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67–929 2011

S. HRG. 112–138 

SPEND LESS, OWE LESS, GROW THE ECONOMY 

HEARING 

BEFORE THE

JOINT ECONOMIC COMMITTEE 

CONGRESS OF THE UNITED STATES 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

JUNE 21, 2011 

Printed for the use of the Joint Economic Committee 

( 

(II) 

JOINT ECONOMIC COMMITTEE 

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

SENATE 

ROBERT P. CASEY, JR., Pennsylvania, 

Chairman 

JEFF BINGAMAN, New Mexico 

AMY KLOBUCHAR, Minnesota 

JIM WEBB, Virginia 

MARK R. WARNER, Virginia 

BERNARD SANDERS, Vermont 

JIM DEMINT, South Carolina 

DANIEL COATS, Indiana 

MIKE LEE, Utah 

PAT TOOMEY, Pennsylvania 

HOUSE OF REPRESENTATIVES 

KEVIN BRADY, Texas, Vice Chairman 

MICHAEL C. BURGESS, M.D., Texas 

JOHN CAMPBELL, California 

SEAN P. DUFFY, Wisconsin 

JUSTIN AMASH, Michigan 

MICK MULVANEY, South Carolina 

MAURICE D. HINCHEY, New York 

CAROLYN B. MALONEY, New York 

LORETTA SANCHEZ, California 

ELIJAH E. CUMMINGS, Maryland 

WILLIAM E. HANSEN, Executive Director 

ROBERT P. O’QUINN, Republican Staff Director 

(III) 

C O N T E N T S 

OPENING STATEMENT OF MEMBERS

Hon. Kevin Brady, Vice Chairman, a U.S. Representative from Texas .............. 1 

Hon. Robert P. Casey, Jr., Chairman, a U.S. Senator from Pennsylvania ......... 12 

WITNESSES

Hon. John B. Taylor, Ph.D., George P. Shultz Senior Fellow in Economics, 

The Hoover Institution, and the Mary and Robert Raymond Professor of 

Economics, Stanford University, Stanford, CA .................................................. 5 

Dr. Simon Johnson, Ronald A. Kurtz Professor of Entrepreneurship, MIT 

Sloan School of Management and Senior Fellow, Peterson Institute for 

International Economics, Cambridge, MA and Washington, DC ..................... 6 

Dr. Kevin A. Hassett, Senior Fellow and Director of Economic Policy Studies, 

American Enterprise Institute for Public Policy Research, Washington, DC . 8 

Dr. Chad Stone, Chief Economist, Center for Budget and Policy Priorities, 

Washington, DC ................................................................................................... 10 

SUBMISSIONS FOR THE RECORD

Prepared statement of Representative Kevin Brady ............................................ 34 

Charts submitted by Representative Kevin Brady ........................................ 40 

Study titled ‘‘Maximizing America’s Prosperity’’ ........................................... 53 

Prepared statement of Dr. John B. Taylor ............................................................ 68 

Prepared statement of Dr. Simon Johnson ............................................................ 74 

Prepared statement of Dr. Kevin A. Hassett ........................................................ 80 

Prepared statement of Dr. Chad Stone .................................................................. 87 

(1) 

SPEND LESS, OWE LESS, 

GROW THE ECONOMY 

TUESDAY, JUNE 21, 2011 

CONGRESS OF THE UNITED STATES, JOINT ECONOMIC COMMITTEE, Washington, DC. 

The committee met, persuant to call, at 2:00 p.m. in Room 1100, 

Longworth House Office Building, the Honorable Kevin Brady, Vice 

Chairman, presiding. 

Senators present: Casey and Lee. 

Representatives present: Brady, Mulvaney, and Sanchez. 

Staff present: Gail Cohen, Colleen Healy, Jesse Hervitz, Jessica 

Knowles, Will Hansen, Ted Boll, Jayne McCullough, and Robert 

O’Quinn. 

OPENING STATEMENT OF HON. KEVIN BRADY, VICE 

CHAIRMAN, A U.S. REPRESENTATIVE FROM TEXAS 

Vice Chairman Brady. Good afternoon. On behalf of Chairman 

Casey and myself, I want to welcome everyone to this hearing entitled ‘‘Spend Less, Owe Less, Grow the Economy.’’ I want to welcome our witnesses as well, and members of the Joint Economic 

Committee. 

Chairman Casey and I have agreed to share the task of organizing hearings for the Joint Economic Committee during the 112th 

Congress. Pursuant to our agreement, I convened this hearing because the once-vigorous American economy is languishing. 

A recent op-ed by Harvard University Professor Martin Feldstein 

entitled ‘‘The Economy is Worse Than You Think,’’ laments that 

final sales grew at an anemic annual rate 0.6 percent during the 

first quarter of 2011. The month of May witnessed the unemployment rate rising above 9 percent again, and a collapse of payroll 

employment gains. Feldstein offers us another wakeup call. 

President Obama’s economic policies have failed to launch a vigorous expansion. Instead, his policies have increased the cost of 

doing business, heightened uncertainty, and deterred job-creating 

investment. Moreover, his policies have burdened our children with 

enormous Federal debt that continues to grow as a share of the 

economy. 

One of our witnesses, Stanford University Professor John Taylor, 

published a graph that depicts President Obama’s last two spending proposals, his budget in February and his informal framework 

in April, and compares them with the House budget resolution. 

From this graph, it is clear that President Obama and congressional Democrats want to make Federal spending a permanently 

2 

larger share of our economy, whereas congressional Republicans 

want merely to return Federal spending to its pre-recession share 

of our economy. 

Returning Federal spending to a pre-recession share of the economy is normal and prudent. Nevertheless, President Obama and 

some in Washington have embraced the radical, historically unprecedented expansion of the size and scope of the Federal Government. 

Let me be clear. Excessive Federal spending is our disease. Large 

Federal budget deficits and accumulating Federal debt are symptoms of this disease. If you cure our spending disease, the symptoms will vanish. If you treat the symptoms, you may temporarily 

alleviate some of the pain, but over time our economy will continue 

to weaken, our international competitiveness will erode, and our 

children will become the first generation in American history that 

is poorer than the previous generation. 

In response to these grave fiscal challenges, the House of Representatives passed a responsible budget resolution that would 

bring Federal spending in line with revenue over time. Unfortunately, the Senate has failed to even consider, let alone pass, a 

budget resolution. 

Congressional Republicans want to cure our spending disease in 

part by reforming entitlement programs to make them sustainably 

solvent for future generations. In contrast, President Obama and 

others have reverted to the discredited notion that entitlement programs can largely continue as they are without reforms if we only 

tax the rich enough. 

Congressional Republicans are demanding that any debt ceiling 

legislation must contain substantial spending reductions and new 

fiscal guardrails to ensure these reductions actually take place. In 

response, President Obama and Democrats in Congress have 

launched all-out political attacks asserting cuts in Federal spending would push the economy back into recession and destroy social 

programs. These false attacks must cease if Americans are to come 

together to reduce Federal spending and grow our economy. 

On March 15 of this year, I released a JEC staff commentary entitled ‘‘Spend Less, Owe Less, Grow the Economy.’’ This study examined other developed countries, our international competitors, 

that had large, persistent government budget deficits and a high 

level of government debt. 

The study found: 

Countries that adopted fiscal consolidation plans to reduce their 

government budget deficits and stabilize the level of government 

debt that were based predominantly or entirely on government 

spending reductions were successful in achieving their goals, while 

countries that included significant tax increases in their fiscal consolidation plans failed to achieve their goals. 

Fiscal consolidation plans based predominantly or entirely on 

government spending reductions not only increased economic 

growth over the long term, but also provided significant short-term 

boosts in many cases. 

Today, we are releasing other JEC Republican staff commentary 

entitled ‘‘Maximizing America’s Prosperity.’’ This study examined 

3 

what fiscal guardrails would keep Congress on track to reduce Federal spending relative to the size of our economy. 

This study found several things: 

A balanced budget amendment to the U.S. Constitution would 

not counteract the bias toward higher Federal spending unless it 

contains explicit spending limitations. 

The Federal Government needs a statutory spending cap with a 

credible enforcement mechanism, regardless of whether a constitutional balanced budget amendment is ratified. 

The item reduction veto has reduced the growth of State spending by strengthening the role of the Governor relative to the legislature in making spending decisions. Enhanced rescission authority 

would also help to control the growth of spending at the Federal 

level. 

Sunset provisions, which have been effective in eliminating inefficient and unnecessary programs and agencies in U.S. States, 

would be helpful at the Federal level. 

So long as the President and congressional Democrats continue 

to behave in politically expedient but fiscally irresponsible ways, 

American families and businesses will look to the future with trepidation. 

Those are the concerns and the issues and the reasons we meet 

today. I look forward to hearing the testimony of our witnesses. 

Senator Casey will be here at about a quarter after to give an 

opening statement, and we will recognize him when he enters. 

[The prepared statement of Representative Kevin Brady appears 

in the Submissions for the Record on page 34.] 

[Charts submitted by Representative Kevin Brady appear in the 

Submissions for the Record on page 40.] 

[Study titled ‘‘Maximizing America’s Prosperity’’ appears in the 

Submissions for the Record on page 53.] 

Vice Chairman Brady. At this point, I would like to introduce 

our witnesses, and on behalf of the Committee, thank you all for 

being here. 

We welcome the Honorable John B. Taylor, George P. Shultz, 

Senior Fellow in Economics at the Hoover Institution, and the 

Mary and Robert Raymond Professor of Economics at Stanford University. He also has taught economics at Princeton, Yale and Columbia Universities. Dr. Taylor has received the Bradley Prize for 

his intellectual achievements and the Alexandria Hamilton award 

for his overall leadership in international finance at the U.S. Treasury. 

Dr. Taylor is a renowned expert on monetary policy and the creator of the Taylor rule for determining what the target rate for 

Federal funds should be for price stability. He served as the Under 

Secretary of the Treasury for International Affairs during the first 

term of President George W. Bush. Previously, he served as a 

member of the President’s Council of Economic Advisers during the 

Ford and the George H.W. Bush administrations. He has also 

served on the Congressional Budget Office’s Economic Advisory 

Panel. 

Dr. Taylor has a long list of academic publications to his name, 

and a recent book entitled ‘‘Getting Off Track: How Government 

Actions and Interventions caused prolonged and worsened the FiVerDate Nov 24 2008 14:01 Nov 09, 2011 Jkt 067929 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 C:\DOCS\67929.TXT DPROCT
4 

nancial Crisis.’’ He is a frequent contributor to the editorial pages 

of the Wall Street Journal and other widely read publications on 

the state of the economy. He earned his Ph.D. in economics at 

Stanford University. Welcome, Dr. Taylor. 

