bennett. Thank you very much. Now with the Chairman

and the Ranking Member having gone on at length, we will enforce the

five-minute rule, but we will have as many rounds as any Member wants

to have. Mr. Saxton?

Representative Saxton. Thank you very much, Mr. Chairman. And

Chairman Hubbard, I would like to use my five minutes to try to make a

point that often comes up in discussions about various tax cut proposals.

Whenever we are on the floor in a debate, there are those who will

contend that reducing marginal tax rates and reducing other tax rates, for

example the double taxation of dividends, may bring about a big number

and it becomes a concern of a lot of folks, in terms of its effect on the

deficit or on the potential deficit. 

Now just by way of explanation for people who may be in the room

or elsewhere listening, the process of determining what a tax cut will do

depends in part at least on explanations by two organizations. In

particular the Congressional Budget Office (CBO) makes projections

about what's going to happen in terms of surplus or deficit as we move

forward in 2003 and 2004. And a separate organization known as the

Joint Tax Committee, scores the tax bill and determines how much it will

reduce potentially federal revenues over the same periods of time. 

And the argument is often made that tax proposals like the one which

we are focusing on this morning cause deficits to rise, or surpluses to go

away. And I brought a chart with me, if we could put it up, which

demonstrates I think quite well the results of the projections of CBO as
18

compared to the projections of the Joint Tax Committee. In the top block

– this is going back to 2001 when the initial Bush tax cuts were put in

place. These were the projections that were made. In the top line, the

total surplus at the time that was projected for 2002 was $313 billion.

That was the projection of CBO.

The Joint Tax Committee scored the cost of the tax bill that year in

static numbers at $38 billion, leaving a projected surplus of $275 billion.

Now we all know that as we began to see these numbers actually play out,

that the surpluses were actually less than the CBO projections. Could you

explain for us these numbers and the actual revenue effect of the tax cuts

as they appear on this chart?

Dr. Hubbard. Certainly, Mr. Saxton. I think you put your finger on

a very important point of information for all Members of Congress as

they debate tax legislation, and that's what do you think the effect is. If

you're a businessperson, and I went to the Capital Budgeting Committee

and I had an elaborate presentation of how much a plant would cost, but

then I didn't tell you how much I expected to make from it, it would be

very hard to get you to agree to that capital budgeting decision. And yet,

I think we sometimes don't provide you the information you deserve on

what the economic effects are of tax policy.

In the context of revenue, those can be large, and they depend a great

deal on the kind of a tax cut. We have estimated, depending on

assumptions and model you use, that over the budget period that's coming

out, over the five-year period, between a third and a half of what we'll

report is the cost of the tax proposals from the President would come back

to the government through higher economic growth and hence higher

federal revenue.

In the long term, I showed the chart earlier, there's a permanently

higher level of GDP and higher federal revenue. 

For many years as an academic and in the government, I have

suggested that you would be better served by getting in addition to

scoring an impact statement that told you based on a range of models

what is likely to happen to the economy in federal revenue.

Representative Saxton. Thank you. So the numbers that we see

here on the chart, particularly the static cost of the tax cuts, you would say

are not responsible for the deficit situation that we find ourselves in

today?

Dr. Hubbard. Well, they're certainly not, the deficits that we have

seen just here in the current period are largely driven by the weak

economy and the necessary spending on homeland security.

Over the long haul, it's our economy's ability to grow that affects all

of us, not just our budgets as families and businesses, but the Federal

Government as well. 

Representative Saxton. Well, thank you, Dr. Hubbard. I think this

is an extremely important point. And as we examine the proposals laid

out by the President and the Administration and we look at the cost

figures, we should keep in mind that the costs, the actual static costs of

the proposed tax cuts are not deficit drivers, they are in fact a very small

portion of what we look at today and the projections in terms of the
19

deficits that may come, or the surpluses if we're more optimistic.

Certainly, if the President's plan performs as we think it will, we'll be

talking surpluses again, not deficits.

Senator Bennett. Thank you. Mr. Ryan?

Representative Ryan. Thank you, Mr. Chairman. Chairman

Hubbard, I wanted to explore with you some questions about the dividend

policy in particular and the difference between corporate and the

individual side. 

I introduced a bill which repealed dividend taxation at the firm level,

at the corporate level, and then brought the individual tax down to the

capital gains tax rate. And from my preliminary discussions with the

score keepers at Joint Tax who are basing it on static, non-reality-based

scoring, the number is looking like it's going to be a huge score relative

to what the individual score that you've proposed.

Can you walk me through why you think it's superior to eliminate the

double taxation of dividends on the individual side versus the corporate

side? And also one of the other large problems with the double taxation

of capital occurs is on capital gains tax treatment. And when you repeal

it at the corporate side, you don't get at the capital gains issue. 

Can you explain how you get at the capital gains issue when you step

up the basis on the individual side? So from my perspective, it sounds

like from now looking at your proposal, you're getting more bang for your

buck. You're using less revenue and you're getting sort of two tax cuts in

one: A reduction in capital gains and an elimination of the tax on

dividends. Can you just explain how exactly that works?

Dr. Hubbard. Sure. Let me start just with the budget question you

asked. One reason the relief at the corporate level will be much more

costly is many dividends go to exempt entities, either tax-exempt formally

or through tax planning or foreign investors receiving a break. That was

one of the reasons the President selected the individual side. 

You've heard the President speak of taxing corporate income, all

income, once. But he means once, not zero. And so if one had it at the

corporate level, much of the income might not be taxed at all, and that's

why there's a big difference.

As you indicated, doing so on the individual side offers very

important opportunities in the capital gains area as well. Just as we now

have a tax code that's biased against dividends, we don't want it then

switched to a tax code biased entirely for dividends. Business people

have many sound reasons for retaining earnings, so we wanted neutrality.

The step-up in basis that you mentioned is equivalent to saying any

earnings you accumulate in the company, in the President's plan going

forward, would not be subject to the capital gains tax because if you'd

paid them out as a dividend, they wouldn't have been subject to the

dividend side.

Representative Ryan. Any of them you pay tax on, correct?

Dr. Hubbard. That's correct. So it is a very large bang for the buck,

because you're focusing on the so-called marginal investors, the taxable

investors, and you are getting very large relief on the capital gains side as

well. So we think in terms of economic efficiency, this is the way to go.
20

Although from an economist's perspective, again, getting rid of the double

tax is the key. 

Representative Ryan. Do you think that the macroeconomic

feedback that you discussed with Mr. Saxton that is derived from the

individual side policy is better the way you structured it than doing at the

corporate side?

Dr. Hubbard. I think the bang for the buck frankly would be

greater, because then the revenue costs are – 

Representative Ryan. Because of the step-up in basis.

Dr. Hubbard. Right. And the inclusion of step-up basis.

Representative Ryan. Could you also inform us on how this

improves corporate governance and how this helps stem tax sheltering?

I saw Mr. Sarbanes here a minute ago, the prime author of a very

important law to improve corporate governing, and one of the things that

we noticed in the last collapse of a lot of prominent corporations was they

weighed themselves so heavily with debt and they went into bankruptcy.

Tax law incentivizes companies to take on more debt because interest is

deductible, but not to grow their companies through equity financing,

because it's not as tax advantage – it's not as advantageous from a taxing

perspective.

Can you go into how this improves from a neutrality point of view

corporate governance?

Dr. Hubbard. Happily. I think as you mention, the Sarbanes-Oxley

legislation is truly landmark and very important, because it gets at

accountability and transparency issues. But I think it's also important, as

your question suggests, to ask what were the incentives for some of these

transactions to begin with? 

The Tax Code, by treating the timing of income and different types

of income differently, creates enormous opportunities for tax planning.

Many companies engage in very complex tax planning techniques. They

are not illegal techniques, but they are techniques that make it very

untransparent what the earnings situation of a company are. By taking

away the bias between debt and equity and getting at the capital gains

piece from the basis adjustment, a lot of the wind in the sails of the tax

planning is gone. So the tax shelters have much less need.

So in addition to the standard economic arguments, I think these

transparency arguments will be very valuable for investors.

Representative Ryan. Am I out?

Senator Bennett. You are out.

Representative Ryan. Okay. Thank you.

Senator Bennett. We'll have another round. Senator Collins, we

welcome you to the Committee here this morning. We appreciate you

being here. 

Senator Collins. Thank you very much, Mr. Chairman. Dr.

Hubbard, I'd like to turn your attention for a moment to the impact of the

President's proposal on state tax revenues. As I'm sure you're well aware,

more than 40 states are facing severe budget shortfalls and are struggling

with how to close those deficits, because unlike the Federal Government,

they have to balance their budgets. 
21

Like many states, my home State of Maine conforms its tax code to

take into account changes in the federal tax laws, and this is done

automatically. That obviously simplifies life for Maine taxpayers, but it

has an impact when the Federal Government changes the tax code on the

amount of revenues that the state of Maine collects.

According to preliminary estimates by the State of Maine, the

President's proposal has both good and bad news for the people of Maine.

The very good news is that the proposal would save Maine taxpayers

more than $350 million. The bad news is that the state, which is already

struggling to close an enormous budget shortfall, would lose $40 million

in tax revenues as a result of the President's proposal.

Could you comment on this issue which is troubling to many of the

states, particularly since the President decided not to include fiscal relief

to the states as part of his package which might have helped to offset this

impact? 

