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93–128 PDF 2004

S. HRG. 108–413

JUMPSTARTING THE ECONOMY

HEARINGS

BEFORE THE

SUBCOMMITTEE ON ECONOMIC POLICY

OF THE

COMMITTEE ON

BANKING, HOUSING, AND URBAN AFFAIRS

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

ON

INCREASING THE INVESTMENT IN THE EQUITY MARKET AND

IN RURAL AMERICA

MAY 22 AND JUNE 25, 2003

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

JOHN E. SUNUNU, New Hampshire

ELIZABETH DOLE, North Carolina

LINCOLN D. CHAFEE, Rhode Island

PAUL S. SARBANES, Maryland

CHRISTOPHER J. DODD, Connecticut

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

ZELL MILLER, Georgia

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

JON S. CORZINE, New Jersey

KATHLEEN L. CASEY, Staff Director and Counsel

STEVEN B. HARRIS, Democratic Staff Director and Chief Counsel

PEGGY R. KUHN, Senior Financial Economist

MARTIN J. GRUENBERG, Democratic Senior Counsel

AARON KLEIN, Democratic Economist

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator

GEORGE E. WHITTLE, Editor

SUBCOMMITTEE ON ECONOMIC POLICY

JIM BUNNING, Kentucky, Chairman

CHARLES E. SCHUMER, New York, Ranking Member

ELIZABETH DOLE, North Carolina

RICHARD C. SHELBY, Alabama

ZELL MILLER, Georgia

STEVEN PATTERSON, Staff Director

JAMES SOCAS, Democratic Staff Director

(II)

CONTENTS

THURSDAY, MAY 22, 2003

Page

Opening statement of Senator Bunning ................................................................ 1

Prepared statement .......................................................................................... 29

Statement of Senator Schumer ............................................................................... 7

WITNESSES

Peter R. Fisher, Under Secretary for Domestic Finance, Office of Public Affairs, U.S. Department of the Treasury ............................................................. 2

Prepared statement .......................................................................................... 29

Wayne D. Angell, Former Federal Reserve Governor .......................................... 10

Prepared statement .......................................................................................... 30

James W. Stuckert, Chairman and Chief Executive Officer, J.J.B. Hilliard

and W.L. Lyons, Inc. ............................................................................................ 15

Mark Zandi, Chief Economist and Co-Founder, Economy.Com ........................... 18

Prepared statement .......................................................................................... 37

WEDNESDAY, JUNE 25, 2003

Opening statement of Senator Bunning ................................................................ 41

WITNESSES

Hilda Gay Legg, Administrator, Rural Utilities Service, Rural Development

Mission Area, U.S. Department of Agriculture ................................................. 42

Prepared statement .......................................................................................... 55

M. Scott Smith, Dean and Director, College of Agriculture, University of

Kentucky ............................................................................................................... 44

Prepared statement .......................................................................................... 57

Mark Haney, Vice President, Kentucky Farm Bureau Federation ..................... 46

Prepared statement .......................................................................................... 58

(III)

(1)

JUMPSTARTING THE ECONOMY:

INCREASING INVESTMENT IN THE

EQUITY MARKETS

THURSDAY, MAY 22, 2003

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,

SUBCOMMITTEE ON ECONOMIC POLICY,

Washington, DC.

The Subcommittee met at 10 a.m. in room SD–538 of the Dirksen

Senate Office Building, Senator Jim Bunning (Chairman of the

Subcommittee) presiding.

OPENING STATEMENT OF SENATOR JIM BUNNING

Senator BUNNING. I would like to call the first hearing of the

Economic Policy Subcommittee of the 108th Congress to order.

I want to thank all of our witnesses for being here to testify.

Today, we have the first in a series of hearings titled, ‘‘Jumpstarting the Economy.’’ I do not think that it could be more appropriately timed, since we are about to embark on a very interesting

2 days as far as the tax bill is concerned. I am very concerned with

the state of our economy. I am very worried about the possibility

of a double-dip recession. I know that that puts me at odds with

more optimistic experts like Chairman Greenspan, but we have disagreed before. We are not growing like we can and we are not creating jobs—particularly not creating jobs. There are many reasons

for this.

I believe Chairman Greenspan acted way too slow to cut rates

back in early 2001. He should have cut them in the fall of 2000.

The corporate governance scandals have hurt trust in the markets.

Sarbanes-Oxley and other actions have helped, but it will take a

long time for corporate America to rebuild that trust. September 11

had a devastating effect on our economy. The two wars that we

have had since then also have not helped.

The reason why most of these events have been so harmful to

this economy is because they have created uncertainty in our markets. If there is one thing that shakes the markets, it is uncertainty. I am hopeful that our witnesses today will help us find a

way to bring some certainty back to the markets.