Dr. Simon Johnson is a Ronald A. Kurtz Professor of Entrepreneurship at the Sloan School of Management at the Massachusetts 

Institute of Technology. He is a Senior Fellow at the Peterson Institute for International Economics and a member of the Congressional Budget Office’s Economic Advisory Panel. 

Dr. Johnson previously held the position of Economic Counselor 

at the International Monetary Fund and was the director of its research department. He is a codirector of the National Bureau of 

Economic Research Africa Project and works with nonprofits and 

think tanks around the world. 

Dr. Johnson is a coauthor of the 2010 book ‘‘13 Bankers: The 

Wall Street Takeover and the Next Financial Meltdown.’’ He is a 

regular Bloomberg columnist and frequently publishes economic 

opinion pieces in major national and international news publications such as The Washington Post, the Wall Street Journal, and 

the Financial Times. He is cofounder of the blog, The Baseline Scenario. He earned his Ph.D. in economics at MIT. Welcome, Dr. 

Johnson. 

Kevin A. Hassett is a Senior Fellow and the Director of Economic 

Policy Studies at the American Enterprise Institute for Public Policy Research. Before joining AEI, he was a senior economist at the 

Board of Governors of the Federal Reserve system and an associate 

professor of economics and finance at the Graduate School of Business, Colombia University. 

Dr. Hassett was a policy consultant of the Treasury Department 

during the George H.W. Bush and Clinton administrations. He 

served as an economic adviser to the George W. Bush 2004 Presidential Campaign and as Senator John McCain’s chief economic adviser during the 2000 Presidential primary. He also served as senior economic adviser to the McCain 2008 Presidential Campaign. 

He is a columnist for National Review. Dr. Hassett earned his 

Ph.D. in economics at the University of Pennsylvania. Dr. Hassett, 

welcome. 

And our fourth panelist today, Chad Stone, is the chief economist 

at the Center for Budget and Policy Priorities where he specializes 

in the economic analysis of budget and policy issues. Dr. Stone was 

the acting executive director of the Joint Economic Committee here 

in 2007, and before that staff director and chief economist for the 

Democratic staff of the committee from 2002 to 2006. He held the 

position of chief economist for the Senate Budget Committee in 

2001 and 2002. Previously, he served on the President’s Council of 

Economic Advisers as senior economist and chief economist from 

1996 to 2001. His other congressional experience includes serving 

as chief economist to the House Science Committee. 

Dr. Stone has also worked for the Federal Trade Commission, the 

Federal Communications Commission, and in the Office of Management and Budget. He has been a senior researcher at the Urban 

Institute and taught for several years at Swarthmore College. Dr. 

Stone coauthored the book entitled ‘‘Economic Policy in the Reagan 

Years.’’ He earned his Ph.D. in economics at Yale University. 

5 

Dr. Stone, welcome today. 

Dr. Taylor, we will begin with you. 

STATEMENT OF HON. JOHN B. TAYLOR, Ph.D., GEORGE P. 

SHULTZ SENIOR FELLOW IN ECONOMICS, THE HOOVER INSTITUTION, AND THE MARY AND ROBERT RAYMOND PROFESSOR OF ECONOMICS, STANFORD UNIVERSITY, STANFORD, CA 

Dr. Taylor. Thank you very much for inviting me to testify. I 

appreciate the opportunity. I am going to refer to three charts during my opening statement. 

Two years ago this month, the recession officially ended and the 

recovery officially began. However, it has been a very weak recovery by any historical comparison, and that is why the unemployment rate is still over 9 percent. I think if you in particular compare this recovery to the last deep recession we had in 1981 and 

1982—and I show that in my first chart—it is quite striking. 

Economic growth in the 2 years, seven quarters we have observed so far since the recovery began, has only been 2.8 percent 

average, and you can see in the bar charts, that is the blue line, 

quarter by quarter. 

In contrast, during the recovery from the 1981–1982 recession, 

economic growth averaged 7 percent, so more than twice as high 

during that same corresponding period of time. Those are the red 

bars. 

You can see how much of a difference there is. So this is a weak 

recovery by any definition. 

I think the reasons for this in my view are policy—fiscal policy, 

monetary policy, and regulatory policy. Since the focus of this hearing is on fiscal policy, I will just mention the $862 billion stimulus 

package did not stimulate the economy. The increase in spending, 

Federal spending as a share of GDP from 19.7 percent in 2007 to 

over 24 percent now, did not stimulate the economy. Things like 

Cash for Clunkers, if anything, moved spending a few months further. 

Instead what these policies did, along with taking our eye off the 

basic ball of controlling spending, was to raise U.S. debt levels to 

very high and they will continue to go high in the future. I think 

these high debt levels raise a great deal of uncertainty. There is 

even concern of a another crisis, but there are certainly concerns 

about higher inflation, higher interest rates down the road. 

So I think the solution to this slow recovery, this weak recovery, 

nearly nonexistent recovery, is to what I call restore sound fiscal 

policy. I think it will bring attention and allow more private sector 

growth, and that is where the jobs will come from. 

My second chart shows the quite striking correlation between 

private investment in the United States as a share of GDP and the 

unemployment rate. As you can see, when private investment goes 

up as a share of GDP, the unemployment rate comes down. Right 

now we have low levels of investment and high unemployment. 

In contrast, if you look at the next chart, the third chart, you see 

that changes in government purchases, another component of GDP, 

have no such relationship. If anything, it goes the other way. But 

6 

I would say it is not existent, and so you should not be worried, 

in my view, about a credible plan to reduce government spending. 

That brings me to the last part of my opening remarks: How do 

we restore sound fiscal policy? 

I think it is very important to have a strategy to do that, a strategy that is credible and understandable to the American public. I 

would say it should have four parts: 

First, a game changer which demonstrates a different attitude 

about spending, bringing spending down starting in the 2012 budget. That establishes credibility which is so important for the effectiveness of a program like this. 

Number two, outline a path for spending. 

Number three, as much as possible, legislate what is required to 

get that path accomplished. Don’t simply rely on promises in the 

future. That doesn’t restore credibility. 

Number four, as you referred to, Mr. Chairman, some kind of 

caps on spending that correspond to the path of spending reductions. 

My next chart, basically you mentioned in your opening, just represents what I think this amounts to. It shows you the share of 

spending by the Federal Government as a share of GDP, and you 

can see that has gone up so rapidly in the last few years. The first 

budget the President submitted didn’t really deal with that. That 

is the top line. 

The next line slightly below that is the CBO baseline. And the 

line at the lower part is the House budget resolution which does 

bring spending down as a share of GDP to levels that are consistent without increasing taxes. 

So in my view, it is pretty clear that the credible strategy is the 

one closer to the bottom. The policy that doesn’t deal with the problem is the one at the top. Right now people are looking to negotiate, I believe, something in between. And if we do negotiate something in between, that will be an important step of progress, but 

really not enough if it doesn’t go all of the way. 

Thank you very much. 

[The prepared statement of Dr. John B. Taylor appears in the 

Submissions for the Record on page 68.] 

Vice Chairman Brady. Thank you, Dr. Taylor. 

Dr. Johnson. 

STATEMENT OF DR. SIMON JOHNSON, RONALD A. KURTZ PROFESSOR OF ENTREPRENEURSHIP, MIT SLOAN SCHOOL OF 

MANAGEMENT AND SENIOR FELLOW, PETERSON INSTITUTE 

FOR INTERNATIONAL ECONOMICS, CAMBRIDGE, MA, AND 

WASHINGTON, DC 

Dr. Johnson. Thank you very much. 

I would like to make three points, if I may. 

First, I fully support the goal of what I expect of everyone in the 

room, and that is we would like to bring the debt-GDP under control in the United States. The trajectory that we face going forward, if you look out, the IMF forecast horizon of 2016 or look at 

the CBO’s longer-term projections to 2030 or 2050, the numbers in 

the baselines are not encouraging and we need to have mediumVerDate Nov 24 2008 14:01 Nov 09, 2011 Jkt 067929 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 C:\DOCS\67929.TXT DPROCT
7 

term fiscal consolidation, meaning that debt-to-GDP-level should 

come under control and be brought down. 

The second point directly to the topic of the hearing is whether 

we could experience at this point in the U.S. cycle what is sometimes called an expansionary fiscal contraction, meaning that if we 

were to cut spending, for example, immediately, this would stimulate the economy and actually help with growth directly. This is a 

policy, for example, that the government of the United Kingdom is 

attempting to pursue at this moment. 

Now, expansionary fiscal contractions, from experience around 

the world, and this has been studied very carefully by the International Monetary Fund recently, such fiscal contractions under 

some circumstances by expansionary, but I do not think that we 

currently have those circumstances in the United States for three 

reasons: 

The first is fiscal contractions can help with the private sector 

economy if they restore confidence, if there is either a high perceived risk of sovereign default or some other concerns weighing on 

either consumer confidence or or firm’s confidence. But I don’t see 

evidence of that right now in the United States. Long-term interest 

rates remain low. 

There certainly are plenty of problems with debt overhang from 

the credit boom, and those are difficult problems, and I think that 

is the main reason we are growing slowly in this case, but they are 

not going to be immediately and directly addressed by cutting 

spending, unfortunately. 

The second thing that can happen, and this is very much I think 

the likely scenario in the United Kingdom, you can combine a restrictive fiscal policy with a more expansionary monetary policy. I 

would fully expect if the U.K. economy slips back towards recession, which is a real possibility, although the latest data are inconclusive on this, I would expect that the Bank of England would cut 

interest rates and otherwise increase its so-called quantitative easing policies. 

Now, in the case of the United States, I doubt very much the 

Federal Reserve would feel it had the space to do that. Short-term 

interest rates are very low, it has already intervened a great deal 

through quantitative easing at the long end of the term structure. 

I also don’t think it would be a particularly good idea for the Federal Reserve to continue its innovations in that direction. So monetary policy would not be able to offset fiscal policy. 

The third way in which fiscal contractions can sometimes be expansionary is if they contribute to depreciation of the exchange 

rate. So if the value of the dollar were to fall, that would help our 

exports and help us compete against imports. Again, I think that 

may well turn out to be a factor in what we will see in the United 

Kingdom over the next 1 to 2 years. But in the United States, 

given the nature of the dollar as reserve currency, given the way 

that the world economy is developing, and particularly the problems in the euro zone—which are very severe, intending to push 

holders of reserve assets actually towards dollars, not away from 

dollars—it is again very unlikely that the dollar would depreciate, 

whether or not we have contractionary fiscal policy. 

8 

So taking all of that together and comparing that with the crosscountry evidence, I do not consider us to have circumstances that 

would allow fiscal contraction, for example, in the form of spending 

cuts. I do not think that would help stimulate the economy. 