Dr. Hubbard. Certainly, Senator. There are really two channels

through which what the President is proposing might affect state finances.

One, as you mentioned, is the fact that dividends would be taken out of

the base for the 1040 and hence affecting states' piggybacking. Another

would be effects people have hypothesized for the municipal bond

market, changing the borrowing cost for states. 

Let me go through each of those. It is true that taking dividends out

of the base would affect states if they chose not to reintroduce.

Nationwide, that's probably about $4 billion, the states. We have

estimated that effects on municipal bond yields using studies done at the

Treasury a decade or so ago and academic work are no more than 10 to

15 basis point effects on municipal bond yields. And the net effect of

both of those we believe is overwhelmed by effects on economic growth.

We expect that states as a whole will gain as much as $6 billion in the

first year from the President's plan, higher economic growth producing

higher revenues. Most states have slightly more than a one-for-one

response. I'd be happy to take a look at Maine if you like. The way you

asked the question made me think also that Maine may be okay in the

sense that the higher gains you mentioned may also feed through

additional revenue from job creation and economic growth. But I would

be happy to work with you on that.

Senator Collins. I would appreciate that. Thank you, Mr. Chairman.

Senator Bennett. Thank you. Dr. Hubbard, following up on Mr.

Stark's comments and the exchange there, I'd like to go back and talk

some more about job creation. And again, as I jotted it down, you're

projecting in the next two years, again with all of the caveats that go

around forecasts, 1.4 million jobs being created as a result of the

President's proposal, and that the Democratic proposal would produce

roughly a third of that number. 

Dr. Hubbard. Well, again, I haven't analyzed the Democratic

proposal. The third was just a reference to the fact that GDP changes are

much less from those sorts of proposals.

Senator Bennett. Okay. Forgetting the specific numbers, where I

want to go is why is there a difference? And I think I heard you say the
22

difference is because the President's proposal is permanent and the

Democratic proposal would be temporary. And a temporary placement

of money into people's hands through a rebate or something of that kind

has relatively small effect, and a permanent change makes it possible for

business people to plan and make investments that will create jobs and

therefore be far more beneficial in the long run.

Have I got it right, or did I miss something?

Dr. Hubbard. Yes, Senator. There are really two channels. One

you mentioned, permanent, long-term tax cuts have much larger effect on

consumer and business decisions. Second, the President's plan is actually

aimed at investment through the rate cuts, through the expensing, through

the elimination of the double tax. The Democratic plans would seem to

be only loosely connected to that problem.

Senator Bennett. Let me change subjects then for just a moment and

ask you something unrelated to your opening statement but that I think we

have to deal with following the President's State of the Union message.

A number of economists have said that the stock market and indeed the

economy as a whole is currently burdened by geopolitical risks and that

concern over Iraq is holding down investment and that we will not see the

kinds of economic growth that you're projecting until the geopolitical

uncertainty is resolved, one way or the other.

There are others who say, no, the market has already absorbed that

kind of risk, and the present softness is not due to fear, or uncertainty

relating to the geopolitical circumstance. Once the Iraq situation is

resolved one way or the other, the softness that is currently there will

continue.

I know you're not in the war forecasting business, but nonetheless, an

economist has to take into consideration all of the uncertainties that relate

to the economy, and certainly geopolitical risk is a major factor here. Do

you have any sense of whether or not the market has absorbed the risk

and therefore we would have a continuation of the soft patch once the Iraq

situation is resolved? Or have you any view that resolution of Iraq would

in fact remove one of the major wet blankets on the economy and we

would see a significant increase? Just your comments about that whole

circumstance.

Dr. Hubbard. Sure. In terms of thinking about uncertainty that

business people talk about, obviously geopolitical risks figure

prominently in that risk. But business people often talk about uncertainty

over the economic recovery itself, which has a kind of chicken-and-egg

character to it, again because their own decisions influence.

When you think about geopolitical risk, I guess it's compared to what.

There are certainly geopolitical risks in the present environment. We all

know events in the world. But let's remind ourselves of the terrorist risk

and threat that the President is trying to address for our national security

also has effects on our economic security as well.

I think what the President was trying to do in his proposals, his tax

proposals as opposed to national security policy, is to make sure that we

do what we can to lower the hurdle rate for investment.
23

Senator Bennett. I have had some very prominent economists say

as soon as Iraq is resolved, the economy will take off like a rocket,

whether it's resolved with a military victory or Saddam Hussein going

into exile or whatever. But that right now, everybody's sitting on the

sidelines. And I take it from your answer you're not prepared to put

yourself firmly in that camp? 

Dr. Hubbard. Again, I think that is among the sources of

uncertainty, but I think there are many sources of uncertainty weighing

on business people's minds. 

Senator Bennett. Okay. Thank you. We'll go on in the next round.

Mr. Stark?

Representative Stark. Dr. Hubbard, in the last recession, the

temporary federal unemployment program (UI) lasted for 30 months.

And the unemployed received 26 weeks of benefits, 33 weeks in the high

unemployment states. That number prevailed for two years after the

recession began and all during the time the state UI exhaustions were

increasing. We don't reach a comparable point in this recession until

March of this year. Your own Department of Labor agrees that we've got

about one million workers who have exhausted all of their federal and

state UI benefits and they're looking for work, trying to find work.

Most of those million workers only receive 13 weeks of benefits,

about half of what workers received at a comparable point in the last

recession. Is the Administration able to explain why we shouldn't spend

$3 or $4 billion out of the $600 billion to assist these workers who are

basically bearing the real pain of this recession when we propose this

huge tax package? Why can't we find $3 or $4 billion out of that to help

the unemployed – almost all of the $600 billion goes to the wealthy. Why

can't we find $3 or $4 billion to expand the 13 weeks? Senators Durbin

and Reed have an amendment that they say would have cost about $6

billion because it covered a few more than just the million workers.

This money would get spent obviously immediately, so there's no

question it would be an immediate stimulus. Why is the Administration

avoiding doing what we've done in the past?

Dr. Hubbard. Well, I can't resist at least commenting on the notion

that $600 billion for the wealthy is grossly inaccurate. As I suggested

before, distribution tables are the same pre- and post, and again, I dispute

who bears the burden of taxes in your statement.

But to your question, I think this is very much on the President's

mind. And in fact, I think his plan both in pro-growth policies and in

reemployment accounts is that we focus on getting people back to work

and not on unemployment insurance. You picked a number of $3 to $4

billion. That's a very convenient number, because it happens to exactly

be the amount the President proposed for personal reemployment

accounts precisely aimed at the population of people likely to exhaust UI.

Our philosophy is that what is important is to get people on the right

kind of training programs to get them back to work. And the purpose of

the reemployment accounts is to give individuals control over training for

income support and so on to get themselves back to work. Extending
24

unemployment insurance creates more unemployment. Getting back to

work is what the President has in mind. 

Representative Stark. I beg to differ. I mean, my God, $3 to $4

billion to create a program that doesn't exist would take a year, year and

a half. You haven't even gotten the homeland security building location

picked out yet, much less spent. Unemployment insurance would happen

tomorrow. These are people who were working. They had jobs, and the

jobs disappeared. They've got the training. They could go back if the

jobs were there.

The humane thing is to give these people the money so they can pay

their mortgage and pay off their credit card, pay their rent, feed their kids.

They were designed to help people who are down on their luck, who had

been working, hard working Americans, working, paying their taxes,

obeying the law. They weren't in jail. They're not welfare people. They

are people who through basically no fault of their own, a million of them,

are out of work. And in the past, past Republican Administrations, thank

you very much, have seen fit to pay them out. And this is a paltry sum

out of however much you're talking about spending and where you think

it goes, at least half of that $600 billion goes to people in the upper 1

percent. You can't deny that. What happens to the other half we won't

argue about. 

But $3 or $4 billion gives people the dignity at least of not having to

beg, not having to go on public assistance. And the states can't afford it.

We know that. We just heard from Senator Collins that you're not

helping the states with their Medicaid, which is increasing. It's a small

amount. It's a humane thing to do. If you're right, and I hope you are,

then why wouldn't you want to let these people have an additional 20

weeks, less than half a year, of knowing that they're going to be able to

feed their families, pay the rent and in a cold spell like this, heat their

houses? 

Dr. Hubbard. Two points. Again, I think what the Federal

Government can best do for everybody, employed and unemployed, is to

promote economic growth and the ability to get back to work and the

dignity of a paycheck. 

I would dispute the notion the personal reemployment accounts are

a long way away. States already use right now this day the same kind of

scoring that are necessary to implement personal reemployment accounts,

and the funds will be distributed as a block grant. So I think this is

something that provides immediate relief, and almost more to the point,

is a very, very important change in the way we view the government's

role; that is, promoting work, not unemployment insurance.

Representative Stark. Are we going to have another extension

when this one runs out? 

Dr. Hubbard. That's a subject that has to be worked out with the

Congress.

Representative Stark. What's the Administration policy?

Dr. Hubbard. The Administration looks forward to working with

the Congress on the unemployment insurance question. The President
25

believes that the best way to get to the problems you correctly identified,

Mr. Stark, are through personal reemployment accounts.

Representative Stark. How soon will these accounts be available?

Next week?

Dr. Hubbard. That's of course in large part up to you, Mr. Stark, and

your colleagues. The sooner the better.