Since the height of the bull market in March 2000, the stock market’s values have been reduced by about $8.5 trillion. At the

market’s height back in early 2000, the market cap of the Wilshire

5000 totaled $17 trillion. By the time of the market’s low in early

October, the index’s market cap had shrunk by about half of that

2

amount, or about $8.5 trillion. We have a $10 trillion economy

right now. We have had stock losses of $8.5 trillion in 3 years. It

is not surprising that investors are skittish.

If we are going to grow this economy, we have to get the people

investing again. We need to create capital so businesses have the

opportunity to invest and grow. Before we adjourn for Memorial

Day, we will be voting on a growth package. I think it is critical

that we send a package to the President for his signature. I wish the package was bigger, much, much bigger, I hope $350

billion is enough to move a $10 trillion economy, but we must make

a start somewhere. We must create jobs and we must make sure

that our economy grows. We must bring back some certainty to the

markets if we are ever going to grow this economy and prevent a

double-dip recession.

Once again, I thank all of our witnesses for testifying today. And

since my colleagues are at other meetings right now, I am going

to start with Mr. Fisher from the Department of the Treasury as

our first witness.

The mic is yours, Mr. Fisher.

STATEMENT OF PETER R. FISHER

UNDER SECRETARY FOR DOMESTIC FINANCE

OFFICE OF PUBLIC AFFAIRS

U.S. DEPARTMENT OF THE TREASURY

Mr. FISHER. Thank you, Mr. Chairman.

I am very pleased that you have chosen to hold this hearing on

the challenge of increasing the incentives for investment. If you

will permit my written statement to be included in the record, I

would like to briefly summarize my remarks.

Senator BUNNING. Without objection.

Mr. FISHER. Thank you.

To reinvigorate our Nation’s economy in this decade, and to pay

for our collective retirement in the coming decades, we need to

enhance the incentives for investment that will create the jobs

we need now and to sustain our standard of living in the future.

To do this, both the public sector and the private sector must do

their part.

We in the Federal Government must examine and remove the

legal and regulatory obstacles to greater savings and investment.

In the private sector, to rebuild investor confidence, as you pointed

out, Mr. Chairman, I believe that publicly traded companies need

to do a better job of disclosing information to their shareholders.

We are not satisfied with the current rate of job creation in our

economy. In order to do something about this, we need to increase

investment. There is only one place that new jobs come from—they

come from the willingness of investors and entrepreneurs to put

capital at risk in a business venture. The President has focused us

precisely on this point, on sharpening the incentives for productive

investment by reducing the biases against equity investment that

now exist in our tax code.

There is no better example of these distortions that discourage

savings and investment than the current double taxation of corporate dividends. No one defends the double taxation of dividends

from first principles, and no other major industrial nation taxes

3

profits at such a punitive effective rate. We are encouraged by the

progress now being made on the President’s jobs and growth proposal, including progress toward lowering tax barriers to savings

and investment.

The Administration, as you alluded to, Mr. Chairman, is working

closely with Congress today, yesterday, and over these next few

days, to obtain the best package possible as quickly as possible.

The President has made clear that the sooner we get this done, the

sooner we will be creating the jobs that put people back to work.

Increasing the incentives for savings and investment in America

will require effort not only, or even principally, by the Government,

but also by the private sector. In particular, it will require a sustained effort by corporate leaders to restore investor confidence.

Congress passed the Sarbanes-Oxley Act, and the SEC and the

Justice Department are successfully implementing its provisions to

improve corporate governance. But publicly traded companies also

have a responsibility to restore investor confidence by providing

shareholders with better, more useful information about the companies in which they invest.

Our Nation’s securities markets are extremely efficient at pricing

and allocating capital on the basis of all available information. Unfortunately, important information about the real economic leverage of the firm and about the firm’s current condition and business

prospects is too often not available.

To restore investor confidence, shareholders need to be able to

see the companies that they own through the eyes of management.

Private-sector leaders should take the responsibility to transform

the practice of corporate disclosure, to set new standards of best

practices that will genuinely inform investors about their firm’s

risk/reward prospects. Until they do, I fear that investor confidence

will not be restored to the point where we will see the increased

equity investment that our economy needs.

But if we in the Federal Government can strive to reduce the obstacles to savings and investment imposed by our tax code, and if

corporate leaders strive to give shareholders more useful information about the companies in which they invest, then we are much

more likely to see the expansion of equity investment that is necessary for our future prosperity.

Thank you for this opportunity to be here and I look forward to

your questions, Mr. Chairman.