The third point I would make, in conclusion, is that we should 

not lose track of how we got to these problems with debt. As you 

said, Mr. Chairman, to some extent these are longer-term problems, and I completely agree that we must deal with those issues 

over an appropriate time horizon. But at the same time, debt-GDP 

went up very sharply, as shown in Professor Taylor’s pictures, for 

example, because we had a major financial crisis. Big risks were 

allowed to build up within the financial sector. 

And coming from a meeting this morning at the FDIC, its new 

Systemic Resolution Advisory Committee, which is a public hearing, and I have to say the tenor of that conversation was not particularly encouraging. There are very big risks around the financial 

sector that pose fiscal risks and threaten if there is another crisis 

or when there is another crisis, to further push up government 

debt relative to GDP. I hope we don’t lose track of the fiscal damage brought by past and potential future financial crises in our 

budget discussions today. 

Thank you. 

[The prepared statement of Dr. Simon Johnson appears in the 

Submissions for the Record on page 74.] 

Vice Chairman Brady. Dr. Johnson, thank you very much. 

Dr. Hassett. 

STATEMENT OF DR. KEVIN A. HASSETT, SENIOR FELLOW AND 

DIRECTOR OF ECONOMIC POLICY STUDIES, AMERICAN ENTERPRISE INSTITUTE FOR PUBLIC POLICY RESEARCH, 

WASHINGTON, DC 

Dr. Hassett. Thank you, Vice Chairman Brady. 

Over the past several decades, many developed countries have 

undertaken fiscal adjustments in an attempt to reduce high debt 

levels. These countries’ restructurings had varying degrees of success and failure, both in reducing debt and in stimulating growth. 

The economics literature is focused on answering two main questions in this area: What aspects of fiscal consolidations produce 

lasting reductions in debt; and what aspects encourage macroeconomic expansion? 

The answer to the first question is clear. Based on a review of 

the economics literature and an analysis of 21 OECD countries, 

two of my colleagues and I recently found that cutting expenditures 

is more likely to produce a lasting reduction in debt than increasing revenues. It is also typical that the more aggressively a country 

cuts expenditures, the more likely it is to successfully reduce debt 

in the long term. 

Averaging across a range of methodologies, the typical unsuccessful fiscal consolidation consisted of 53 percent tax increases and 47 

percent spending cuts. The typical successful consolidation consisted of 85 percent spending cuts. In particular, cuts to social 

transfers and the government wage bill are more likely to reduce 

debt and deficits than cuts to other expenditures. 

9 

There is more debate over the second question: What aspects of 

fiscal consolidation encourage macroeconomic expansion? The essence of the debate hinges on the balance between two economic effects of fiscal consolidation, the expectational effect and the 

Keynesian effect. The expectational effect is the positive effect on 

consumption and investment that occurs when policy is put on a 

sustainable path. These likely surge after a consolidation because 

of expectations of lower future tax liabilities. In other words, an 

immediate consolidation will alleviate the hoarding that accompanies fears of a larger and largely tax-driven consolidation in the 

future. 

Expenditure-based consolidations would provide stronger 

expectational effects because there is a better chance they are successful at reducing debt and because higher near-term taxes are 

hardly designed to ignite optimism in investors and consumers. 

The Keynesian effect reduces aggregate demand, and, therefore, 

GDP growth when government spending declines. 

The controversy is over whether the expectational effects of fiscal 

consolidation can completely outweigh the Keynesian effects in 

order to create short-term growth. There is less controversy around 

the view that the long-term benefits of fiscal consolidation are substantial. 

Two schools of thought have emerged in the debate. Harvard 

economist Alberto Alesina and his various coauthors argue that 

consolidation, especially expenditure cuts, can lead to a burst of 

growth starting immediately. A team of IMF economists, however, 

identified possible methodological flaws in Alesina’s studies and 

claim that the typical fiscal consolidation would be contractionary. 

It is beyond the scope of this testimony to resolve the dispute between the two corners of the literature. A fiscal consolidation optimist would believe that the Alesina work is correct, and then would 

expect a large fiscal consolidation would lead to near-term growth. 

But a pessimist would point to the alternative work at the IMF and 

argue that the growth effects are more uncertain. But it is important to note that, even in this case, the IMF study points to positive growth effects if the fiscal consolidation is correctly designed. 

That is, both sides of the literature find that reducing expenditures 

will provide a better growth outcome than increasing revenues. 

Although the IMF finds that a tax-based consolidation would reduce GDP by around 1.6 percentage points 3 years following implementation, they find that the negative effects of a spending-based 

consolidation would be small and statistically insignificant. That is, 

even in the most pessimistic corner of the fiscal consolidation literature, there is little to dissuade us from pursuing a consolidation 

today. 

Moreover, they find that spending-based consolidations that are 

focused primarily on transfer cuts could produce positive near-term 

growth effects, although we should add that those are statistically 

insignificant. 

The latter point is especially interesting. Since the authors studied near-term cuts and entitlements, one might expect that these 

would have a relatively large short-run negative effect on consumption behavior. The fact that expectational effects dominate, even 

when entitlements are cut immediately, suggests that out-of-control 

10 

entitlement spending has a profoundly negative impact on forwardlooking sentiment and business and consumer confidence. 

This result also suggests a policy opportunity. Given the massive 

imbalances that exist today, it is likely that consumers have very 

little faith that current programs will remain in place throughout 

the course of their lifetimes. Accordingly, cuts to entitlements that 

phase in gradually over time will likely have little impact on their 

perceived lifetime wealth as the benefit cuts are effectively already 

factored into consumers’ expectations. If consumers don’t expect 

promised benefits to be paid, government can reduce promised benefits without causing today’s consumption to go down, which 

means, of course, that the expectational effects of a fiscal consolidation could easily be expected to dominate and produce significant 

near-term growth if there are few immediate cuts to benefits but 

significant longer-term cuts. If, in addition, the fiscal consolidation 

were paired with a tax reform that broadened the tax base and reduced marginal tax rates, then a significant growth spurt would be 

the natural expectation to draw from the economic literature. 

Thank you. 

[The prepared statement of Dr. Kevin A. Hassett appears in the 

Submissions for the Record on page 80.] 

Vice Chairman Brady. Dr. Hassett, thank you. 

We have been joined by Chairman Casey today. With his permission, we will finish Dr. Stone’s testimony, and then he will be recognized for his full opening statement. 

Dr. Stone. 

STATEMENT OF DR. CHAD STONE, CHIEF ECONOMIST, CENTER FOR BUDGET AND POLICY PRIORITIES, WASHINGTON, 

DC 

Dr. Stone. Thank you. Chairman Casey, Vice Chairman Brady, 

and other members of the committee, thank you for inviting me to 

testify before a committee where I have a strong personal connection, as my biography showed. I have a longer written testimony 

for the record which I will summarize here. 

U.S. policymakers must make smart choices about taxes, spending, and deficits to craft the right set of policies to help the economy emerge from its current deep slump and achieve sustainable 

economic growth with high employment and broadly shared prosperity. 

Making smart choices requires differentiating between: one, the 

longer-term policies needed to produce sustainable growth at high 

levels of employment; and, two, the short-term policies needed to 

restore high levels of employment in the wake of a deep recession. 

In particular, policies aimed at reducing the budget deficit are a 

key ingredient of longer-term policy but are likely to be counterproductive in the short run if implemented too precipitously. 

This is the mainstream economic position as enunciated, for example, by Federal Reserve Chairman Ben Bernanke. In the quote 

in my statement, he observes that fiscal sustainability is a long-run 

concept, and achieving it requires a credible, practical, and enforceable long-run plan. 

In current circumstances, he says, an advantage of taking a 

longer-term perspective is that policymakers can avoid a sudden 

11 

fiscal contraction that might put the still-fragile recovery at risk. 

At the same time, there are advantages to acting now to put in 

place a credible plan for reducing future deficits. The Congressional 

Budget Office has made similar points, and we at the Center on 

Budget and Policy Priorities believe this is the right framework for 

thinking about deficit reduction and economic growth. 

I recognize that one of the purposes of this hearing is to highlight a different point of view from what I regard as this mainstream economic consensus, but for the reasons that I will lay out, 

I think that some of the arguments that are produced to support 

that alternative view are unpersuasive. 

The premise is that we are suffering from an unwarranted explosion of government spending that has produced an immediate debt 

crisis; that immediate sharp reductions in government spending 

are necessary and could even make the economy grow faster in the 

short term; and that deficit reduction is more likely to be successful 

if it is composed largely of spending cuts. I have questions about 

all three of those premises. 

First, policies enacted since the 2008 election are not the main 

drivers of deficits and debt. The U.S. fiscal imbalance problem is 

a long-term problem that has little to do with the short-term imbalances that have emerged as a result of the financial crisis and the 

great recession. The main driver over the long term is 

unsustainable growth in health care costs throughout the U.S. 

health care system in the public and private sectors alike. 

As the charts in my testimony show, increases in the deficit due 

to policies enacted over the past few years are temporary, and only 

their relatively modest associated interest costs add to the longerterm deficits. The reason government spending remains higher 

over the next decade than it was before the crisis is primarily longstanding trends in health costs and large interest costs on debt associated with deficit-financed tax cuts from an earlier era, deficitfinanced wars, and deficits arising as a result of the economic 

downturn itself. 

CBO estimates that discretionary spending as a share of GDP in 

the President’s budget would be 2.1 percentage points lower in 

2021 than it was in 2008 and that net interest costs, for the reasons I talked about largely, would be 2.1 percentage points higher. 

Second, large intermediate cuts in government spending will 

hurt the still-fragile economic recovery. We have heard some discussion about the international evidence, and both the IMF and recently the Congressional Research Service in a new report have 

looked at this evidence, and we at the Center on Budget have also 

looked at it, and were surprised to see the extent to which, when 

you look into the data, the examples tend not to conform to conditions that we have in the United States. 

The best circumstances for reducing deficits are if you are experiencing a debt crisis and interest rates are high, monetary policy 

has the ability to react, and as Simon Johnson said, if the exchange 

rate can react. That is not the situation in the United States. And 

I should say most importantly, when you have the degree of economic slack that the United States has, deficit reduction efforts 

that are short and sharp are unlikely to be successful. 

12 

Third, on the question of the composition of deficit reduction, 

international evidence has little to say about how much of U.S. deficit reduction should be spending cuts and how much should be 

revenue increases, because it is focused on the short term. It does 

not deal with the kind of long-term deficit reduction that we need. 