Representative Stark. But the unemployment benefits are up to you.

They could be available next week, couldn't they?

Dr. Hubbard. Again, the Administration looks forward to working

with the Congress – 

Representative Stark. Just technically, they could be available

instantly and the training programs would have to be put in place. I'm

just suggesting, I mean, how about ten weeks? I'll split the difference

with you.

Dr. Hubbard. The training programs require – 

Representative Stark. It's cold.

Dr. Hubbard. – very little time, Mr. Stark. What's at issue is giving

individuals the power to select from training programs that are already

there.

Representative Stark. I'm sorry, Mr. Chairman. We're talking about

two different things here. The price of heating oil is a buck eighty and it's

cold outside. And if you're unemployed, training isn't going to get you

warm.

Senator Bennett. Mr. Ryan?

Representative Ryan. Thank you, Mr. Chairman. I'd like to go back

to dividends if I might, because Mr. Stark and I serve on the House Ways

and Means Committee, which is in charge of this bill. Can you help me

understand how implementation of a dividend works from the corporate

perspective on informing the taxpayer on the basis and the dividend?

How does it actually occur where the corporation communicates to the

person so they can prepare their tax returns appropriately and for the

step-up in basis? 

Dr. Hubbard. Sure. Let's first think at the corporate level, our top

tax lawyer at the Treasury estimates that in her distinguished private

practice, she would only be able to squeeze a few billable hours out even

for a large company to set it up. For the investor's perspective, there's

really two boxes that would be added to the 1099, the form that you

currently get to tell you about dividends. And basically one would be the

dividends that are excludable or not, and second, what your basis

adjustment is.

If you own mutual funds, the record keeping for that is done by the

mutual fund – 

Representative Ryan. Mutual fund sends you the – 

Dr. Hubbard. For individuals who own a lot of individual stocks,

most of whom would be more well-to-do, they would simply keep track

of the pieces of paper. You can in no way be worse off than current law.

If you don't want to keep track of paper, you can pay the capital gains tax,

but I think it's a pretty modest record keeping for most individuals.
26

Representative Ryan. One of the other issues that we're going to

have to deal with in Committee is our whole ETI foreign sales

corporation problems on the international tax side of the code. Can you

help me understand the interplay with this dividend proposal with respect

to companies who get foreign source income, how it works with the

anti-deferral rules and the tax credits, how they report it back, how they

report the step-up in basis? Isn't it a little more difficult to do for

companies that earn foreign sources income? Can you explain that. 

Dr. Hubbard. Well, first of all, all companies, multinationals and

not, benefit from the lower cost of capital. The foreign tax credits abroad

for foreign taxes paid are flowed through, because we're trying to

eliminate double taxation. For companies who are foreign operating in

the United States can still pass through income they've earned in the

United States. 

As you know as well as I, the foreign area of the Internal Revenue

Code is very difficult, but we don't see this as adding to the complexity.

Representative Ryan. Okay. Let me go at it another way. We

really do still double tax companies on foreign source income. The tax

credit does not adequately protect against paying two taxes, a foreign

government's tax and the U.S. government's tax. That's something we're

going to have to clean up. We're going to have to move bills to do that.

We're going to have to do it so it's WTO compliant, because we've lost

four of these rounds.

So in the absence of having a clean tax credit regime to prevent

companies from being double taxed from a country perspective, aren't we

going to have some problems keeping records on that kind of income

where we send dividends from overseas back to the United States and

where we send a step-in basis from overseas back to the United States?

Do you foresee any more higher degree of complication? 

Dr. Hubbard. You needn't, Mr. Ryan, depending on how you

approach the ETI fix, it's quite possible to clean up interest allocation

rules, to clean up the way we tax active income abroad, that would go

hand-in-glove with what the President's proposing.

Representative Ryan. That's what I'm trying to get at. I think we're

going to hopefully fix the interest allocation rules, the base sales and

services, shrink the baskets from nine to three or something like that.

Does this jibe well with those plans?

Dr. Hubbard. It does indeed. In fact, there is a January 1993

Treasury pamphlet that describes how to make the foreign tax system

more consistent with exactly this kind of a proposal.

Representative Ryan. Those are the questions I think you're going

to get some more of when you come over to the House side, so I think

that that's important to focus on that. Thank you. 

Senator Bennett. Thank you very much, Mr. Ryan. As we sum up

here, Dr. Hubbard, I am struck, as a number of people are, with the

changed economic atmosphere in which we live. I say to people, this is

the first recession of the Information Age, not the last recession of the

Industrial Age.
27

I think the recession that we had in the early '90s was the last

recession of the Industrial Age. And now that we live in the Information

Age where data are available to managers in real time instead of delayed,

decisions can be made virtually by the hour. You see something showing

up on the sales floor, you can change your inventory immediately with a

computer. You can get a hot item into the customer's hands by tomorrow

morning. Very, very different from the traditional inventory recession

where you get a build-up of cars in the back lot and then suddenly

discover that they're not selling and you have to shut down the plant till

all of the cars move out, and that's going to take you six months.

That's the old model that I learned about in school of the Industrial

Age recession, and it simply doesn't apply anymore. And I think your

chart showing the difference between the pattern of this recession and

recovery compared to the average validates that view. So if this is indeed

the first recession and the first recovery of the Information Age, we are

plowing new ground, and we're trying to learn new things. And that adds

in a way to our uncertainty.

With that background, this is my question. There is worldwide

overcapacity in a number of basic industries. Steel is the poster child for

worldwide overcapacity. As we work our way through that, do we have

a problem with respect to stimulating investment if the impact of the

stimulation of investment is going to add to an existing circumstance of

overcapacity? And globalization means that steel capacity in Singapore

impacts steel capacity here. 

In microchips there is a cutthroat, vicious kind of competition around

the world, with other countries subsidizing through government for

extended periods of time – beyond what we would ever have thought they

could sustain – investment in still increased capacity in microchips. I'm

particularly interested in that because Micron has built a plant, put more

than a billion dollars of investment into my home State of Utah for the

privilege of producing chips at a loss because of where the world market

is going.

Step back from the partisan kind of questioning that sometimes goes

on up here where some people are throwing spears at you and other

people are throwing softballs at you, and address this question long term

from your perspective as a thoughtful economist, what you think is going

to happen in terms of the new age in which we now live, a global

economy, an economy without borders, information that makes it possible

for people to make more intelligent kinds of investments but the desire to

seize the market by overinvesting perhaps and then driving your other

competitors out of business, this is a world very different from the one

that was outlined in the economic classes that I took in the 1950s.

Can you share with us your view of the impact of overcapacity on the

kind of recovery we're looking at and then the world as a whole in the

brand new world we've entered?

Dr. Hubbard. Sure. We're of course working through, and in my

view have largely worked through overcapacity from excess investment

in the late 1990s. As for steel, it's important to note that a lot of steel

investment around the world was uneconomic on private economic
28

grounds. Government subsidies in a variety of ways kept steel capacity

too high, and this is one of the things that is going on, as you know,

Senator, in the OECD discussions on how to rationalize capacity in the

steel industry. And our government has played a big role in that.

At the Council, we've tried to estimate what we think excess capacity

is, and we believe that outside of the telecommunications sector where

that is truly still a major problem, excess capacity is relatively modest and

suggests that a stimuli to investment can really boost investment and

capital formation.

Your point about globalization I agree with 100 percent. And to me

as an economist, what it suggests is the need to make sure the nation has

the most competitive policies possible, to make sure that we have a tax

policy that is very much centered on the age that you described. Mr.

Ryan had inquired about the way we treat multinational companies. That

is clearly part of it. The way we treat investment in the United States.

These are issues that will become more and more on your agenda in this

new age.

Senator Bennett. So I repeat a question that came up earlier. Do

other countries with whose industries we compete with tax dividends

twice?

Dr. Hubbard. Almost all of the G7 has some sort of integration

relief, not all as much as the President has suggested, but we are the

double tax bad boys in the G7.

Senator Bennett. So this question is not only a fairness question, a

corporate governance question, it is also a competitive question as far as

the rest of the world is concerned?

Dr. Hubbard. It's very much a competitive question not only for

companies operating here at home, but for companies operating around

the world. 

Senator Bennett. And again, coming back to what I think I heard

you say, but want to be sure, the major difference in the long-term growth

impact of tax reform is whether or not it's permanent or temporary? That

a temporary tax fix comes and goes as a quick spike and has no long-term

effect, but a permanent change of the kind the President has talked about

builds in long-term productivity. Do I have that right?

Dr. Hubbard. You're exactly right, Senator. The long-term tax

changes are better. They help stimulate spending. They give households

and businesses a longer horizon to plan. In addition, of course, what the

President has done is proposed a fairly dramatic tax cut on the cost of

capital for investment.

Senator Bennett. Thank you very much for your testimony. We

appreciate again your service. 

Dr. Hubbard. Thank you, Senator.

Senator Bennett. I go back to when I was first in this town as a

young staffer and remember the fight led by John F. Kennedy when he

wanted to reduce the top marginal tax rate from 90 percent to 70 percent,

and everyone said it was going to blow a huge hole in the budget and that

it wasn't fair. Does that sound somewhat familiar in today's

circumstances?
29

Dr. Hubbard. We've been there once a decade, Mr. Chairman. 