Senator BUNNING. Thank you very much, Mr. Fisher.

Let me start out by talking about the current bill that we have,

or proposed bill that we have before us in the stimulus package,

or the job-creation package, whatever you want to call it. It is the

tax bill. What do you believe would happen if we did not—I say

not—pass the stimulus package?

Mr. FISHER. Well, when I look out at the economy, as you described it, I see a need for us to do two things to get the economy

moving at a pace that will create jobs. We need to have balanced

support for both consumption and investment. The package the

President proposed, and still the variables now being debated these

last few days do provide us balanced support—doing something for

homeowners and families and hard-working Americans, and doing

something to give business incentives for greater investment.

4

Particularly the latter. We see that over the last few years, we

have a lack of business investment. As both you and I have pointed

out, business investment is the key to new jobs.

Therefore when I look at the risks to our economy now of underperforming its potential, then we will run a much higher risk of the

double-dip inflation that you are concerned about. Or if not a double-dip, then lower growth than needed to create the necessary

jobs. We simply do not need to take that risk. We should be doing

something to provide balanced support.

Senator BUNNING. There are many ways to put 51 votes together

to get a package passed. One of the unique ways that is in this bill,

at least it was as of last night, and I suspect that it was this morning when the President appeared up here, is a $20 billion allotment

for States.

Now, we all know that State governments are having the same problem as the Federal Government. I know that a $8 billion shortfall is occurring presently in California. In Kentucky, it is not as

large, but it is proportionately as large. And many other States are.

I think there is only one State that does not have a budget deficit.

It seems to me that, on the policy side of tax, that this is a horrible

idea. I just would like your opinion on the Federal Government investing $20 billion in the shortfalls of State governments.

Mr. FISHER. Well, I am aware of the proposals now circulating.

I haven’t had a chance to study the bill language that you may

have been up late last night with.

Let me be clear. Direct support for the States was not part of the

President’s proposals, going back to January. We felt the best thing

to do for State governments was to try to get the economy going.

I do not remember the exact figures now, but for every 1 percent

increase in GDP in the country, States experience a greater than

1 percent increase in sales tax revenues.

It seemed to us that the more we focused on the combined problem of job creation and revenue shortfalls, that the best way to address both problems was to get investment moving and try to get

the economy moving. So that was certainly our first choice going

back to the President’s proposals.

Senator BUNNING. Okay. You stressed in your testimony the

need to reduce market distortions that discourage savings and investment and the need to increase transparency. Do you really

think that the same measures will bring benefits in both the shortand long-term?

Mr. FISHER. Yes, I do. I think that the real way to restore investor confidence and business leader confidence is to give them the

kind of planning horizons that they need to make investments now.

That is, confidence to make an investment today comes from being

able to see far enough into the future, that you can make plans and

have confidence.

So to give our economy a boost today in the form of investment

and, frankly, also to give American families confidence in their financial position for the future so that they can make consumption

decisions today, you will get the effect in both places if you provide

sound tax policies.

And so, on the rate front, as I have said many times, just as

homeowners experience an enduring improvement in their houseVerDate 11-MAY-2000 09:07 Apr 21, 2004 Jkt 000000 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 93128.TXT SBANK4 PsN: SBANK4
5

hold cashflows when they refinance their mortgages at lower rates,

and they get to see that they are going to have that income there

month after month and quarter after quarter, they then feel more

confident about their future and may feel better about buying large

durable goods—a new refrigerator or a new car.

Now for business men and women, it is the same issue. To make

an investment now, they need to see that investment horizon, lowering the burden on investment, lowering the tax burden, in order

to make that investment so that they can see the return.

I think that when we do sound tax policies that have an enduring impact, we will get the benefit now of the investment that we

have been lacking, and that very investment is what will sustain

us into the future.

Senator BUNNING. Let’s go back to the tax bill, then, because I

am not a policy work, but I would like sound tax policy.

We are creating a bill that adds more confusion and more pages

to the current tax code. It certainly is not simplification. We are

doing investment tax credit for 1 year at 50 percent. We are doing

expensing 1 year at $100,000, it is my understanding. We are doing

the child tax credit for 2 years. We are doing the marriage penalty

correction for 2 years. That seems to me to be a horrible tax policy.

You are talking about having the knowledge and the ability to look

into the future and that business and investors like to be sure of

what is going to be there. In 2 years, some of these things are not

going to be there. In some cases, they are not going to be here after

1 year.

So, as far as policy is concerned, we have created something that

will pass with 51 votes. My opinion is that it will stimulate for a

short period of time.