It also does not come to grips with the fact that the United 

States is unique in the extent to which it relies on the Tax Code 

to do what other countries do directly through government spending. I’m referring to the trillion dollars a year of so-called tax expenditures, which are a prime place to go to find worthwhile budget savings, but it is not clear whether they should be regarded as 

spending or as revenues. 

And, finally, it ignores lessons from the successful longer-term 

deficit reduction efforts such as the United States pursued in the 

1990s when revenue measures were a significant component of the 

1990 budget agreement and the Deficit Reduction Act of 1993, 

which were followed by the longest economic expansion in our history and a balanced budget by the end of the decade. Thank you. 

[The prepared statement of Dr. Chad Stone appears in the Submissions for the Record on page 87.] 

Vice Chairman Brady. Thank you, Dr. Stone. 

Chairman Casey, thank you for joining us. You are recognized for 

your full opening statement. 

OPENING STATEMENT OF HON. ROBERT P. CASEY, JR., 

CHAIRMAN, A U.S. SENATOR FROM PENNSYLVANIA 

Chairman Casey. I have to apologize first for being late, but I 

appreciate the testimony of our witnesses, Dr. Taylor, Dr. Johnson, 

Dr. Hassett, and Dr. Stone. I know there are others who will be 

asking questions and maybe making statements. I will be brief. 

I wanted, first of all, to make the following assertion. I don’t 

think there is any disagreement on this committee, and actually 

throughout most of the country, about the need to reduce the deficit and have a strategy to do that. I think it is shared in a bipartisan manner, and we are all of one mind to do that. 

The questions that we are trying to resolve here are the timing 

of that and what policies yield the best results. On these questions, 

I think there is honest disagreement, but also significant disagreement. We are having a robust debate about it, as we speak, and 

throughout the next couple of weeks and months. Today’s hearing 

is part of that debate. It is important that we have this debate at 

this time. 

We have a lot of able economists across the country and several 

here today who offer their perspective. I want to provide a little bit 

of context in terms of some of the assertions that have been made 

today and will be made today. 

One assertion is that government borrowing is interfering with 

private investment. That is one assertion. 

The second is that deficit reduction can promote economic growth 

in the short run. 

And third, that deficit reduction is best achieved through spending cuts rather than revenue increases. 

I think a number of us would have significant disagreement with 

one or more of those, or at least with part of those assertions. But 

13 

I think, at the same time, we can all come together and agree that 

we have to have more spending cuts and deficit reduction, but we 

also have to be mostly concerned, I believe, about job creation. 

My main concern with any strategy that might be discussed 

today or that we would enact into law is that we don’t take a step 

that would derail the recovery in what we do in the next couple of 

weeks and months. If we do that, if we take steps that will derail 

the recovery, it will worsen the long-term budget outlook, and it 

will reduce revenues and increase government spending on automatic stabilizers like unemployment insurance. 

The U.S. economy is recovering, and we have recorded now seven 

consecutive quarters of growth, but the rate of growth that we have 

achieved so far has been modest. In the first quarter of 2011, GDP 

grew at less than 2 percent annual rate. The reality is that there 

are still major economic challenges in front of us. Fourteen million 

Americans are unemployed. Housing prices continue to decline. 

Consumers have been hit hard by rising gas prices, and businesses 

are waiting for demand to return before expanding their operations 

and hiring more workers. Small businesses, of course, are struggling as well, and the biggest challenge we face, I believe, is job 

creation, or at a minimum, increasing the pace at which jobs are 

created. So getting people back to work has to be our number-one 

priority. 

We cut this year’s budget substantially by tens of billions of dollars, but there is more to do. There is waste and inefficiency that 

we must cut. Rooting out that waste and inefficiency is a prime 

way to reduce Federal spending in the short run. 

I was the Auditor General of Pennsylvania for 8 years and State 

Treasurer for 2. And in that decade, I spent a lot of those days, and 

my team did, locating and eliminating waste and fraud, so I know 

something about it. But I also believe making deep, indiscriminate 

cuts immediately—immediately—to proven strategies that we know 

will help our economy grow and create jobs could, in the end, be 

self-defeating. So I think that the question of timing is critically 

important. 

Let me wrap up just with a reference to someone who has spent 

a lot of time analyzing these problems for many years, chairman 

of the Federal Reserve, Ben Bernanke. He said recently, ‘‘If the Nation is to have a healthy economic future, policymakers urgently 

need to put the Federal Government’s finances on a sustainable 

trajectory. But, on the other hand, a sharp fiscal consolidation focused on the very near term could be self-defeating if it were to undercut the still fragile recovery.’’ He goes on from there. 

Chairman Bernanke has laid out the challenge that we must confront. We must have a credible plan to put our fiscal house in 

order, for sure, reducing the deficit in the medium and long term. 

A strong economy is critical to sustainable deficit reduction. We 

cannot reduce the deficit if we are not growing and creating jobs, 

and getting people back to work is the key to that. 

I am grateful for the opportunity today to be part of this hearing. 

I am grateful to Chairman Brady for getting us here. 

Vice Chairman Brady. Chairman, thank you very much. 

I appreciate the testimony of all four witnesses today. 

14 

I recently held a round of town hall meetings with job creators, 

small- and medium-sized businesses, and asked for their input on 

how we jump-start this economy. And I dutifully set aside my debt 

crisis PowerPoint to focus on job creation, going through a list of 

ideas that had come from Washington, DC. They said, ‘‘Put away 

that PowerPoint, go back to the debt crisis,’’ one, because in their 

view until we tackle the debt and deficits, they were not going to 

make the decisions to create jobs, at least in our 11 counties in 

Texas. 

So I want to ask Dr. Taylor and Dr. Hassett—Dr. Taylor, a separate question. You talked about a game changer to restore credibility in our financial order. But we are oftentimes told that we 

can’t do that; that introducing a fiscal consolidation program would 

mimic that of the Great Depression where spending reductions, 

they claim, created the recession of 1937 and 1938, and they use 

that analogy to apply to today. 

What is your assessment of that analogy; and is it important for 

us to engage in a serious fiscal consolidation program now in order 

to spur the economy? 

Dr. Taylor. I think it is essential to engage in a consolidation 

program now, and it will spur the economy. Again, since this recovery began, and it is, quite frankly, hardly a recovery, growth has 

been only 2.8 percent. So the low growth now, it is consistent with 

this pattern from the last 2 years since the recovery began. 

As I said before, if you compare that with the last time we had 

a big recession, the growth is less than half as much. It was 7 percent at that point. When I look at it, I think that negative difference, that low growth we have now, is because of all of this fiscal activism. If you look carefully at the data, that increased spending that we have had—and it is huge over the last 2, 3 years—has 

not really stimulated—this is the weakest recovery we have had by 

comparison. So there is no evidence that it has. 

So I think if you start undoing that, and after all, what is so draconian about bringing spending back to where it was in 2007? Why 

should that be so hard as a share of GDP? So when we use the 

words ‘‘draconian’’ or ‘‘deep,’’ think about, for example, the 2011 

budget—which you agreed to recently—that did reduce spending in 

terms of budget authority from what was originally asked for, but 

the outlays are only down by less than a billion. Less than $1 billion in 2011 compared to 2010. 

So the focus should be on how do you get a game changer, get 

enough spending down so it is credible. The problem isn’t trying to 

find ways to spend more, the problem is trying to find ways to 

spend less. So the more that you can go in that direction, the more 

you will demonstrate to the country that we can get our house in 

order and that will definitely be beneficial to people who are worried about the debt, who are worried by inflation and are worried 

about higher interest rates down the road. 

So I think I would emphasize so much just taking the efforts now 

to get started, because if you don’t, if it is just promises for the future, promises for the next 10 years, it will not be viewed as credible and it won’t work. 

Vice Chairman Brady. Thank you, Dr. Taylor. 

15 

Dr. Hassett, in your study, what types of cuts do governments 

undertake that bolster the economy in the short term, that restore 

confidence for those making private business investment, and also 

for consumers? What worked? 

Dr. Hassett. The two biggest components of successful consolidations were entitlement reductions and reductions in the government payroll. I think that both of those show a kind of credible 

commitment to getting the fiscal house in order. 

You both know, Mr. Vice Chairman and Mr. Chairman, how difficult such moves would be politically and would require broad bipartisan consensus. And to show that we can accomplish that 

would really create kind of a celebration in financial markets because people would think, oh, finally, the U.S. has solved this big 

problem. 

I would point, Mr. Vice Chairman, also to the beginning of my 

testimony, and highlight the urgency of action. I think in a traditional recession that lasts 11 months or so, and then has a recovery, pre-1990s, that grows 5 or 6 or 7 percent in the year that we 

get out, that we launch out of the recession, then if you have a 

really well-timed Keynesian stimulus, that you might take a percent or 2 out of growth out of the recovery year and move it into 

the recession year, and if you are growing 5, 6, 7 percent, then that 

kind of a trade could be something that everyone on this committee 

would want to consider. 

The difference this time is that we know from the work of Carmen Reinhart and Ken Rogoff and also Vincent Reinhart that the 

recovery from a financial crisis is a long slog. It lasts maybe a decade. So if we take a Keynesian approach, what is going to happen 

is the hangover from the Keynesian spending is going to be present 

in the slow-growth period, and maybe even—even if you are a 

Keynesian optimist about the effects of government on growth— 

pushes down toward a recession. And then we might have to have 

that argument that we need another stimulus because we don’t 

want to have a recession this time. 

I would urge members to consider leaving the Keynesian roller 

coaster and thinking about policies that can put us on a sustainable growth path without a hangover. 

Vice Chairman Brady. Thank you. 

Chairman Casey. 

Chairman Casey. Dr. Stone, I wanted to ask you a question 

that relates to part of this debate. As you can tell from my statement, I want us to focus more on job creation. 

Tell me what your sense is in terms of what is the optimal, or 

even if you have by way of a list, the optimal way to create jobs 

in the near term, meaning the next year or two, in terms of either 

a strategy that the Federal Government employs or just by way of 

tax policy? 

We had, as you know, a tax bill at the end of last year, elements 

of which both parties really disliked and other elements which they 

embraced. But both sides were willing to look past their disagreement or their objection to parts of the bill in order to keep tax rates 

where they were and to add features like a payroll tax cut which 

put a thousand bucks in the pocket of the average American family. But when you think about either government action or a stratVerDate Nov 24 2008 14:01 Nov 09, 2011 Jkt 067929 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 C:\DOCS\67929.TXT DPROCT
16 

egy that has been tried, or maybe has not been tried, in addition 

to tax policy, what do you think the best approach is to job creation 

and how would you itemize those, if you can? 