Senator Bennett. And the phrase that was used then echoes I think

with your testimony. JFK said, “A rising tide lifts all boats”. And the

people at the bottom will be benefitted as the economy works out, the

growth in the economy works out as a result of this. 

It's very interesting that there were those who resisted the top

marginal tax rate at 70 percent on the ground that we couldn't afford it

long-term in deficit. I don't think anybody would today say in order to be

fair, we've got to go back to a 70 percent marginal tax rate. At least we've

made some progress in that we're trying to fight between a 42 percent,

which is the effective rate today when you add the Medicare on top of the

tax, income tax. The President is trying to get it down below 40 percent.

I'd love to see it below 30 percent and so would the majority of the

American people if we pay attention to the recent polls.

With that, again, thank you for coming. This hearing is adjourned.

[Whereupon, at 11:42 a.m. on Thursday, January 30, 2003, the hearing

was adjourned.]
30

 SUBMISSIONS FOR THE RECORD

PREPARED STATEMENT OF 

SENATOR ROBERT F. BENNETT, CHAIRMAN

Good Morning and welcome to the first hearing of the Joint

Economic Committee (JEC) in the 108th Congress. I am happy to have

the privilege of chairing the Committee for the next two years, and would

like to begin by thanking Representative Saxton for the fine work he did

as chair during the previous Congress. I hope that the JEC is able to

accomplish as much this term as it did under his able hands during the

previous Congress. I also wish to welcome our Democratic JEC members

to our hearing today; I look forward to continuing the Committee's

tradition of working together with the utmost in courtesy and civility. 

Today, I am pleased to have as our distinguished guest Dr. Glenn

Hubbard from the Council of Economic Advisers(CEA). Dr. Hubbard

has served the President ably over the past two years, and I hope that your

return to academia is refreshing, productive, and brief, for we have all

benefitted from your wise council over the past two years. It is fitting

that we have the head of the CEA here with us today; the JEC and CEA

were created together in 1946 and have worked hand-in-hand over the

years to provide timely and objective analysis of public policy for our

respective branches of government. My staff and I have enjoyed working

with the CEA and I expect this cooperation to continue.

The economy currently appears to be going through what Fed

Chairman Alan Greenspan called at a recent JEC hearing a "soft patch",

and the lack of robust, sustained economic growth has been a frustration

to all of us. The proper role of government in alleviating a sluggish

economy and accelerating the nascent recovery is a difficult one, and one

with as many different answers as there are economists.

The primary focus of today's hearing is the Administration's attempt

to counteract the recent pause in robust growth as well as ensure future

economic growth with its recently proposed economic growth package.

The proposal involves accelerating tax cuts already scheduled in 2004 and

2006 so as to take affect in the current year, increasing the expensing of

investment for small firms, eliminating the marriage penalty, increasing

the child tax credits, and providing states with funds to establish

individual re-employment accounts.

The tax cut proposal is a bold one, and one that is sure to increase the

budget deficit in the short run. However, I do not necessarily believe that

the primary factor in judging a policy ought to be its impact on the nearterm deficit. I think one lesson we have learned over the past thirty years,

through both Republican and Democrat administrations, and Democratic

and Republican Congresses, is that solid economic growth can be a

wonderful elixir for an economy. I am very much interested in how Dr.

Hubbard and his staff believe the President's proposal will increase

economic growth in both the short run and the long run.

The most ambitious part of the stimulus growth package is

undoubtedly the removal of the double taxation of dividends, and I am
31

sure that most of the questions today will be about the particulars of this

plan. There are many different ways to structure tax reform so as to

eliminate the double taxation of dividends, a pernicious distortion of the

tax code that has been almost entirely done away with in developed

economies. I welcome the opportunity to have Dr. Hubbard explain some

of the details of the tax cut and the choices made in constructing the plan.

I also welcome Dr. Hubbard's thoughts on the current state of the

economy. The recent release of the fourth quarter GDP numbers seem to

indicate that the current soft patch is still with us. While the growth

numbers were disappointing to all of us, the data I have examined

suggests to me, at least, that we should expect more rapid growth in the

upcoming year.

Again, we welcome you to the JEC, Dr. Hubbard, and look forward

to your testimony.
32

PREPARED STATEMENT OF REPRESENTATIVE PETE STARK, 

RANKING MINORITY MEMBER

Thank you, Chairman Bennett. I want to congratulate you as the new

Chairman of the Joint Economic Committee. I also want to congratulate

you for holding thishearing. All indications are that Dr. Hubbard was an

important architect of the Administration’s latest economic plan, and I

welcome this opportunity to hear how he responds to some fundamental

concerns that I and many others have about that plan.

I hope we can all agree that almost two years after the start of the

recession in March 2001, the economy is still in a slump and is not

creating jobs. GDP growth in2002 was too weak to bring down the

unemployment rate, which stands at an eight year high of 6 percent. On

net, no new jobs were created last year. In fact, payroll employment

ended the year slightly below the already depressed level reached at the

end of 2001.

The economic outlook can be summed up in the title of the old Buddy

Holly song, “Crying, Waiting, Hoping.” We’re crying because the

economy is not delivering the jobs it should; we’re waiting for businesses

to start investing and rehiring again, because new business investment is

critical for mounting a sustainable recovery; and we’re hoping that the

battered and anxious consumer will keep spending in the meantime, so

that the economy does not slip back into recession.

I wish I could say that the President has a plan that would address the

real problems in the economy, but he does not. Instead of a plan that

would put money into the hands of those who need it and would spend it

immediately, the President has proposed to eliminate the individual

income tax on dividends paid by corporations and to speed up the rate

cuts that go to a relatively small number of high-income taxpayers. There

are other things in the President’s plan, but those two proposals account

for more than half of the cost. I see three major problems with the

President’s plan.

First, it does not provide job-creating stimulus when we need it. The

impact in this fiscal year is a paltry $35 billion or so in a package that

costs a whopping $674 billion over the next 10 years. We need to do

more now to create jobs and put people back to work. The

Administration’s program relies almost exclusively on tax cuts and

ignores government spending, which can have a direct and immediate

impact on jobs and incomes.

For example, the President’s program provides no relief for the states,

whose financial crisis will force them to raise taxes or cut spending at

exactly the wrong time in the business cycle. States will have to lay off

workers and there will be no money for child care and other support

services that help single working mothers. Moreover, the

Administration’s dividend proposal would automatically reduce the tax

base of states that tie their income tax to the federal form. The President’s

plan does not directly address the problems facing people who have

exhausted their unemployment benefits but are still having trouble finding

a job. A true job-creating stimulus package would pack more punch in the

first year. For example, the proposals of House Democratic Leader Pelosi
33

and Senate Democratic Leader Daschle would each provide about $140

billion of immediate stimulus to put people back to work as quickly as

possible.

A second problem with the President’s plan is that it is fiscally

irresponsible. It either drains budget resources that could be put to better

use—such as really improving Medicare—or it increases the deficit. In

the latter case, once interest costs are taken

into account, the President’s new tax cuts would add almost a trillion

dollars to the national debt over the next 10 years.

You would think that with the retirement of the baby boom

generation just a few years away, we would be taking steps to make sure

that we have the budget resources to honor our Social Security and

Medicare commitments. Instead we are squandering them on tax cuts that

are hard to justify. I think you would be hard pressed to find many

economists who think that the major reason unemployment remained

stubbornly high last year was the double-taxation of some dividends. But

I think you could find a lot who believe that large increases in the public

debt are bad for interest rates, investment, and long-term growth.

So, why is the Administration proposing something that doesn’t help

in the short-term but undermines budget discipline in the long run? Once

again, it is instructive to compare the President’s proposal with the

Democratic alternatives, which concentrate almost all their impact in the

first year, without worsening the deficit in subsequent years.

My final problem with the President’s plan is that it is unfair. People

with incomes over a million dollars get tax cuts of almost $90,000, much

of it from the dividend proposal and the upper bracket rate cuts. The

average family receives almost no benefit from those provisions. The

Administration cites new data from the Federal Reserve showing that

more than half of American families own stock, either directly or

indirectly through mutual funds and pensions. But owning some stock

and benefitting from the President’s dividend proposal are two different

things. What the Administration does not point out is that wealth,

including stock ownership, is much more unequally distributed than

income. In 2001, the wealthiest 10 percent of households held 70 percent

of all the wealth. Those are the people who are going to get most of the

benefit from the President’s dividend proposal.

Some provisions of the President’s plan provide tax cuts to middle

class families, but middle class families fare at least as well under the

Democratic alternatives as they do under the President’s plan. The

difference is that the Democratic alternatives are able to provide more

stimulus with less long-term harm to the budget because they do not

provide expensive tax breaks to very high-income taxpayers. And, unlike

the Administration, they recognize that there are a million people out

there who have exhausted all federal and state unemployment benefits

and are still out of work, and that helping out those workers should be

part of any program to get the economy moving again.

I must agree with my colleague in the U.S. Senate, Senator Breaux,

who recently commented that investing in our health care system would

do far more to stimulate our economy and improve the lives of real people
34

than anything in President Bush’s latest tax cut. President Bush always

finds the money for tax cuts, but falls short when it comes to Medicare,

prescription drug coverage, and people’s health.