The dividend is not the exact dividend policy that the President

has brought forward, but it is the House version where we reduce

capital gains on dividend income from the current rate, which

would be 35 or whatever bracket that you are in, to apply a capital

gain rate to it at 15 percent. If you are in the 10 percent bracket,

it is reduced to 5 percent. And that stays in for quite a while.

What we are doing is taking dividend taxation and not doubletaxing it, but taxing it at a capital gains rate. You are looking at

tax policy and that is your job. What kind of tax policy is that?

Mr. FISHER. Well, as I said, the President’s first preferences were

in the proposal in January.

Senator BUNNING. I understand that.

Mr. FISHER. And we prefer enduring, and enduring would be

even better than what we may have on the table in front of us.

However, I think we understand that sunset provisions are not uncommon in all forms of legislation so that Congress can take another look. I think it would be better to have enduring, but we are

trying to get the best package that we can.

Senator BUNNING. The restrictions of $350 billion is pretty restrictive and pretty infinitesimal in a $10-plus trillion economy. Or

if you look at the big picture of a 10-year picture, where you have

a $100 trillion plus economy and you are looking at $350 billion,

you must front-load—thank God for our Budget Act, where we

allow about $190 billion to be in the first 2 years.

6

But it is really difficult for me to swallow the way that we sunset

because the planners, the policy planners, the people who do the

planning for corporate America, that do the planning for individual

accounts, have difficulty with the short-term effect of what this tax

bill will bring.

I just hope that it is stimulative enough to keep us on the upswing and we do get the capital necessary, particularly for the

small business person because about 65 to 70 percent of all new

jobs are created by small business, not the giant corporations.

I will ask you one more question and let you be on your way.

As you know, the 1-year anniversary of Sarbanes-Oxley is coming

up. I know that Chairman Shelby of the full Banking Committee

is planning an oversight hearing to mark the anniversary. Do you

believe anything else is needed to be done in the area of corporate

disclosure? Is there anything that you think we need to be watching as the SEC continues to implement that law?

Mr. FISHER. Yes, let me make two observations.

First, I think that I cannot now identify any additional actions

that Congress should be taking. I am not aware of any. I think that

we want to see the implementation of Sarbanes-Oxley work its way

through the corporate system going forward. However, I think

there is an area we should be sensitive to and try to observe over

the next year or so, which is the impact of the additional requirements to improve corporate governance, corporate disclosure, on

small companies coming to our capital markets.

That is a sensitive area that we should look at and observe. I do

not think that we have enough data now to draw conclusions. But

I think over the coming year or so, we should be sensitive to the

question of whether small companies, emerging companies, can

reach into our deep capital markets and become public companies

and raise capital efficiently that way, or whether the requirements

we have put in may be an obstacle.

Clearly, given the weakness of the economy and the investment

climate, I think the current data on new public offerings by small

companies is something that we should not view as a consequence

of Sarbanes-Oxley. But this is an area that I think we have to be

concerned with going forward.

I would also say that I think there is a great deal that corporate

leaders can do and should do to improve the clarity of their disclosures to investors.

I think the SEC is working diligently in implementing SarbanesOxley. It has very good rules out on off-balance sheet disclosure. I

know that FASB is working on these issues. But I still think that

there is a good deal more that corporate leaders can do to improve

the clarity of their disclosures with respect to off-balance sheet

leverage and the clarity of disclosure with respect to their business

prospects.

I am very concerned looking back over the last decade that corporate leaders now have access to much better information internally, as a consequence of the data management revolution and

what computers have been able to do for them in managing data.

So, they have a much better sense of not so much the financial

issues, but just their business prospects—new order flow, customer

orders. That information is available to them in a way it was not

7

available a decade ago. And that compounds the information, a

symmetry on insiders versus outsiders. I think there are a number

of businesses and a number of academics who are trying to lead the

way to what is called the value reporting revolution, the business

value—not so much the financial indicators, but business value disclosure to shareholders about the prospects of the business.

I think there is a lot of room for corporate leaders to do a better

job in the MDNA section of their disclosures to get that information

out to shareholders. And that is another area that I think we

should be watching over the coming years.

But I think that is a terrific question you asked.

Senator BUNNING. Senator Schumer.

STATEMENT OF SENATOR CHARLES E. SCHUMER

Senator SCHUMER. Yes, thank you. I want to apologize to you,

Mr. Chairman, and to the witness and the other witnesses. Unfortunately, we have a simultaneous hearing in Judiciary where I am

offering, along with Senator Grassley, the amendment on cameras

in the courtroom. So, I am going to have to scuttle on down there.

But I thank you, Mr. Chairman, for having this hearing.

Thank you, Mr. Fisher, for your terrific service.