Dr. Stone. Let me begin by endorsing the idea that, on the 

budget, a game changer would be really good; and my vision of a 

game changer is bipartisan, a bipartisan agreement that recognizes 

the reality that tax measures, starting with going after the tax expenditures perhaps, and spending cuts need to be part of a sustainable, believable, credible budget effort. 

So there is no disagreement on the panel about the importance 

of putting in place a plan to get our fiscal house in order and that 

that matters. And it needs to be credible. 

The issue is if you do it too fast, does that harm the recovery. 

My first answer to your question is the Hippocratic oath: First, 

do no harm. Don’t try to do too much too fast on the deficit reduction effort while the economy is still struggling to recover. That 

doesn’t mean that you can’t put a plan in place that is serious and 

begins to take effect a couple of years down the road. 

The most recent economic news has been pretty disappointing; 

and, therefore, I think we should be considering whether we want 

to allow the payroll tax holiday to continue. And also, the unemployment rate is still extremely high, and unemployment insurance 

is one of the most effective measures of injecting demand into an 

economy that is suffering from inadequate demand. And yet the 

unemployment insurance benefits are scheduled to expire at the 

end of the year. 

So I think those are two things that are already in place; probably it is worthwhile extending them into next year. 

This is particularly true because the Fed is—it is not out of ammunition, but the ammunition that it would have to use to provide 

further demand stimulus to the economy would be very unusual 

measures that we don’t have a lot of experience with. 

So I think don’t cut too fast, put a credible deficit reduction plan 

in place, and consider extending the payroll tax and the unemployment insurance. 

Chairman Casey. Just very quickly, and I don’t know if others 

have an opinion on this, but we had at least three really good private sector job growth months in a row, above 200; one was 230, 

222, and a third that was maybe higher than that. But 225 or 

above for 3 straight months. And May came along, and every number is off. The net, the overall job growth, the private sector number was a lot lower. Anyone have a sense of why that happened in 

that particular month, A; and, B, do you think it will prevail or do 

you think we can get back in June, July and August where we 

were in January to April? 

Dr. Johnson. I think the important point that Dr. Hassett made 

is that this is a fairly standard recovery from a serious financial 

crisis. That is why it is so different, the employment pattern is so 

shockingly different than what we have seen in all postwar recessions in the United States, including the one in the 1980s that Dr. 

Taylor was emphasizing. This is what happens when you take on 

a massive amount of debt, particularly in the housing sector, you 

will have some sort of stop-start on the job side. And, personally, 

17 

I don’t think that you should be throwing more Keynesian rollercoaster type stimulus at it. I don’t think that works. 

But I would emphasize that most of the increase in the debt-toGDP that we have experienced in the short term is due to the automatic stabilizers. You have to let the automatic stabilizers work. 

Our automatic stabilizers, by the way, are relatively weak compared to almost every other industrialized country. That is a main 

reason why it made sense to supplement them at the beginning or 

the deepest part of the recession. But that is done now. That is history. 

I agree completely with Dr. Stone; you don’t want to derail the 

recovery now by overreacting. Sure, we want debt-to-GDP to come 

down, but it will come down as the economy recovers. If you try 

and cut spending too much, too soon, that will have counterproductive effects. Unless you think ownership policy can respond 

with a massive expansion, but I haven’t heard anybody on the 

panel yet make a convincing case for that. And I don’t think Mr. 

Bernanke also would be inclined to make that case. 

Dr. Hassett. I just wanted to add that we did a recent calculation comparing the U.S. recovery in this financial crisis to the past 

financial crises that were studied by Carmen Reinhart and Ken 

Rogoff, and asked ourselves, if we have the typical experience of a 

country after a financial crisis, what will the unemployment rate 

in the U.S. be in 2018? And the answer is about 8 percent. 

So we are in a base case that it is a really tough slog and a real 

painful challenge for America’s workers. And if we don’t get serious 

about doing something that is not going to jack up growth for one 

year, but really fix the problem—and I think that we need both a 

fiscal consolidation and a fundamental tax reform—then we are 

looking at a base case that is really terrible. And I think that is 

probably something that we all agree with on the panel. 

Chairman Casey. Thank you. 

Vice Chairman Brady. Senator Lee. 

Senator Lee. Thanks to all of you for coming. I wanted to start 

with Dr. Taylor. 

What do you think would be the impact of a tax rate increase on 

our economy at a time like this one? 

Dr. Taylor. I think it would be very harmful to have a tax rate 

increase. In fact, I think Senator Casey asked about explanations 

for the sort of little pick-up in job creation. It occurred around the 

time of December when the deal was made to postpone the tax increases. I think that was quite significant. I wish it was permanently postponed. But there were tax increases on the books, and 

they had been postponed. I think that is positive. It gives you some 

sense of what you can get from agreeing not to increase tax rates. 

I think it would be very harmful to the economy. 

Senator Lee. What if we limited the tax increases to the 

wealthy? Couldn’t we forestall the problem by doing that? 

Dr. Taylor. It is a very important step. Tax reform is also important, and I am glad to hear there is more interest in that on 

Capitol Hill at this point. But to me, the first step is don’t increase 

taxes. Leave those tax rates alone. 

Senator Lee. Even in the higher income brackets? 

18 

Dr. Taylor. Across the board. There is no reason to increase 

those tax rates. There is this phrase that people sometimes use, ‘‘It 

is a spending problem, not a tax problem.’’ That is the truth, actually. If you look at the numbers carefully, it is hard to convey that 

to people without looking at the numbers; but when you look at the 

numbers, that is really what it is. And you don’t want to risk the 

disincentives. There are enough disincentives now for firms to invest, with the regulations and the fear of the debt problems, and, 

for that matter, I think monetary policy. There are lots of reasons 

that investment is not as strong as it should be or could be. Of 

course, housing is part of that. Unless we get investment moving, 

unless firms start investing and expanding, unemployment is going 

to stay high. So I think that would drive that private investment, 

whether it is equipment, structures, and you will see jobs being 

created. 

Senator Lee. And that investment, you would argue, is less likely to occur when those would-be investors have the promise, the assurance, that they will be able to keep less of that money? 

Dr. Taylor. Right. You tax something more, you are going to get 

less of it. These days there is a fear of increasing taxes quite a bit 

because of the budget. I think if that could be clarified, that is part 

of the idea of being credible, predictable, is to recognize that the 

best way to do this is by not trying to raise tax rates. Quite frankly, I don’t see there is much interest in doing that in the country 

anyway. 

Senator Lee. Would it be fair to conclude that a supposed tax 

rate that affects only the rich is in fact a misnomer because it 

would end up impacting perhaps most acutely, most severely, those 

most-vulnerable people, those people who most desperately need 

jobs would be less likely to find them as a result of diminution of 

investment leading to less employment? 

Dr. Taylor. Yes. If you reduce the incentives for firms to invest 

and expand, you are going to reduce the incentives for them to create the jobs, and that is where the jobs come from. The jobs are 

not coming from more government purchases, or even less government purchases. That will detract from the jobs. It is that private 

sector investment. That is what the data show. And to the extent 

you can encourage that by not raising the tax rates on those firms, 

there are a lot of small business firms, larger small business firms, 

to be sure, it is going to be counterproductive and we will have this 

high unemployment rate—which is a tragedy—for quite awhile. 

Senator Lee. We hear a lot about the debt limit and about how 

the failure to raise the debt limit could result in this or that economic catastrophe. Is there not also an economic catastrophe that 

could and would await us if we were to raise the debt limit reflexibly, as it has been raised many times in the past, without any 

significant strings attached, without attaching it to significant, 

binding spending caps? 

Dr. Taylor. I think tying the spending reductions to the debt 

limit increase is very important. I wrote in the Wall Street Journal 

about that a couple weeks ago. I think the position that has been 

taken there has been very productive. It has actually driven, I 

think, the talks in a good direction. So a clean, so-called clean debt 

limit increase, without spending, would damage credibility, espeVerDate Nov 24 2008 14:01 Nov 09, 2011 Jkt 067929 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 C:\DOCS\67929.TXT DPROCT
19 

cially at this point because we have had such a surge in spending. 

So I have argued strongly for tying these together. And I can see 

why they would just like to have a clean debt limit increase, but 

I think especially at this point in time it would be a mistake. Moreover, I think from what I hear about these budget negotiations we 

stand a good chance of tying those together, as the Speaker originally suggested. 

Senator Lee. Thank you. 

Vice Chairman Brady. Thank you, Senator. Congresswoman 

Sanchez is recognized. 

Representative Sanchez. Thank you, Mr. Chairman. And 

thank you, gentlemen, for being before us. Oh, gosh. I always am 

amazed at the difference of opinions that we get to whomever we 

speak about the economy. And I am always amazed also when I am 

at events and people come up and think they know all about the 

economy and try to tell us what we should be doing. But what I 

have learned in the 15 years I have been here and in my studies 

when I graduated with an economics degree, and as an MBA, as 

a former investment banker, sometimes you just don’t know. 

You know, I would like to say something about the stimulus, because I think that it has been maligned a lot here, the stimulus 

package or the Recovery Act. Yes, it was $800 billion, but remember that a third of that was tax cuts, it was not spending, it was 

tax cuts. So you can’t have it both ways. You can’t say that the renewal of the tax—of the Bush taxes in December were not spending. You just can’t say that. You just can’t say—you can’t count 

spending, a third of the spending package that were taxes as 

spending and not count the Bush continuation of tax cuts as not 

spending either. You can’t have it both ways. So we either count 

it one way or we count it the other. 

We were told in December that if we passed that package of tax 

cuts it would give stability and businesses would start using their 

$1.4 trillion that they sit on on their balance sheet. And you know 

what, they haven’t. It has been a jobless recovery. So we hear all 

of these issues about keep the taxes low, don’t collect, but the fact 

of the matter is that Bush’s own Comptroller has stated that 70 

percent of the debt and the majority of this debt was accumulated 

under George Bush, that 70 percent of that was due to the tax cuts 

over and over and over during that time. And we had a couple of 

other things, a couple wars I didn’t vote for, a couple wars I think 

we should be out of, a couple of wars that we keep spending money 

on more and more to the point where it is taking away from investing in the future of our military because it is operational, and halfway around the world, and it is not money going in our pockets, 

it is money outside of our economy. 

So, you know, I am hearing all sorts of information out there, but 

in the bottom line I think we need a little of both. We need to talk 

about some real spending reforms, and I think defense has to be 

on it. From the looks of the House bill passed on defense recently 

that was increased significantly. Everything else took a cut, but defense increased significantly. And by the way, it is not going to our 

people working back at home or our defense contractors trying to 

build systems. They are in fact being cannibalized and they are not 

being paid. And they are stopping their production lines, which is 

20 

going to cost us more on the long run to retool and reset our military. 