Over the past two decades we have seen two different fiscal policy

experiments. In the one, we enacted a large tax cut and saw budget

deficits balloon. That was the 1980s. In the other, we took steps to bring

down the budget deficit, including some tax increases on the richest 1 to

2 percent of taxpayers. That was the 1990s. Did it matter whether we had

deficits? Here’s what one textbook says:

We can represent the large increases in the federal budget deficit in

the early 1980s...creating short-run pressures for higher output and

interest rates (emphasis added). By the late 1990s, an emerging

federal budget surplus put downward pressure on interest rates.

That is a quote from Dr. Hubbard’s textbook, Money, the Financial

System, and the Economy. Like most academic economists, he

recognized that a lack of fiscal discipline contributes to higher interest

rates and fiscal discipline contributes to lower interest rates. I hope he

would recognize that large budget deficits drain the pool of national

saving, reducing the amount available for new investment or forcing us

to borrow from the rest of the world, incurring an obligation that we will

have to repay in the future.

It looks to me like the fiscal policies the Bush Administration is

pursuing are more like those of the 1980s than they are like those of the

1990s. Of course, there is one difference. In 1982, President Reagan

recognized that the tax cut that was passed in 1981 was excessive, and he

scaled it back substantially.

I am looking forward to Dr. Hubbard’s testimony, and I hope he

addresses these concerns.
35

PREPARED STATEMENT OF 

REPRESENTATIVE JIM SAXTON, VICE CHAIRMAN

It is a pleasure to join in welcoming Chairman Hubbard before the

Committee this morning. 

A review of the data shows that the economy has not yet fully

rebounded from the slowdown that began in the middle of 2000.

Although GDP growth was about 3 percent during the first three quarters

of the year, it lagged in the fourth quarter. Consumption has held up quite

well until the last quarter, but weakness in business investment continues

to be a feature of the slowdown. Employment has also been weak, with

manufacturing employment, for example, falling for 29 consecutive

months since the summer of 2000. 

The President has proposed to accelerate already scheduled tax

reductions in individual marginal income tax rates and the marriage

penalty, provide a dividend exclusion for individuals, and expand

expensing of investment for small business, among other things. 

During 2001, many economists noted the timeliness of the first

installment of tax relief, given the fact that the economy had slipped into

recession. The current concerns about the pace of economic expansion

indicate that accelerated tax relief now would also be appropriate. The

end of the double taxation of dividends would also reduce the bias against

saving and investment in the tax code, and enhance the prospects of

economic growth over the long run. 

Unfortunately, opponents of the President's tax proposal have

misrepresented it as skewed towards the affluent. However, this argument

is typically based on incomplete information taken out of context. As I

have pointed out before, disclosure of the shares of taxes paid by each

income group before and after a tax relief plan goes into effect is usually

not made by such critics. Such information would demonstrate that the

proportion of tax relief is mostly driven by the shares of taxes paid before

tax relief becomes effective, and usually subsequent changes in total tax

shares are quite small. 

Another issue related to evaluating the impact of tax relief is income

mobility. Over ten years ago this committee asked the Treasury

Department to provide an analysis of the mobility of tax filers over an

extended period of time. In the last Congress, I requested an updated

examination of this critically important issue, and think such information

would be valuable to policymakers now. There are those who persist in

viewing the U.S. economy as a sort of caste system in which people are

cemented into a particular income class forever. Data on income mobility

demonstrate a much more flexible and dynamic reality characterized by

fairly high degrees of income mobility. 
36

Bush Tax Cuts and Projected Surpluses

(billions of dollars)

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Total

Surplus

(Projecte

d in

January

2001)

313 359 397 433 505 573 635 710 796 889

Tax Act -38 -91 -108 -107 -135 -152 -160 -168 -187 -130

Total 275 268 289 326 370 421 475 542 609 759
37

PREPARED STATEMENT OF DR. R. GLENN HUBBARD,

CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS

Chairman Bennett and members of the Committee, I thank you

for the opportunity to testify today on the President’s Jobs and Growth

Initiative. As a starting point, I would like to review the economic

situation facing our Nation. In many ways, the economy’s recent

behavior has been different than that of past recoveries. Typically,

business investment declines most sharply in recessions and expands most

briskly in recoveries. By contrast, the household and government sectors

do not fluctuate as much. In 2002, however, the recovery from the

economic contraction in the previous year took place amid continued

weakness in business investment and strength in the household sector.

Weakness in investment, in turn, has reduced job growth below what is

normal for this stage of the expansion. In the near term, the central

challenge for the economy will be to support rising investment, so that

robust job growth can resume. 

Over longer horizons, the fundamental strengths of the American

economy are clear. Most importantly, the productivity acceleration that

began in the late 1990s continued in 2002. As Chart 1 shows, the trend

rate of U.S. labor productivity growth has risen from rate of 1.4 percent

per year from 1973 to 1995 to 2.5 percent per year from 1995 to 2000.

Over the last four quarters for which we have data, labor productivity has

risen by 5.6 percent – the best four-quarter change in productivity since

the early 1970s. Because productivity growth is the key to growth in

incomes and living standards, the ongoing productivity revival speaks

well for the long-term outlook. Additionally, inflation remains low and

stable, which helps the economy interpret relative price signals efficiently

and which gives policymakers the room to support near-term growth.

GDP data for the fourth quarter of 2002, which were released

earlier this morning, highlight the importance of supporting near-term

growth with a fiscal policy that improves long-run outcomes as well. 

After rising at an annual rate of 3.4 percent during the first three quarters,

GDP rose at an annual rate of 0.7 percent in the fourth quarter. Business

fixed investment rose at an annual rate of 1.5 percent – the first quarterly

increase since mid-2000 – but larger rates of increase will be needed for

the recovery to be fully established. The role of investment in the current

recovery and the importance of productivity growth in the long run

provide the context for the President’s jobs and growth proposals, which

I will discuss extensively today. In the short term, the focused, specific

proposals that the President has outlined are the most appropriate way to

insure that the investment recovery proceeds as expected. In the long run,

the proposals will raise long-run living standards by increasing

investment and the capital stock, which will make workers more

productive and thereby raise their standard of living. Before I turn to

those proposals, I will review the recent performance of the U.S.

economy. Doing so will illustrate how the President’s proposals support
38

the immediate recovery as well as improve incentives for long-term

growth.

 THE ECONOMIC SITUATION IN 2002

Household sector. The household sector was a robust and

consistent source of final demand in 2002. In large part, the strength of

the household sector last year stemmed from the aggressive monetary

easing by the Federal Reserve in 2001. Over the course of that year, the

Federal Reserve cut its target federal funds rate eleven times, lowering the

target from 6.5 percent to 1.75 percent. Given the well-known lags in

monetary policy, these reductions continued to provide stimulus

throughout 2002. Lower interest rates, for example, allowed motor

vehicle companies to offer aggressive financing incentives, which have

supported auto sales through much of the year. 

Additionally, the substantial cuts in the target federal funds rate

by the Federal Reserve have translated into lower mortgage interest rates,

supporting housing starts and mortgage refinancing. In the first three

quarters of 2002, mortgage refinancing alone injected more than $100

billion into home owners’ pocketbooks. After they paid down second

mortgages and outstanding home equity loans, they had more than $59

billion left over to spend in other ways. Survey evidence indicates that

about half of this $59 billion was probably used for consumption and

home improvements – two components of aggregate demand – which

would have raised nominal GDP by about 0.4 percent in the first three

quarters of 2002. All in all, the interest rates cuts were helpful in

maintaining the recovery last year. The most recent rate reduction of 50

basis points undertaken on November 6, 2002, will provide further

support for the recovery in 2003.

Fiscal policy has also been an important force behind robust

consumption in 2002. In addition to enhancing long-term economic

efficiency, the tax cut proposed by the President and passed by Congress

in 2001 provided valuable support for disposable income, which has been

far more robust than is typical at this stage of a recovery. The upshot has

been solid growth in both personal consumption expenditures and

residential investment that has supported the recovery so far.

Business investment. In contrast to positive impetus from the

household sector, business investment has been the economy’s key weak

spot. As I noted earlier, during the current business cycle, the decline in

business investment has been sharper, and the recovery more modest, than

an average postwar business cycle. On average, the peak-to-trough

decline in nonresidential investment in the typical post-war recession is

6.2 percent. Assuming that the trough in the most recent recession

occurred during the fourth quarter of 2001 – a decision that ultimately

resides with the National Bureau of Economic Research – the

corresponding decline in the most recent recession was 8 percent.

Comparing the typical pace of recovery, during the first three quarters of

this recovery, business investment fell 2.0 percent further, compared to

a typical increase of roughly 2.7 percent. Chart 2 displays the current

weakness investment graphically, by comparing it to the typical
39

experience of recoveries since 1960. Simply put, the recovery in

investment that one would expect at this stage of the business cycle has

yet to materialize.

The current weakness in investment results is linked to adverse

developments in equity markets during the past three years. Indeed, both

stem in large part from the same underlying shock – a scaling back of

expected profit growth. Evidence that earnings growth was adjusted

downward comes from surveys of Wall Street analysts who track

individual firms. According to one such survey, five-year-ahead earnings

growth forecasts for the firms in the S&P 500 fell from a peak of more

than 18 percent per year in mid-2000 to slightly more than 13 percent per

year by September 2002. Another factor in lowering both equity values

and business investment is the current risk climate. Higher levels of

uncertainty in the economy and/or higher aversion to risk on the part of

investors reduce the willingness of investors to hold corporate equities

and lowers stock prices and investment. One reflection of the risk

outlook is the spread between yields on corporate bonds and U.S.