First, I would like to just tell you that I think it was great that

you were considering a position at the New York Fed. I guess you

are not going to take that. I do not know. But if you are, we are

going to miss you. Do you want to comment on where you are

going, what you are doing, and all that?

Mr. FISHER. No. No, thank you.

Senator SCHUMER. No? I did not think so.

[Laughter.]

But you have done a great job.

Mr. FISHER. Thank you very much.

Senator SCHUMER. If you are staying, continue to do a great job.

If you are leaving, you have done a great job.

[Laughter.]

Mr. FISHER. Thank you very much, Senator.

Senator SCHUMER. The question I really wanted to focus on just

a little bit is Secretary Snow’s comments on the dollar, which have

caused a whole lot of controversy and comment.

The Wall Street Journal editorial—well, they were pretty negative. They said: ‘‘But the huge danger in bashing the dollar comes

from the currency markets themselves. Famous for overreacting,

the dollar could fall too fast and too far. Foreign investors hold almost half of U.S. bonds, a third of U.S. corporate bonds, 10 percent

of U.S. stocks. Their confidence in the U.S. dollar is not helped if

they think the Treasury Secretary is trashing the value of what

they own in order to squeeze out more export growth.’’ And I am

skipping a sentence or two. ‘‘A dramatic sell-off in the dollar would

force up interest rates, trounce the stock market, slowing economic

growth even further. Someone in the White House should tell Mr.

Snow that he is playing with fire.’’

Could you clarify the Treasury’s position on the dollar? Are we

abandoning a commitment to the strong dollar, being a strong currency, not one that people happen to like?

8

Do you agree with the Journal that this is a dangerous position

that could trounce the stock market? The worry here is not that

Secretary Snow or the Administration or the Treasury would force

the dollar to go down, but given the precariousness of it all, given

that bond trading is now—Euros are an alternative currency,

which we have had no alternative currency I guess since Bretton

Woods. That even comments to that effect could cause the markets,

as the Journal says, to push the dollar down.

So that is my first question.

Then, second, once it starts going down, many experts I have

talked to say it could keep sliding down and there is nothing that

we could do to stop it. Could you comment in general on this?

Mr. FISHER. Senator, I think that I would rather talk about my

future career.

[Laughter.]

Senator SCHUMER. Take your pick.

[Laughter.]

The pit and the pendulum.

[Laughter.]

Mr. FISHER. Senator, we have a policy of having the Secretary of

the Treasury be the spokesman on the dollar.

Let me be clear—I do not agree with the editorial you read me.

I think it is really prudent and in our Nation’s best interest to have

one spokesman on the exchange rate.

I have a great deal of experience in this area going back to my

previous employment, and in the 1990’s, on a bipartisan basis, I

think we learned that having more than one spokesman on the exchange rate makes things worse, not better. I think that the best

course here is to let us have one spokesman on the exchange rate.

Senator SCHUMER. Let me ask you just a general question based

on your knowledge and experience. Many people believe what Secretary Snow says. You have substantial input which I believe and

I hope is correct. Is there a danger that if something, whether it

be the Secretary’s comments or anything else in the world, starts

causing the dollar to slide, that that slide could become a cascade

and could be unstoppable? Do we worry about that in Treasury before making remarks about the dollar?

Mr. FISHER. We are always thinking about the market impact

that our comments may have. And sometimes we correctly anticipate—I will speak for myself—what those remarks will be, vis-a`-

vis bond markets, for example, and sometimes we do not. But we

are certainly always trying to anticipate the impact that our utterances can have.

I also think, going back over the last several Administrations, we

have learned that the less verbal intervention we have in markets

of all types—bonds, stock, exchange—the better we are.

Senator SCHUMER. Well, that would seem to—I do not mean to

be persnickety here—that a little bit undercuts what the Secretary

said the other day because his remarks clearly caused some change

in the temperature.

You know that. We all know that, and that was foreseeable. Now

maybe it was positive, maybe it was negative. These issues are far

more complicated. I leave them to much more complicated minds.

9

So maybe that admonition holds. Let me just ask you one more

question. How much should we worry that a decrease in the

strength of the dollar could become more of a cascade and it gets

to places where we wouldn’t want the dollar to be for a whole lot

of both domestic and international reasons. How much do you

worry about that? That is the great worry everyone has, not where

the dollar exactly is versus the Euro or any other currency. But if

we do not stay with that strong dollar and bolster it, we do not

have any control over this because it is so much in the hands of

the great herd, as Thomas Freedman calls it, the traders. And that

instead of it ratcheting down a few percentage points, or ten, it just

starts going down. Do you worry about that? Is that a real worry?

Apart from anything that the Treasury Secretary said.