So I want to ask each of you, do you really think that it doesn’t 

take a little of both, some spending cut, maybe in a moderate way, 

but with a firm commitment, and some increase in taxes to start 

to get this back? And maybe we will start with Dr. Stone and go 

down the list. 

Dr. Stone. I did say that I think we do need a balance that has 

both. I think that is one of the things that is problematic about debating over the debt limit, which really has nothing to do with controlling deficits; it may be a way to get people talking, but when 

people are talking they have to be talking about something that 

can really happen, and that would require a balance of the two. 

When you ask businesses what is the problem, they don’t say— 

they always say it is taxes, but that stayed constant. What has 

really gone up is they say sales. And so to give businesses incentives to add to their capacity when they don’t have customers in 

the stores is problematic. I think they need the customers in the 

stores first. 

Dr. Hassett. Yes, Congresswoman, thank you. I in my testimony, I say that it should be both. I recommend modeling it after 

the typical successful consolidation which had a balance of both. 

Representative Sanchez. Thank you, Doctor. 

Dr. Johnson. I completely agree with you, Congresswoman, that 

military spending needs to be capped over the long run, but particularly health care spending as a percentage of GDP, if you look 

out to 2030 or 2050, that is a major problem. I would actually go 

further than Dr. Taylor just now. If you have the possibility of putting in place a credible limit on future health care spending as a 

percentage of GDP, by all means tie that to the debt cap discussion 

or implement it in some other way. That would have a major effect 

on fiscal credibility. That is mostly about spending, but I would emphasize it is not just government spending, not just Federal Government spending, you have to look at general government spending and you have to look also at private sector spending. 

When I talk to entrepreneurs, which I do a great deal in my various jobs, they are worried about health care costs that they will 

face in 5 years, 10 years, and 20 years. That is a major burden that 

we have not yet seriously addressed. So I would put that front and 

center of the long-term fiscal consolidation needs. 

Representative Sanchez. Thank you, Doctor. 

Dr. Taylor. May I use a couple of my charts to answer this question? I guess not. Okay. 

One of my charts shows that if we brought spending back—the 

next to last one, I believe. This is Federal spending as a share of 

GDP, going back a few years, and you can see how it grew a lot 

in 2008, 2009, 2010. It was 19.7 percent of GDP in 2007. And the 

House budget resolution, which is the line that brings us down, 

brings it back to about the same level, 19.7 percent of GDP. So that 

is roughly what you need, maybe a little bit less, depending on 

what we think is happening with taxes for budget balance, because 

the deficit was like 1 percent of GDP in 2007 or so. So that is why 

I think it is a spending problem, that is why I say it is that way. 

21 

If you look at the next slide, the next slide, that first slide divided everything by GDP because I think that is how economists 

like to think about it. But in fact we are not talking about cutting 

things. This is the total spending without just what it is. And you 

can see where it has been, and you could see where it would go 

with the President’s first budget, and you could see where it goes 

with the House budget resolution. And they all increase, I mean 

these are all increases. I think you have to put that in perspective 

as well. 

And then finally your question about the tax part of ARRA and 

the tax part of the 2008 stimulus is a very important question. 

When I look at the impact of the tax rebates or the one time payments, they seem to do very little good in terms of stimulating consumption. Both in 2008, February 2008, the Economic Stimulus 

Act, and 2009, the ARRA, the tax components of those were mainly 

just to send money to people, tax credits from previous earnings 

and mostly was spent. It did not jump start the economy. You can 

see that in the data. 

When we talk about tax rates increasing, that is a different 

story. That is what is going to happen if you create a job or if you 

expand your business. The money you are going to get from doing 

that or the benefits from that. That is not a rebate from the past, 

which just tends to get wasted unfortunately in terms of stimulating the economy. But what is so important are these tax rates, 

and that is why in answer to Senator Lee’s question I said raising 

tax rates would be a terrible mistake at this point in time. 

Thank you. 

Representative Sanchez. Thank you, gentlemen. 

Vice Chairman Brady. Thank you. Mr. Mulvaney is recognized. 

Representative Mulvaney. Thank you, Mr. Chairman. I will 

continue on what the Congresswoman was talking about and see 

if we can’t find some similarities of opinion in what we are talking 

about today. I would like to start with taxes, following up with 

what the Senator said as well. If they would bring up slide number 

1, please, which is the Federal income tax revenue and top income 

tax rate. This is a graph that shows two different things, which essentially, once they get it up, what you will see is a red line that 

shows the Federal revenue as a percent of GDP and a blue line 

that shows the top tax rate. 

And as you can see, I think several of you may be familiar with 

this graph. Over the course of the last 60 odd years the Federal 

Government generally has taken out between 15 and 20 percent of 

GDP and tax revenues. I think the average over the course of the 

last years 50 years is roughly 181⁄2 percent, but that during that 

period of time where the government’s share of the economy was 

relatively stable, tax rates were all over the map. This is the top 

marginal tax rate. 

What I heard just a moment ago from this panel as we went 

down and talked about the importance of having a mix between 

spending reduction and tax increases I did not hear anybody clamoring for dramatic increases in the income tax. What I heard Dr. 

Stone actually mentioning was tax expenditures. Dr. Hassett, I 

have read some of your work. I think you have done some work on 

22 

other fiscal consolidations that focus on tax increases on consumption as opposed to productivity. 

So I guess what I am looking for, gentlemen, is some consensus 

here that as we look our hand over and as we look at different options that are available to us, is it fair to say that increasing the 

top marginal tax rates is probably the least desirable way to go forward? And I will start with Dr. Stone. 

Dr. Stone. I mentioned tax expenditures because that is something we ought to be able to agree on. Dr. Taylor is talking about 

how government spending has moved to a new higher level. I think 

that if we are realistic about the demographics in this country, 

about rising health care costs, and the increased interest that we 

are now paying because of the debt incurred as a result of the recession, we are not going to be go back to historic levels of spending 

as a share of GDP without more revenues. And the President’s proposals would move us back to—would include some increases in tax 

rates in the income tax, that will move us back to the levels that 

we had in the 1990s when we really did not have—when we had 

our longest economic expansion and a balanced budget. So it is not 

prohibitive. Very high marginal tax rates are discouraging, but 

modest increases in tax rates I don’t think we need to be so afraid 

of. 

Representative Mulvaney. Thank you, Dr. Stone. I have heard 

this before, so I don’t mean to interrupt and I will give everybody 

a chance, but I look at the rates during the late 1990s when they 

were increased, and while they did represent a slight, they did lead 

to a slight increase in the government’s share of GDP, it was not 

marked at all. In fact, you could argue that it was actually the 

GDP growth that was experienced during that time that boosted 

the government’s share of revenues. It wasn’t the tax increases 

that actually boosted the revenues, it was the larger share of the 

overall economy. 

Dr. Stone. I don’t disagree that the strong economy helped and, 

importantly, those tax rates did not interfere with that very strong 

economy. 

Representative Mulvaney. Thank you. Dr. Hassett. 

Dr. Hassett. I agree with Mr. Mulvaney. I would add it is especially urgent, as Mr. Camp who is often in this room knows, to address the fact that we are about to have the highest corporate tax 

on earth. And if you are wondering why it is that it has been a long 

time since any of us has driven down the road and seen a new 

plant building growing there on the side of the road, it is because 

they are being located offshore to take advantage of much lower tax 

rates. And so I think that as we think about the fiscal consolidation 

then one of the urgent design problems will be finding the space 

to get to U.S. to at least the middle of the OECD in terms of corporate rates if we expect growth to renew here. 

Representative Mulvaney. Dr. Johnson. 

Dr. Johnson. I completely agree with the need for tax reform. 

I don’t know the details of Dr. Hassett’s proposal. We may differ 

on that. But I think shifting away from taxing and towards taxing 

consumption and doing that in a way that protect relatively poor 

people, which certainly can be done, and it is done in other industrialized countries, that is a good idea. 

23 

However, with regard to what you do about marginal tax rates 

within the existing code, just two points. First of all, I don’t think 

anybody paid the very high rates that we had in the 1960s. There 

were many exemptions, as you know, many ways to manage your 

tax liabilities there. And I don’t think anyone is proposing to go 

back to those levels. However, I for one did argue against extending the Bush tax cuts in December. In terms of the feasible ways, 

credible measures you can take to bring the budget under control, 

if you have ways to control health care spending, if you have ways 

to end foreign wars, I am completely open to that. I think those 

will be better. But given the feasible choices before us, addressing 

a little bit of discretionary domestic spending is not going to make 

a big difference. Addressing or not further extending the Bush tax 

cuts next time they come up in 2012 would make a first order of 

difference. And I think now is the time to start considering that. 

Representative Mulvaney. Mr. Chairman, I would ask Dr. 

Taylor be given an opportunity to respond. 

Vice Chairman Brady. Dr. Taylor. 

Dr. Taylor. Your chart is very important to take into account 

when people are thinking about raising marginal tax rates, because 

history showed especially at the top end where people can avoid 

them or take actions not to pay them it doesn’t raise the revenues 

people think. But I would also add that since spending is an issue 

here, too, that if you grab spending going way out into the future, 

along with what taxes would be even with a marginal tax rate increase, spending just dominates. Spending is like this exponential 

thing that eats you alive. And if you try to raise taxes and deal 

with this it may take you up just a little. It is hard to notice in 

a graph. It is hard to notice what it will do. So forget that for a 

while, you know basically that is not the thing to do in a weak recovery. Put that off to the side. Look for tax reform, broaden the 

base and reducing marginal rates is always good to try to do, but 

in the meantime it really seems like it is a spending problem, as 

people say. 

Dr. Johnson. Mostly health care spending in the 2050—— 

Representative Mulvaney. Thank you. 

Vice Chairman Brady. Thank you, Mr. Mulvaney. Let me ask, 

we hear a theme that spending cuts will endanger this recovery 

however weak it is. But as economists you are aware of a body of 

work of fiscal consolidation looking at our competitors around the 

world who in the last 40 years took on various forms of fiscal consolidation, as many of you mentioned. And in 26 instances they 

grew their economy in the short term as well. They spent less, controlled their fiscal policy, they owed less as a nation, reduced their 

debt, mainly through targeted spending cuts and grew the economy 

in the short term as well. Canada is a great example. You know, 

hobbling along at less than 1 percent growth, high debt levels. 

They went on a conscious effort to reduce their spending, lowered 

their country’s debt by around 12 percentage points. Their economy 

went to a 31⁄2 percent average growth rate that lasted for more 

than a decade. Sweden did the same. New Zealand had an even 

more interesting experience along the same way. 