Treasury securities, because corporate bonds are subject to default risk

while U.S. Treasuries are not. The widening gap between yields for

corporate and Treasury securities after 2000 coincided closely with the

decline in the stock market during this period. Spreads continued to

widen sharply in 2002, reaching near-record levels, indicating that risk

aversion played a key role in markets in the months following September

11, 2001 as well.

Inventory investment contributed strongly to the economic

slowdown in 2001, but by early in 2002, the pace of inventory decline

slowed, providing a significant boost to production. In some sectors of

the economy, evidence suggests that inventory restocking is underway.

Over the next several quarters, as inventory and sales growth come

together, inventory investment’s role in real GDP growth should provide

upward momentum to the recovery.

Government purchases. The war on terror continued to exert

upward pressure on Federal government purchases in 2002. In late

March, for example, the President requested that Congress provide an

additional appropriation of $27.1 billion, primarily to fund the effort in

the war against terror. More than half of this amount was allocated to the

activities of the Defense Department and various intelligence agencies.

Most of the rest was needed for homeland security (mainly for the new

Transportation Security Administration) and for the emergency response

and recovery efforts in New York City. Though most of this spending

was required for one-time outlays only, it nevertheless contributed to the

large 6.4 percent annual rate of increase in real Federal government

purchases in the first three quarters of 2002. State and local government

purchases rose by a more moderate 1.7 percent annual rate during the

same period.

External sector. While the United States economy remained

below potential in 2002, its growth rate still outpaced that of many other

industrialized countries. Growth in Canada – America’s largest trading

partner – was a healthy 4.0 percent in during the four quarters ending in
40

the third quarter of 2002, but growth in many other countries, such as

Mexico, France, Japan, and Italy lagged behind. Low demand for U.S.

exports combined with the emerging recovery in the United States (and

the subsequent increase in the U.S. demand for imports) caused the U.S.

trade deficit to reach record levels in 2002. 

The widening trade deficit placed additional downward pressure

on the U.S. current account, which reached almost five percent of GDP

in the middle of 2002. As a matter of accounting, the current account is

simply the difference between net domestic investment and net domestic

saving. Several factors can raise the current account deficit, including

higher investment in the within our borders on the part of foreign

investors, or lower savings rates on the part of U.S. citizens. In light of

the large number of trade-related and financial forces operating on the

current account, it is impossible to label a current account deficit as either

“good” or “bad.” Indeed, one factor contributing to high U.S. investment

relative to savings is the rapid increase in U.S. productivity relative to

many other major countries, which makes the United States a good place

to invest. Because productivity growth is ultimately responsible for rising

living standards, the current account deficit reflects at least in part good

news about the American economy. Even so, a current account deficit

indicates that the United States is consuming and investing more than it

is producing, and the U.S. current account has typically been in deficit for

the past two decades. As a result, the net international investment position

in the United States has moved from an accumulated surplus of slightly

less than 10 percent of GDP in the late 1970s to a deficit of almost 20

percent of GDP in 2001. 

Recent increases in the current account deficit have led to some

concerns that continued current account deficits (and the subsequent

increases in international debt that would result) could not be sustained.

Because debt has to be serviced by the repatriation of capital income

abroad, the ratio of a country’s debt to its income must stabilize at some

point. Yet the U.S. is currently far from the point at which servicing our

international debt becomes burdensome. In fact, until 2002, more

investment income was generated by U.S. investment in foreign countries

than was generated by foreign investments inside the United States. 

In the end, the key determinant of the sustainability of the U.S.

international debt position is continued confidence in the economic

policies of the United States. As long as the United States pursues its

current market-oriented, pro-growth policies, then the current account

deficit will not represent an impediment to continued economic growth.

Labor market. The unemployment rate hovered between 5.5 and

6.0 percent throughout the year after rising 1.8 percentage points in 2001.

Nonfarm payroll employment in 2002 was similarly weak, with 181,000

jobs lost in 2002, compared with 1.4 million jobs lost the previous year.

As in past business cycles, declines in manufacturing

employment have been especially pronounced. Factory employment fell

592,000 in 2002, following a decline of 1.3 million in 2001 and about

100,000 in 2000. Another feature of previous business cycles that has

recurred in the past two years is the increase in the number of workers
41

who report a long unemployment spell. Like the overall unemployment

rate, the number of workers unemployed for 26 weeks or more rose in the

2001 and remained high in 2002. Yet the pattern of long-term

unemployment observed in 2001 and 2002 was similar to patterns traced

out in previous postwar fluctuations. Like the overall unemployment rate,

the level of long-term unemployment remains moderate relative to past

business cycles.

RISKS TO THE OUTLOOK

The slowing of GDP growth and weakness in labor markets in the

fourth quarter of 2002 highlight the risks the recovery currently faces. In

order of importance, these risks include: 

A Delayed Investment Recovery. The key to transforming the

current recovery into sustained robust growth is an increase in the pace

of business fixed investment. Only with robust business investment will

labor markets improve. A recovery in investment is a key factor in

creating more jobs because when companies build new factories, they hire

directly and boost employment in capital-goods industries. 

While private forecasters expect business investment spending to

recover in 2003, there are several potential sources of a delay in an

investment recovery. One risk is weaker profit growth. Due to a sharp

increase in the fourth quarter of 2001, corporate profits have rebounded

from recessionary lows. (This is the most recent quarter for which we

have data on corporate profits.) Yet the recovery in profits has been

uneven. In the first three quarters of 2002, profits as a share of income

averaged 7.5 percent. While this represents a recovery from the 7.2

percent share in 2001, it is still below shares of 8.7 percent in 1999 and

7.9 percent in 2000. Moreover, on a quarterly basis, corporate profits

declined in each of the first three quarters of 2002. Because current

profits are an indicator of future profits, firms may interpret recent

weakness in profit growth as an indication of reduced investment

opportunities. Moreover, the decline in profits may have an even more

negative impact on investment at firms that depend on retained earnings

(rather than external capital markets) to fund investment projects. 

A second potential setback to the investment recovery reflects an

increase in the level of uncertainty about the course of the near term

events or higher levels of risk aversion on the part of investors. Higher

levels of uncertainty in the economy can also make firms delay new

projects until the uncertainty is resolved. This delay is translated into a

higher expected rate of return in order for new projects to be undertaken,

which reduces the level of investment that is undertaken in the near term.

Additionally, higher levels of risk aversion on the part of investors can

reduce investment by making it harder for firms to raise external funds.

A Decline in Consumer Spending. As mentioned, the recent

business cycle stands apart from the typical postwar recession in that

household income growth has been stable while stock price declines have

eroded household wealth. In the typical recession, incomes and net worth

move together, but in the most recent recession, net worth fell

dramatically relative to income. Yet in contrast to the negative effect of
42

lower equity values on business investment, consumption has remained

remarkably robust, even as household net worth has suffered. The

contrast in the pattern of spending mirrors a reversal of conventional

income and wealth dynamics. In the current cycle personal income –

especially disposable personal income, supported by the tax cuts of 2001

– has held up quite well, even as household balance sheet positions have

weakened. 

The deterioration in household wealth over the past three years

raises the possibility that consumers will increase their active saving out

of disposable income in order to restore at least some of their lost wealth.

An increase in precautionary saving of this type could have a substantial

effect on yearly consumption. From the first quarter of 2000 to the last

quarter of 2002, households lost nearly $7 trillion in equity wealth. A

rough rule of thumb suggested by aggregate data on wealth and

consumption is that yearly consumption declines by 3 to 5 cents for every

dollar of lost equity wealth. Based on the midpoint of this range, the $7

trillion reduction in equity wealth since early 2000 would be expected to

eventually lower yearly consumption by about $280 billion per year. For

comparison, a reduction of this amount would represent nearly 4 percent

of consumption and almost 3 percent of GDP in 2002. 

Empirical findings also suggest that response of consumption to

stock market wealth is drawn out over time, a fact which has crucial

implications for the precise path of consumption over the next few years.

Because the appreciation of equity prices before 2000 would be expected

to increase consumption, some of the implied $280 billion drop in

consumption after 2000 may simply represent a “cancellation” of an

implied consumption increase that had not yet taken place. Moreover,

positive influences from the other determinants of consumption (such as

current income and the continuing appreciation in housing wealth) are

likely to offset the stock market’s negative effects on personal spending.

Even so, the possibility that consumers might pull back somewhat

represents a risk to the recovery in the near term.

An Increase in Oil Prices. Oil prices trended upward in 2002,

with the spot price of the benchmark West Texas Intermediate rising from

about $20 per barrel at the start of the year to about $32 by year’s end.

Much of the increase was due to the recent turmoil in Venezuela. The

general strike in that country began in the first week of December; since

then, the WTI price has risen from around $27 dollars per barrel to about

$33 dollars per barrel today. Concerns over the failure of the Iraqi regime

to disarm in a credible way may have also been partly responsible for the

increase in oil prices in 2002.

The effect of further oil price increases on the economy is

difficult to determine. To be sure, there are “rules of thumb” that are often

used to quantify the effect of export disruption on oil prices as well as the

subsequent effect of higher oil prices on GDP. For disturbances of a few

million barrels per day, a reduction of oil supplies of one million barrels

per day typically raises prices by about 3 to 5 dollars per barrel.