Mr. FISHER. The most important thing to recall is that we have

had a floating exchange rate regime for almost 30 years now. The

markets go up and down.

I have felt that, and part of my job over the last decade both here

and in my previous employment has been to lean against some of

the conventional wisdom.

Some people look out at markets and try to understand them by

canvassing their available theories. They look back in their textbooks and if they find a theory, they say, well, there, I have my

theory. Now it fits the market behavior, whether it is interest rates

or exchange rates.

I view one of the things that I have brought to this endeavor is

to remind—excuse me—to go back. But if people look in their textbooks and they cannot find a theory, then they say, it is just a

bunch of 30-year-olds shouting at TV screens.

I have always reminded people, it is always 30-year-olds shouting at TV screens, whether you have a theory that explains it or

not. And they are trying hard to be rational actors with the incentive structures they work with.

Now sometimes they do things that we have a hard time understanding. And the best thing that I have always tried to do is to

try to understand what is motivating their behavior as a way to

understand it.

I think that we get in a very odd, circular loop when the traders

are trying to understand the official utterances and the thing goes

around a little circle, and I think that is probably a counter-productive place to be, and that is why the less verbal intervention we

have, the better.

Senator SCHUMER. But that both says yes and no to my question.

It says the 30-year-olds could take us on a tear in a place we

wouldn’t want to go. Right?

Mr. FISHER. It is possible. I do not know what probability to attach to it.

Senator SCHUMER. All right. Well, anyway, I want to thank you,

Mr. Chairman. I want to thank you, Mr. Fisher, and our other witnesses. I apologize for the brevity. It is an interesting hearing. I

am glad we are holding it. And I am sorry that conflicts occurred.

Mr. FISHER. Thank you.

Senator BUNNING. Thank you, Mr. Fisher, very, very much for

being here.

Mr. FISHER. Thank you.

10

Senator BUNNING. If the second panel would come forward:

Wayne Angell, the former Member of the Board of Governors of the

Federal Reserve; James Stuckert, Chairman and CEO of J.J.B.

Hilliard and W.L. Lyons, Louisville, Kentucky; and Mark—I am

going to say Zandi——

Mr. ZANDI. Yes, that is correct.

Senator BUNNING. Chief Economist, Economy.com.

Mr. ZANDI. Yes, thank you.

Senator BUNNING. Mr. Angell, it is good to see you again. If you

would like to start with your testimony, we are ready.

STATEMENT OF WAYNE D. ANGELL

FORMER FEDERAL RESERVE GOVERNOR

Mr. ANGELL. Mr. Chairman and Members of the Subcommittee,

thank you for the opportunity to testify today on the subject of the

use of economic policy to speed up economic growth in our economy

that has been mired too long in recession. This is a very welcome

opportunity to address the particular difficulties faced by an economy in the throes of a capital goods cycle beset by risk of deflation.

Half-way measures are handicapped at the outset by a tendency to

underestimate the lingering power of previous episodes of policy restraint. Both monetary policy and fiscal policy are likely to be

deemed stimulative or accommodative even while policy continues

to retard economic growth. If policy had been accommodative then

economic performance would not long be regarded as a problem.

Now to make matters worse, the capital goods investments that

we have seen and the capital goods technology have increased our

capacity to growth this economy so much, that we could grow this

economy at a 6 percent real rate for 6 years and not over-pressure

our labor force. So the gap is large.

We would not be hearing warnings about the risk of deflation if

monetary policy had not been less accommodative than reported.

We would not be beset by such a rapid and prolonged decline in

equilibrium interest rates if fiscal policy had switched from restraint to stimulation. This problem is so severe, that at the outset,

we need to define fiscal stimulus as a fiscal policy that would

produce a Federal budget deficit even when labor and capital resources are fully employed. The current Federal budget deficit is

not stimulative as the deficit only exists due to the reduction of tax

receipts forthcoming from an economy seriously underutilizing its

resources.

Before we get to the question as to whether or not economic policy response might be the right course of action, I think it is important for us to look at the incoming data to see the nature of this

downturn.

First, as you can see by Chart 1, which actually is the last chart

in the packet, nonfarm payroll employment has declined in 24 of

the last 25 months to bring April employment as a percent of peak

employment to the lowest level of the recession.

Now many talk about the recession in the past tense. I do not

use that tactic because, to me, a recession is a period in which employment is declining. And as you look at this chart, you can see

that the employment is farther below the peak, 1.6 percent, than

it has been at any time since the recession began.

11

Labor markets continue to be weak. The weekly unemployment

claims numbers we had this morning once again showed that there

is no sign this employment recession has ended.