So to this theme that if we control spending it will harm this economic recovery, Dr. Taylor, Dr. Hassett, do you believe that to be 

24 

the case? Do you think Congress is capable of such severe spending 

cuts that it will endanger this remarkable recovery? 

Dr. Taylor. I don’t think so based on the 2011 agreement which 

was good, but budget authority has shifted from plus 39 to minus 

39 in the discretionary accounts, but outlays just down by less than 

a billion. So that is an example I think of why it is so hard. 

I would say, quite frankly, I think that the credibility is very important to make sure it does have positive effects. Willy-nilly, unpredictable changes in government policy is not good. It makes for 

more uncertainty. So everything that you can do to say that what 

we are doing is part of this long-term path, caps on spending, tying 

it to debt increases, putting in legislation, everything that can 

make it a credible, believable deal will make it more powerful in 

a positive sense and mitigate the negative things that Dr. Stone is 

referring to. The credibility, to be able to plan for the future, to 

know that this is what government is doing, at least it is clearer 

now than it was. They are getting their house in order. That will 

enable businesses to expand. So I put a great deal of emphasis on 

credibility. It is going to be gradual almost for sure. That is the nature of the politics. It will be gradual. And I think to some extent 

the statements that it is going to hurt the economy if we go too 

fast, if it is too draconian, I don’t think that helps the discussion 

because it puts up this thing which is like a straw man. That is 

not where we are going. Look at my charts. The charts don’t have 

draconian—even with the most ambitious budget there are not draconian changes we are talking about. 

Vice Chairman Brady. Thank you. Dr. Hassett. 

Dr. Hassett. Yeah, Mr. Brady, one way I like to think about the 

potential scale of the near-term effects is that in present value 

maybe we guesstimate all of the things that we are short. It’s 

something like $100 trillion if we just tried to in present value, you 

know, let Medicare run the way it is planned and so on. If businesses expect to have to pay their normal share of tax increases to 

cover that $100 trillion, then we are talking a tax liability in 

present value that is bigger than $10 trillion—bigger than 10 percent of that, which is closing in on the market cap for U.S. firms. 

And so the scale of the tax shortfall is humongous, and it is really 

large relative to the scale of U.S. corporations. 

And so maybe they don’t think that we are going to cover the 

whole thing with tax increases, but if they think even that half of 

it is going to be covered with tax increases then that is a significant liability, implicit liability that is on their books. And if you do 

something to relieve that, then that is good news today. You could 

set off an investment boom today. 

And so I think the scale of the problem is such that this 

expectational effect that I talked about could be really large if it 

was credible, if the spending deal was accompanied by maybe some 

very clever new Gramm-Rudman style rules that made believe that 

the spending cuts are there to stay. 

Vice Chairman Brady. Thank you, Doctor. I would point out 

we often talk about people looking to the Clinton years as the golden years of the economy. I would point out that President Clinton, 

working with the Republican Congress from 1993 to 2000, lowered 

the spending to GDP ratio from over 21 percent to around 18 perVerDate Nov 24 2008 14:01 Nov 09, 2011 Jkt 067929 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 C:\DOCS\67929.TXT DPROCT
25 

cent, and the economy grew as we did it. So shrinking, spending 

less, owing less can spur this economy very much in the right direction. 

Senator Lee. 

Dr. Stone. Excuse me. May I? 

Vice Chairman Brady. Absolutely. 

Dr. Stone. A couple things. You point out what happened in the 

U.S. in the 1990s, and you mention the Canadian experience. I 

won’t ask that the chart be brought up, but I have a chart in my 

testimony that talks about the Canadian experience. And two 

things are notable. One is that Canada is very sensitive to U.S. 

economic conditions. And Canada rode the expansionary boom of 

the 1990s that you talked about. Also Canada started with a higher 

level of spending than we had and came down but not all the way 

to the level of spending as us. And so I would be careful about Canada as an independent successful experience. 

One other thing, you talked about the 26 episodes of expansionary contractions. Expansion was defined in that study by being 

in the top quarter of the 107 episodes that they studied. When you 

look at examples that were both expansionary and successful at 

bringing down the debt to GDP ratio, there are only 9 examples, 

and three of them are Norway, one is Sweden, one is the Netherlands, Scandinavian economies that looked quite different from 

ours. 

Vice Chairman Brady. I would point out, too, if we could bring 

up another chart about Canada. This shows Canada’s experience, 

total government spending, where government, as you can tell in 

a very struggling economy, took on a conscious effort to reduce 

their debt, including spending caps on each budget area where 

agencies that were run in effect by members of parliament could 

not increase spending without commensurate spending cuts elsewhere to keep it under those caps. They lowered their debt and 

grew the economy in a substantial way. It is as a neighbor, I think 

a very key example of how countries can consciously control their 

spending and grow their economy in the short term as well. 

Senator Lee. 

Senator Lee. Several of you have discussed the importance of 

credibility in the eyes of the public as we approach the debt limit 

increase and other decisions that will affect the spending of Congress as we move forward. 

Dr. Hassett, a minute ago you referred to Gramm-Rudman, 

Gramm-Rudman-Hollings legislation. I was a big fan of that. I was 

in high school when it passed, and I had great optimism for it. I 

was disappointed when it ceased to do its thing because as we 

found over time Congress has a certain tendency to be a walking, 

breathing, living waiver unto itself. One Congress may not bind another Congress. We can’t speak now for what successive Congresses 

will do. PAYGO was a great idea, but PAYGO has been waived so 

many times that it doesn’t really do a whole lot. 

But there is one way that we could bind a future Congress, 

which is by amending the Constitution to cap to a fixed percentage 

of GDP the level of our spending, to require a balanced budget and 

to put certain restrictions on what it would take to raise tax rates. 

26 

What would you think about that, Dr. Hassett, in terms of its 

credibility with the marketplace? 

Dr. Hassett. I would very much support such a cap, a constitutional amendment. It could be that it is impossible, that it is so 

hard to change it. 

Senator Lee. Nothing is impossible, Dr. Hassett. 

Dr. Hassett. But a constitutional amendment with a spending 

cap, especially if the spending cap were relative to something like 

potential GDP so that we didn’t have a kind of very procyclical effect of the budget rule, then I think it would be very easy to support. 

Senator Lee. What potential GDP? Do you want to explain what 

you mean? 

Dr. Hassett. So if we are at full employment then it would be 

say how much GDP we could make. And if that is the sort of metric 

that we use to say, well, how big should government be, then we 

won’t have a problem that if suddenly GDP collapses then we are 

hitting this cap, then we have to really reduce everything government does in the middle of a recession, which would make it hard 

for automatic stabilizers to work. 

Senator Lee. Thank you. Dr. Johnson. 

Dr. Johnson. If you had an amendment that said you must hit 

a number in terms of government spending in terms of actual GDP, 

and sometimes that might work fine, but you could also have a calamity, financial crisis, or some other kinds of problems. So the 

GDP falls by 20 percent, this happens in many economies around 

the world. The U.S. fortunately hasn’t had that experience recently. 

And then if you had to reduce government spending to hit constitutionally the target ratio, well, then you would have to do all kinds 

of things, including perhaps raise taxes at the worst possible moment, which would be in the economic freefall. 

Then of course, once you start to define it around potential GDP, 

how do you define potential GDP. Who will be the arbiter of this? 

The cross country experience with very tough and hard budget 

rules of this kind is that is only as good, as you yourself have said, 

as the Congress will or the equivalent body because you can always 

find ways to redefine potential as circumstances change. So it is a 

little bit more elusive than you might think. 

Senator Lee. Sure. And I understand why the task of defining 

potential GDP would be difficult, and that is one reason why basically all balanced budget amendment proposals, including that 

sponsored by all 47 Republicans in the Senate, have provisions in 

them allowing for these restrictions to be circumvented. It just requires a higher vote threshold. 

Did have you something to add, Dr. Hassett? 

Dr. Hassett. One thing I wanted to add short of a Constitutional 

amendment is that, as you know, there are a lot of States, almost 

every State has a balanced budget requirement, and they also often 

have things like supermajority rules to increase taxes. And mechanically it is often the case that a simplemajority could vote to 

ignore the supermajority rule, but it almost never happens. And so 

I think that, if you are thinking about a design short of a constitutional amendment that could accomplish your objective, you might 

try to think about whether something like a supermajority rule 

27 

could create a taboo that Senators and Representatives would not 

want to violate. 

Senator Lee. Thank you. 

And I have one final question for Dr. Taylor. Interest rates are 

really low right now. They are substantially below the 40-year average, as I understand it, maybe as much as 350 basis points below 

the 40-year average. How high do you think interest rates could 

rise, let’s say, in the next, I don’t know, 18 to 24 months once 

quantitative easing, QE2, comes to an end and if other factors 

change. How much play do you think there is in the sort of intermediate term, meaning 18 to 24 months? 

Dr. Taylor. Well, right now this weak recovery that I referred 

to before is one of the reasons why rates are low, so hopefully we 

will get the recovery moving with some of these policies and they 

will go back to normal levels. And a normal level is you could have 

a real interest rate of 2 percent, and if inflation is 2, then that is 

sort of 4 percent on the short end. That is kind of a normal level. 

I think the fear and the concern is that when we might get behind the curve on dealing with inflation and that inflation would 

over—you know, go higher, if you like, overshoot any reasonable 

target. And of course that would drive interest rates up dramatically. That would be very harmful. So we haven’t talked about 

monetary policy, but there is a concern with all this overhang of 

reserves and money whether the Fed will be able to pull it back 

out at a sufficient speed without also being disruptive as it pulls 

it out to prevent inflation from picking up down the road. 

We have already had some movements up in inflation. I think 

they will probably come down a little bit, but the real concern is 

they are going to go back up again. That would be the main driver 

of interest rates down the road, and it is a concern to me. 

Senator Lee. Thank you very much. 

Vice Chairman Brady. Thank you. Congresswoman Sanchez. 

Representative Sanchez. Thank you, Mr. Chairman. I just 

wanted to read into the record because we were talking about—I 

think it was Dr. Taylor who was saying that is not draconian to 

go back from what we are today back to the 2007 fiscal numbers, 

for example. I had stated that in fact I think we have to have some 

spending cuts, and we have to look at them carefully and that in 

fact we had not cut spending on defense. In fact, my Republican 

colleagues continue to increase. 

I just want to read into the record that in fiscal year 2007 the 

total for defense spending was $110 billion as a base and $109 billion because we were in the wars we are in, for a total a $219 billion. In the fiscal year 2012 bill NDAA, that was just approved in 

the last week or two, the authorized amount is $690 billion. So 

$690 billion is what they have set it at from the House, with a Republican controlled House; $219 billion are your 2007 numbers. 

Again I think there are a lot of places to cut, and I think that 

would be one of those that would show some credibility about how 

Congress feels about some of the spending. 