Additionally, a sustained increase in oil prices of $10 per barrel would be

expected to lower GDP growth by about 0.25 to 0.50 percentage points
43

after six months to one year. While these rules of thumb are useful

guideposts, the actual effect to the economy could vary greatly from

episode to episode. For example, a disruption of oil production that was

that was expected to last indefinitely would affect prices differently from

one that was likely to be unwound quickly. Moreover, if higher oil prices

accompany a serious deterioration in consumer and business confidence,

their ultimate effect on GDP could be much larger than a simple rule of

thumb would suggest.

THE PRESIDENT’S JOBS AND GROWTH INITIATIVE

In light of the risks to the near-term outlook, the President has

advanced a proposal to enhance long-term growth while providing nearterm support against downside risks to the Nation’s economic outlook.

It is important to note that the recovery is not in immediate jeopardy.

Private forecasters expect the recovery to gather momentum over the

coming year, with both higher investment and improved job growth. Yet

the presence of current risks suggests that insurance against unforeseen

deterioration in economic activity is especially valuable. The best

proposals are those that will raise the rate of long-term growth even if the

recovery takes shape as private forecasters anticipate.

The President’s proposal targets the areas that are most

fundamental to the continued health of the current recovery – investment,

consumption, and job growth. Specifically: 

1. Accelerate to January 1, 2003 features of the 2001 tax cut

currently scheduled to be phased-in: the reductions in

marginal income tax rates, additional marriage penalty relief,

a larger child credit, and a wider 10 percent income tax

bracket.

2. Eliminate the double taxation of corporate income, whether

this income is paid out to individuals as dividends or retained

by the firm. Dividend income will no longer be taxable on

the individual level, while a step-up in basis will be allowed

in order to reflect the effect of retained earnings on share

prices. 

3. Increase to $75,000 the size of small business investment

incentives – the amount that they may deduct from their

taxable income in the year the investment takes place.

4. Provide $3.6 billion of funds to the states to fund Personal

Reemployment Accounts. These accounts provide up to

$3,000 to assist unemployed workers who are likely to need

help in finding or training for a new job. If a new job is

found quickly, the unspent balance in the account can be

kept as a “reemployment bonus.”

How the Proposals Will Help the Economy in the Near Term

Supporting investment. To be effective in aiding the current

recovery, any proposal must support investment. The President’s

proposals do this in three ways: ending the double taxation of corporate
44

income, raising the expensing limits for small businesses, and lowering

individual marginal tax rates (which are the relevant tax rates for small

firms that pass through their income to their owners). 

The most immediate effect of ending the double taxation of

corporate income will be to lower the cost of capital faced by firms in

equity markets. Under the double taxation inherent in the current law,

investment projects funded with new equity capital face effective federal

taxation of up to 60 percent. The President’s proposals address this

problem by removing the layer of tax at the individual level. Corporate

income will be taxed once – and only once – which will make corporate

equities more attractive to investors and lower the implicit cost that firms

pay for equity-financed investment. As an example, the cost of capital for

equity-financed equipment investment in the corporate sector would fall

by more than 10 percent. For investment in structures – the weakest part

of the investment outlook today – the decline in the cost of corporate

equity capital would be more than one-third. For equipment investment,

this decline in the cost of capital is equivalent to an investment tax credit

of from four to seven percent. 

In addition to the direct stimulative effects of lower costs of

equity capital, ending the double taxation of corporate income will

rationalize dividend payout policy among American companies. This will

also aid investment, even in the short run. Currently, the tax code

encourages firms to retain earnings and remit income to shareholders

through share repurchases. This gives firms an incentive to inflate their

reported earnings, so that their stock prices will rise. A main goal of the

President’s policy is to reduce this incentive by making tax policy neutral

with respect to retaining earnings or paying dividends. Firms wanting to

transmit their profitability to outside investors need only show them the

money, in the form of dividend checks. With less uncertainty about the

true profitability of firms, investment funds will flow more easily to firms

with good investment prospects. This will not only make financial

markets more efficient, but – like the reduction in the equity cost of

capital – rational payout policy may also raise the total level of

investment as well.

Other parts of the proposal support investment for smaller firms.

Small firms will be allowed to expense up to $75,000 in new investment,

which will lower the tax-adjusted cost of capital significantly. Eligibility

for this immediate deduction would begin to phase out for small

businesses with investment in excess of $325,000, which is increased

from $200,000. (Both the expensing limit and the phase-out range will be

indexed to inflation.) Additionally, the acceleration of the marginal tax

rate reductions will help firms that pass-through earnings to their owners.

According to the Treasury Department, more than 30 million individual

returns listed small business income in 2000. Virtually all of these firms

will enjoy marginal tax relief by accelerating the rate reductions which

have already been approved by Congress. 

Supporting consumption. Consumption accounts for about twothirds of economic activity, and consumption spending must remain

vigorous if the recovery is going to continue. The President’s proposals
45

will accelerate the tax relief that has already been enacted, which will put

more money in the pockets of consumers this year – when it is needed

most. The Treasury estimates that calendar-year tax liabilities will be

reduced by almost $100 billion in 2003. Of this amount, about $29

billion will be due to the marginal rate reductions, while another $16

billion will result from the acceleration of the increase in the child credit.

On a “cash-out-the-door” basis, the proposal as a whole will infuse

around $52 billion into the economy this year, and tax savings for

individual families will be substantial. A typical family of four with two

earners making a combined $39,000 in income will receive a total of

$1,100 in tax relief under the President's plan. 

As with any attempt to increase economic activity with a tax cut,

an important question is how much of the cut will actually be spent. An

acceleration of the marginal tax reductions the 2001 tax cut is likely to

result in significant spending increases, because the acceleration is done

in the context of long-term tax relief. Delivering tax relief now, rather

than in 2004 and 2006, sends a message that the government will meet its

commitment to the American people to allow them to keep more of what

they earn. As taxpayers realize that their long-term disposable income

has risen, their spending plans will rise as well. By contrast, tax policy

based on temporary changes to tax rates, or one-time tax rebates, has

rarely worked as advertised. A temporary tax increase did not rein in the

economy in 1968, a temporary tax cut did not stimulate the economy in

1975, and a temporary tax cut is not the right policy for 2003. Former

Federal Reserve governor and CEA member Alan Blinder has written that

in the year after enactment, a temporary tax cut has only about half the

effect of a permanent tax cut.

Supporting job growth. The best policies for improved job growth

are those that insure the economy itself will continue to grow. Still,

government policy can affect the rate at which unemployed workers find

and train for the jobs that a growing economy provides. The Reemployment Accounts in the President’s proposal build on the existing

Workforce Development System and empower unemployed workers by

giving them more flexibility and personal choice over their assistance. 

Unemployed workers have a wide range of needs and are best-suited to

understand their particular circumstances. Some workers may want

extensive retraining. Others may not require retraining, but may need

help relocating or may need child care while looking for work. 

Economists have long recognized that except in rare circumstances,

giving individuals choices over how to spend their money improves their

welfare. In this case, giving unemployed workers a choice of whether to

receive training or to receive alternative services for which they may have

a greater need will not only improve the efficiency of government

services (by matching unemployed workers with the services they need

most), it will improve unemployed workers’ welfare at the same time.

The potential to receive a reemployment bonus would provide

eligible workers a greater incentive to find new employment. At various

times from 1984 to 1989, four states—Illinois, New Jersey, Pennsylvania,
46

and Washington—conducted controlled experiments to determine the

effectiveness of providing reemployment bonuses to unemployed

workers. In these experiments, a random sample of new UI claimants

were told they would receive a cash bonus if they became reemployed

quickly. The advantage of these experiments is that the effect of offering

a reemployment bonus on the duration of unemployment and on earnings

upon reemployment can be directly evaluated by comparing the

experiences of UI claimants randomly chosen to be offered a

reemployment bonus with those of UI claimants not chosen for the bonus

(who received the regular state UI benefit). 

An evaluation by the Department of Labor of the reemployment

bonus experiments conducted in the states of Washington, New Jersey,

and Pennsylvania showed that a reemployment bonus of $300 to $1,000

motivated the recipients to become reemployed, reduced the duration of

UI by almost a week, and resulted in new jobs comparable in earnings to

those obtained by workers who were not eligible for the bonus and

remained unemployed longer. Similarly, a study of the experiment

conducted in Illinois—and published in a leading American economics

journal—found that a reemployment bonus of $500 reduced the duration

of unemployment by more than a week and did not lead to lower earnings

at the worker’s next job. Therefore it is likely that giving unemployed

workers the option of receiving the unspent balance in their Personal

Reemployment Accounts will provide them an incentive to find a new job

quickly, reducing the time spent unemployed, but will not result in

workers taking lower paying jobs than they would get if they searched

longer. 

How the Proposals Will Help the Economy in the Long Run

In the near term, the President’s proposal insures that the

recovery proceeds by supporting investment. In the long run, the higher

investment delivered by the plan leads to higher productivity – the

fundamental source of higher standards of living for American workers.