Although the decline in employment has only been 60 percent as

deep, and the decline in output only 70 percent as deep as in the

1981–1982 recession, as you can see in Chart 2, it is a record since

the 1930’s in regard to the length of the employment decline.

This is a capital goods downturn rather than a typical inventory

cycle. As depicted in Chart 3, the total index of industrial production has declined only 6.7 percent from its April 2003 peak, whereas the index of business equipment production stands 18.5 percent

below the peak month—indeed, this is a capital goods cycle.

Six months after the March 2001 employment peak economic activity was hammered by the September 11 terrorist attacks and

many, I think, believed that the bounce-back from that post-attack

doldrums amounted to a recovery. I do not agree.

Another misleading indicator of economic recovery emerged in

2002 as solid gains in labor productivity enabled output to expand

while employment and hours worked declined.

Second, I think it is important for us to have a clear understanding as to why and how the 1991–2000 expansion came to an

end. Was it simply that we had an unprecedented coincidence of

bad events, such as Y2K and an over-exuberant stock market or

was there an economic policy failure that was decisive?

Sometimes the makers of economic policy become convinced that

the best way to avoid an unwelcome event is to engage decisively

in a new economic plan. That is exactly what happened in the

1990’s when voices of alarm predicted a low savings rate in the

United States would result in an unsustainable increase in imports

in excess of exports until our indebtedness to the rest of the world

would produce a global economic collapse. The chosen remedy was

to pursue a large enough Federal budget surplus to offset deficient

private-sector saving.

It worked.

In the four quarters to the second quarter of 2000, individual income tax payments to the IRS rose exactly twice as fast as the

growth rate of personal income: 11.4 versus 5.7 percent.

The engine that had been driving our prosperity was an unprecedented capital goods boom that matched up with an unprecedented

surge in capital goods technology. Disposable personal income took

such a hit from the 11.4 percent increase in individual income tax

payments that there was simply not a sufficient increase in disposable income to enable households to buy what had been produced.

When I saw those second quarter at 2000 income tax receipts figures, I knew we would soon be in a recession.

In the turning point year 2000, a second-, third-, and fourthquarter slowdown in the growth of personal consumption expenditure coincided with a high rate of increase in capital good capacity

that the return on capital goods plummeted. While interest rates

on real capital were plunging in the second half of 2000, the FOMC

action in lowering the target Fed funds rate was not begun until

January 3, 2001. Even though the January 3 cut in the Fed funds

target was followed by an unprecedented stream of rate cuts

through the year 2001, it was not sufficient to have avoided an

12

employment recession. But without the FOMC’s unprecedented

actions, results would have been far worse.

Although a tax rate cut was proposed by President Bush in early

2001, its enactment came in a compromise form that distributed

nonincentive tax rebates in the third and fourth quarters of 2001

and implemented a phased-in tax rate reduction in fiscal years

2002, 2004, and 2006.

Even though the monetary policy and tax rate policy response

was far from ideal, it seems appropriate to credit the FOMC and

the Congress for alleviating the rate of decline in employment and

output. The half-scale tax remedy did not prevent a recession, but

it cushioned the recession’s rate of decline. And you can see that

in comparison to the 1981 events.

Now, I am going to skip most of the next section, but I am going

to point something out as clearly as I can, Mr. Chairman. And that

is, we all seem to understand that the growth of credit almost is

identical to the growth of dollar GDP.

What everyone seems to misunderstand in our double-entry

bookkeeping, the growth of credit is exactly the growth of debt. So

when people oppose the growth of debt, they are opposing the

growth of credit. To get our economy in a zero-inflation environment to grow at a 5 percent level, we must have a growth of credit

at the 5 percent level. If credit is going to grow at 5 percent, then

debt has to grow at 5 percent.

If the Federal Government does not want to be a player in the

growth of debt as a percentage of Federal borrowing keeping pace

with the necessity of the growth of debt in the economy as a percent of borrowing, then we force the growth of household borrowing

as a percentage of household debt to rise to unsustainable levels.

And the same happens in the business sector debt.

So if we have the Federal Government playing we are on strike

in regard to our increase in borrowing, then it is important to understand that that requires then household borrowing to increase

at a faster pace.

Now the only thing that saved us in this swing of the Federal

borrowing is the fact that the Federal Reserve maintained enough

liquidity to keep housing prices moving somewhat higher and the

low interest rates prompted a huge amount of refinancing, which

enabled us to take a lot of household debt and slide it under the

house. And that is why household debt was able to be increased as

rapidly as it has in the past. But no one needs to look to an increase in household debt to get this economy moving toward full

employment. It just is not going to happen.