I would also note for the record that with respect to PAYGO because it was brought up by one of my colleagues, I personally when 

I first arrived here at the Congress voted for the PAYGO rule almost 14 years ago as a Blue Dog. We were the ones who proposed 

28 

it. We were the ones who helped to get it through. And I will remind my colleagues that it was actually when the Republicans controlled both the House and the Senate that they let the PAYGO 

rule expire. 

So there can be a lot of talk about what we want to do. We actually had it and it was working, but because of the large spending 

that happened when the Republicans controlled both houses of the 

Congress they did not want to abide by PAYGO and they let it expire. 

And I would just like to have those comments in the record, Mr. 

Chairman. 

Vice Chairman Brady. Probably no chance I could deny that 

one. 

Mr. Mulvaney. 

Representative Mulvaney. Thank you, Mr. Chairman. And 

gentlemen, the chairman has informed me that I am last, which ordinarily is a bad thing, but it is actually good for me in this circumstance because he says that I can have more than the 5 minutes if need be, and it is a tremendous opportunity for me to sit 

here and get you all in one room together. I am a big fan of Dr. 

Hassett and Dr. Taylor’s work. I am looking forward to reading 

more about Dr. Stone and Dr. Johnson’s work after today. 

So let me come at a couple different topics. We have talked about 

Canada, something that I have spent a little bit of time looking at. 

Dr. Stone, you mentioned something that I hadn’t thought about 

before, which was the fact that may have been along for the ride 

on the economic boom that we had during the 1990s and that may 

have contributed to their success. And I had not considered that 

and will going forward. I would encourage you to consider the fact 

they also dramatically reduced their automatic stabilizers, that’s 

one of the things they did. The two major reductions they had to 

their spending was number one their health care, but also to their 

unemployment benefits, which I thought was interesting. We have 

heard a lot of talk about leaving the automatic stabilizers in place, 

but clearly if we do look to what Canada did, it is clear that they 

actually reduced their automatic stabilizers. 

As I go out and I drive around and I talk to employers, I hear 

oftentimes they are finding difficulty finding people to go to work 

because of the stabilizers. I have several examples of them going 

back to folks they had laid off during the downturn, offering them 

their jobs back, and then being told that they have 8 months worth 

of benefits left and to please call them in 71⁄2 months. 

Do you gentlemen not think that maybe extending these automatic stabilizers—I heard, I think Dr. Johnson mentioned that in 

his testimony—would have a negative impact on job growth, that 

there are jobs out there that are going unfilled at this point simply 

because we are essentially incentivizing unemployment. So, Dr. 

Johnson, I put that to you to begin with. 

Dr. Johnson. No, I don’t think we incentivized unemployment 

in this country. Compared with any other industrialized country, 

this is a tough place to be unemployed. You get relatively low benefits, you are getting them for a relatively short period of time. And 

I am sure you are right that there are employers who have trouble 

finding the precise workers that they want. 

29 

In general the employment picture around the country is bleak, 

and that is actually another very disconcerting parallel or comparison with other postwar recessions. There is always—previously, for 

example, at the end of the S&L crisis, when Texas was in big trouble other parts of the country were booming and people were able 

to move to those booming parts of the country. That is not available right now, and we have the problems of house mortgages and 

people being underwater on their homes, making it even harder to 

move. 

But no, I think overall our automatic stabilizers are weak, and 

I think with regard to Canada where I was just a couple of weeks 

ago meeting with finance people, the Department of Finance there, 

and the Treasury and Central Bank, it is true that there were 

some reforms. It is also true they had one of the greatest commodity booms of all times in a very commodity intensive economy. 

And their health care system is still far more generous to far more 

people than the U.S. And I am sure you were not proposing that 

we go in the direction of Canadian health care. 

Representative Mulvaney. Thank you. Let’s talk about jobs for 

a second, gentlemen, because I think it was Dr. Hassett mentioned 

why you don’t see the plants built anymore as you drive down the 

road. And certainly I think there is a tax component to that. I also 

think there is a regulatory component to that. Unfortunately, I live 

in a textile area and a lot of what we used to do is simply illegal 

to do now, especially dealing with chemicals and dyes and so forth. 

So the regulatory environment certainly I think explains why we 

are not seeing more job growth. But I had a discussion the other 

day with folks in the construction business. That is what I used to 

do. And the analysis that they go through on whether or not to 

build a new plant I think is insightful. Not only are they looking 

at the after tax returns, and so forth, there is no question about 

that, not only are they looking at the regulatory environment, but 

they are also looking at the net present value of their particular 

investment, which means that they have to focus relatively sharply 

on what the discount rate is going to be. And I think it was Dr. 

Johnson who said that one of the things they are concerned about 

is the long-term implications of what you are doing. And I think 

you are seeing that raise its head in the discount rates. We are assuming that inflation is zero, hear what Dr. Taylor says about 

some incipient inflation. They actually think it is higher than is reported simply because we took food and energy out. But I think 

businesses look at what we are doing and recognize that there is 

going to be inflation, that businesses look at us and say, look, they 

are either going to have to print money in order to get out of this. 

They are never going to be able to agree on tax cuts or increases, 

they are never going to be able to agree on spending cuts, and they 

are going to end up printing money. As a result the discount rates 

that businesses are looking at are dramatically different than we 

think from an academic standpoint. 

Would you agree with me, gentlemen, that by us continuing to 

run up these dramatic deficits we are discouraging investment in 

this country? Is there anybody who disagrees with that statement? 

Dr. Johnson. I agree completely, but the CBO forecasters are 

ambiguous, 2030, 2050 we have massive deficits, much higher 

30 

debts, GDP much more than any country will get away with, including Japan, is due to uncontrolled health care spending. That is 

the primary driver of Federal Government, general government, 

and also the burden on the private sector, on the private business. 

That is what they are terrified of, with good reason. If you can fix 

that you will be heroes, whatever side the political spectrum you 

come from. 

Dr. Stone. Can I also say about that, long run health care costs 

are the game. If you can control them in the economy, the deficit 

problems are manageable. If you can’t, you won’t. But the other 

thing that is driving those horrible long-term pictures, I guess CBO 

is going to come out with its long-term outlook tomorrow, is there 

is interest on the debt. So a huge amount of what is going on in 

the outyears is spending on interest payments. And if you control 

the deficits now, whether with taxes or with spending, you get rid 

of an awful lot of the spending problem that is due to interest in 

the outyears. 

Representative Mulvaney. Lastly, at least I am getting ready 

to finish. If you could bring up, please, Dr. Taylor’s figure number 

3 and I can’t get—I was trained as a Keynesian and I have come 

to see the light, and I disagree with you gentlemen philosophically, 

but I can’t get two highly qualified Keynesians in a room and not 

ask them to explain to me where Keynes went on this graph. The 

top line is the unemployment rate, the bottom line is the Federal 

Government purchases as a percentage of GDP. And you can see 

unambiguously that those two lines move together. Government 

spends less, people go back to work. When the government spends 

less, people go back to work. There is another graph, by the way, 

the committee has come up with that shows the correlation between private fixed nonresidential investment and private payroll 

employment. And those two numbers are perfectly correlated. See 

if they can bring that up. 

So tell me, gentleman, what I am seeing in the real world, and 

the reason I am no longer a Keynesian is that what I see is when 

the government spends less, business spends more, and when business spends more, people go back to work, and the exact opposite 

is true. So tell me why are we still clinging to this concept that the 

government needs to spend more in order to put people back to 

work? 

Dr. Johnson. Look, you have to ask the question of causation. 

I am not by any means an unreconstructed Keynesian. As I said, 

I am not favoring generally fiscal stimulus left, right, and center. 

I am the former chief economist of the International Monetary 

Fund. I am a fiscal conservative by any reasonable standard 

around the world. But what happened in the United States in 

2007, 2008, the financial system blew itself up. We had a huge crisis and we can argue for a long time about the consequences, but 

that is the fact of the matter. 

A massive financial crisis at every country which that happens 

drives up unemployment and causes the economy to contract. And 

it was Dr. Hassett who told you, completely accurately, that when 

you have a calamity and GDP falls, you are going to naturally have 

government spending rise relative to GDP. Actually whether or not 

you have automatic stabilizers that is probably what is going to 

31 

happen. And if you have some reasonable automatic stabilizers, 

that is usually what we have, not super strong and they are not 

zero, then that is the consequence certainly of the big change that 

you are seeing here. 

Over longer periods every time I think it absolutely makes sense 

to keep tax burdens down to allow entrepreneurs to make good 

money, to allow them to get a better return on their investments, 

to have less uncertainty about the value of future taxes. 

Representative Mulvaney. I don’t mean to interrupt you, but 

you may have hit on exactly my point, and the reason I no longer 

am on maybe your side or Dr. Stone’s side of the aisle, which is 

that we have been doing this forever. We have been in a Keynesian 

stimulus for the last 25 years. I guess I can agree philosophically 

what you said that if you get into a short term you could use a 

Keynesian stimulus in order to prevent the bottom from falling out, 

but we have been pumping this system full of Keynesian cocaine 

for the last 25 years. 

Dr. Johnson. Well, seeing you brought it up, Congressman, let 

me be honest. Congress, when it was controlled by the Democrats 

and by the Republicans, has leaned away from balancing the budget towards big deficits and towards debt. That is absolutely true. 

Sometimes you have been helped by an administration and sometimes the administration has tried to pull back a little bit, but 

there is no question that spending has tended to outrun revenues 

in this country for a long time. 

Actually, to be honest, the other point we haven’t discussed at all 

today is how we finance these deficits. Increasingly we finance 

them by selling bonds to foreigners. So now we run 11 nuclear aircraft carriers around the world. Nobody else has a single one. We 

finance that by selling bonds to China. How does that make sense? 

If you want to make it something taboo, I would suggest you make 

that taboo, financing the U.S. military by selling debt to China because that surely is not going to prove ultimately sustainable. 

Representative Mulvaney. Thank you, gentlemen. I could do 

this all day, but the tapping sound means that I have run out my 

patience with my chairman. So thank you, gentlemen. It has been 

a privilege. 

Vice Chairman Brady. No, it was a good line of questions. You 

could have done that all day, but I think we all could have, the 

truth of the matter is. Yeah, this is a great discussion. We are all 

looking for a game changer, I think, in this country both for the 

economy and for spending questions. How do we do it, how do we 

do it smartly, and what are the best approaches? You all provide 

us very good ideas and input and insight as we go forward with 

that. Thank you for the testimony today. Thank you to our members for being here as well. And with that, this hearing is adjourned. 

[Whereupon, at 3:43 p.m., the committee was adjourned.] 

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