Economists have long known that from the workers’ point of view, the

optimal rate of capital taxation is no taxation at all. The reason for this

surprising result concerns the burden, or “incidence” of the capital tax. An

investor with an extra dollar to spend can either use it to fund

consumption today or save it to fund a larger amount of consumption

later. His or her preferences for consuming now versus consuming later

determine how much extra consumption he or she must enjoy in the

future in order to resist consuming the dollar’s worth of goods and

services today. Lowering the capital tax means that investors receive

much larger after-tax returns on their investments. This change in returns

makes it more likely that households will defer consumption and invest,

which will raise the amount of savings available to firms that want to

borrow in financial markets. As firms invest more, the amount of capital

that workers available to workers goes up, as does their productivity. In

the end, higher productivity raises workers’ wages and their standard of

living. This line of reasoning shows that even though workers may not

write a check to the IRS for dividend taxes, all of us as workers still pay
47

part of the dividend tax in the form of lower wages, because the dividend

tax reduces the amount of capital in the economy.

Workers enjoy long-run gains from the President’s proposals in

other ways as well. Marginal rate reductions and permanently higher

expensing limits for small business will also raise investment, which in

turn raises productivity and wages for the same reasons outlined above.

The rationalization of dividend payout policy will improve corporate

governance and place corporations on equal footing with non-corporate

users of capital. Both of these developments will improve the efficiency

of markets. (A 1992 Treasury Department report on the double taxation

of corporate equity showed that the reallocation of capital toward more

efficient uses would permanently raise economic well-being by the

equivalent of $36 billion worth of consumption per year in today’s

dollars.) Additionally, ending the double tax in the way in which the

President has suggested will increase economic efficiency by reducing the

incentives for corporations to engage in tax sheltering activities, because

only income on which corporate taxes have been paid can be transmitted

to shareholders tax free. 

Effect on national saving and budget balance. Some critics of tax

relief have argued that now is not the time to cut taxes, but to raise them.

The view is that if the government adopts deficit reduction as its number

one goal, growth will somehow follow. I disagree. To begin with,

surpluses tend to follow growth, not the other way around. Raising taxes

may lower the deficit, but this is not equivalent to spending restraint that

limits the size of government in the economy and lets the private sector

create jobs. Moreover, tax relief of the size that the President has

suggested does not significantly worsen the government’s fiscal position.

One way to judge the effect of tax proposals on the government’s fiscal

position is to view them in the context of a “fiscal anchor,” such as the

debt-to-GDP ratio, or the share of Federal outlays that go to service the

government’s debt. By either of these measures, the tax relief offered in

the President’s proposals remains sound policy. For example, the

proposals would raise the debt-to-GDP ratio by less than one percentage

point in the year of adoption, and the debt-to-GDP ratio would decline in

the out-years of the budget window.

CONCLUSION

Though the long-term fundamentals for the U.S. economy are

strong, we still face a number of challenges. The recovery which began

in the fourth quarter of 2001 must be maintained, and fiscal policy must

remain on sound foundation. By focusing on the economy’s most

uncertain component – business investment – the President’s proposals

insure that the recovery will proceed. Chart 3 shows that the President’s

proposals will raise the level of real GDP by 0.9 percent by the end of

2003, assuming that the proposals take effect in the middle of the year.

At the end of 2005, the level of GDP will be 1.8 percent higher.

Although the proposals focus on the economy’s near-term needs, they

also promote stronger growth in the long term as well. In doing so, they
48

insure that the standard of living enjoyed by American workers will

continue to improve in the coming years.
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52

PREPARED STATEMENT OF SENATOR EDWARD M. KENNEDY

I commend our Chairman, Senator Bennett, for his leadership in

holding this hearing on the Administration’s Jobs and Growth Plan, and

I join in welcoming Dr. Hubbard to the Joint Economic Committee.

Many of us in Congress have continuing concerns about the

Administration’s economic record and its responses to the challenges

facing our economy. Many families are asking themselves the question,

“Are we better off than we were two years ago”? For most Americans

their response is “No”.

The principal proposal that President Bush has put forward to

strengthen growth is to reduce taxes for the wealthy. In doing so, the

Administration’s plan does not recognize the basic needs of most

Americans and their widespread concerns about the economy. Massive

tax breaks that benefit corporations and the wealthy, while shortchanging

essential priorities such as protecting social security and investing in

health care, education and job training, homeland defense and public

safety are not what the nation needs.

Only two years ago, the national unemployment rate was 4

percent - - not 6 percent as it is now. The ranks of the uninsured and the

poor were falling - - not rising, as they are now. Workers were building

retirement savings and planning for the future - - not worrying about

whether their jobs are secure or how to restore lost savings in the stock

market, as they are now. The states had budgets with record-setting

surpluses, not ballooning deficits that require cuts in basic services or new

tax increases.

The economy has declined significantly under the leadership of

President Bush. The nation has lost 1.7 million jobs over the past two

years after adding 5 million jobs in 1999 and 2000. Last month alone,

we lost over 100,000 jobs – the biggest monthly decline in nearly a year.

According to the Department of Labor, there are 2.5 job seekers for every

job opening. Unemployment is at an eight-year high and expected to

grow. Ten million unemployed workers want jobs but cannot find them.

 The uncertainty generated by a possible war against Iraq is affecting the

economy. 

The number of long-term unemployed - - those out of work for

more than 6 months - - has now soared to nearly 2 million – a 70 percent

increase from last year. More than half those workers will receive no

help under the law signed by the President earlier this month, even though

they have run out of their state and federal unemployment benefits and

still don’t have jobs. 

The ranks of those without health insurance rose to more than 41

million in 2001. An estimated 300,000 individuals lost health coverage

during the first six months of 2002. Most Americans without health

insurance – 80 percent – are in working families, and workers who still

have health insurance are paying substantially more for it. Workers’

premium payments rose 27 percent for single coverage and 16 percent for

family coverage during the first six months of 2002. Most employers are

passing along higher costs to workers in 2003 and plan to do so next year.
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The crisis in state and local budgets has forced drastic cuts with

harsh consequences. Budget shortfalls have required school districts in

Oregon to cut school weeks by a day. Many states have cut Medicaid,

reducing health care for as many as one million low-income Americans.

Many cities are closing fire stations and laying off police officers and

firefighters, who are our first responders in case of terrorist attacks.

The President’s answer to this continuing economic crisis and the

deep concern of America’s families is another flawed and unfair trilliondollar tax plan heavily tilted toward the very rich. The President’s plan

will not create jobs, will not improve schools or public safety or

homeland defense, will not restore health coverage or retirement savings

for workers and their families, will not help the states, and will not

strengthen and protect social security. 

The President’s proposal is not a serious economic stimulus

package. A true stimulus plan should meet three key criteria: It should

accelerate short-term temporary economic growth, provide new jobs and

opportunities for Americans. It should be temporary to avoid damage to

the nation’s long-term finances. It should provide needed assistance for

state governments that offer a safety net for our most vulnerable citizens.

Obviously, Congress is sharply divided on these issues. Most

Republicans want more tax cuts targeted primarily on wealthy individuals

and corporations. Most Democrats want more resources for education,

health care, homeland defense and other key domestic priorities. Instead

of seeking a victory of party, both sides should do what’s right for the

country. A sensible compromise makes sense. Together, Congress and

the Administration should determine how much we can afford overall,

based on ten-year budget estimates, and then allocate half to tax cuts –

including the President’s recent proposal and the portion of the tax cuts

already enacted that have not taken effect – and half to other important

priorities.

I am hopeful that the President will work with Congress to find

common ground on a genuine economic stimulus plan. This approach

will demonstrate our new bipartisan common purpose for America. It

will be fiscally responsible. It will strengthen our economy for the longterm, while we fairly address the most pressing needs of our society and

our national security.

The Senate Democratic economic plan is based on three commonsense principles: it includes immediate tax cuts to promote economic

growth and a return to job creation this year; it focuses on middle class

families; and it is fiscally responsible in the future, maximizing our

nation’s flexibility to meet the challenges of the future.

The plan puts more money into the hands of the people who will

spend it, provides tax incentives to businesses to invest and create jobs

immediately, and channels money to states and local governments to head

off state tax increases and cuts in critical services. It provides more than

three times the economic stimulus in 2003 compared to the Bush plan, but

at a fraction of the 10-year cost. The Democratic plan costs $141 billion

in 2003 and $112 billion over 10 years. 
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Our plan provides a real economic stimulus by providing an

immediate broad-based tax cut of $300 for each adult in a family and

$300 for the first two children. That means a $1,200 tax cut for a family

of four. It will return $71 billion to American taxpayers in 2003 – more

than twice the amount under the entire Bush “stimulus” package for this

year. It will extend unemployment benefits to the 1 million people who

have exhausted their benefits but still cannot find work.

Our plan has incentives to encourage businesses to invest and

create jobs, including a 50 percent bonus this year for equipment

depreciation. It triples the amount that small business can expense this

year. It also contains health care tax credits for small businesses, and the

broadband tax credit.

Finally, our plan provides $40 billion in immediate aid to state

and local governments. States are facing their worst budget crisis since

World War II. In fiscal years 2002 through 2004, the states have been - -

and will face deficits totaling $171 billion. Massachusetts is facing a

budget deficit of $1 billion. A major part of any plan should be relief to

state and local governments.

I urge the Administration to work with Congress to include these

proposals as part of an effective economic stimulus plan to benefit all

Americans. The economy will benefit, and so will all our citizens.