Business debt that was growing at an 8 percent rate in 2002, the

growth of business debt was down to 2.8 percent.

So that ends the lesson in regard to the flow of funds data and

the relabelling of debt as something that is positive because debt

is the opposite of credit, and everyone knows we have to have more

credit.

Is the stimulus of Federal borrowing offset by a crowding-out effect on private borrowing? Or, to put it another way, does an increase in Federal borrowing put upward pressure on interest rates?

The answer to the first question is a clear no. Crowding out only

occurs when Government expenditures require resources to be

13

taken away from private goods production. A reduction in tax rates

increases incentives to invest and to produce more and does not

produce any crowding-out effect.

Now the answer to the second question is yes. An increase in

Federal borrowing will mean that interest rates will be somewhat

higher than if we did not have an increase in the borrowing. But

it is a far different matter to push the natural rate of interest up

to 1 percent than to push it up to 10 percent.

So it is important to understand that we could have a problem

with interest rates being too low, as well as a problem with interest

rates being too high. If interest rates are too low, the reward for

saving are too low to provide an adequate safe fixed income for people facing retirement or currently retired.

I think we need to identify that as a problem. If you think lowinterest rates are nice, you should want to move to Japan. But my

friends in Japan have experienced 12 very sad and painful years.

There is not likely to be any crowding-out effect from tax rate reductions. In the 1981–1982 recession, a tax rate cut worked to create jobs without any crowding-out effect. Now get this—the average

monthly employment gain was 367,000 per month in the 22nd,

23rd, and 24th months past the peak of employment in July 1981.

In contrast, the average monthly employment change in this recession in the same 22nd, 23rd, and 24th months was minus 87,000

per month after the March 2001 peak in employment. If economic

policy should be geared toward an increase in employment then the

1981–1982 model warrants emulation.

Is monetary policy likely to work in a deflationary environment?

Monetary policy always works as long as the target variable chosen

is countercyclical. The FOMC has the choice of selecting one of

three target variables.

I think maybe, Mr. Chairman, I will skip through that section.

But I do want to mention that persistent economic growth rates

below the growth rate of the labor force and the growth rate of capital goods capacity is a clear indication that the chosen target Fed

funds rate has been too high to accommodate the money-hoarding

preference of households and businesses. Selecting a lower target

Fed funds rate will require an increased injection of monetary

liquidity into the banking system.

The sixth question I want to consider is could monetary policy restore the desired price level and thus the desired economic growth

rate without changing tax rates?

The pragmatic answer is not likely in a capital goods contraction

as compared to a recession driven by an inventory correction. A

persistent failure of the price level and the growth of output and

employment to respond to significant cuts in the target Fed funds

rate is evidence of fiscal restraint. Whereas, inventory recessions

tend to be followed by a motive to increase production more than

the increase in sales, in order to reverse previous inventory

rundowns, capital goods recessions are not prone to such a predictable end. After a labor market has passed the ‘‘soft market’’ stage

to a stage where labor market uncertainty has a cumulative depressing effect on ‘‘lifetime income perceptions,’’ then monetary easing alone is likely to be transmitted only through disruption of

global exchange rates.

14

My advice is to choose a tax rate that is likely to increase the

expected economic growth rate of the United States to keep the

dollar strong and stable. Monetary policy alone runs a danger of

providing ‘‘beggar thy neighbor’’ remedy to domestic deflation. In

other words, the more than moderate 2003 decline in the exchange

value of the U.S. dollar against the Euro is likely simply to have

transferred deflationary pressures from the United States to Europe. This is less than acceptable economic policy leadership.

What tax proposals do I favor? The elimination of the double taxation of corporate income paid out in dividends is far better than

any other proposal as it reduces our highest effective tax rates. The

15 percent capital gains tax rate and a 15 percent dividend tax rate

still leaves a 44.75 percent combined tax rate.

Chairman Bunning, that to me seems way too high to have the

kind of capital goods market that we need and we cherish.

There is simply more bang for the buck in eliminating double

taxation as no other proposal will make common stock ownership

so much more attractive. Not only does it eliminate the pernicious

double taxation, but it also is likely to have the greatest effect in

modifying corporate executive branch behavior to perfectly align

the CEO’s interest with shareholder interest. Why would top management wish to distribute the fruits of their labor in any other

way than in paying dividends?

And the exclusion of qualified dividends from taxation will first

increase the dividend payout ratio, then it will alter the choice of

employed workers to reduce the amount of income deferred from

taxation into company retirement plans in favor of direct stock

ownership. And for retired workers it will encourage withdrawing

funds from the retirement programs, paying the income tax, and

then securing tax-free income. I am convinced that Federal tax receipts would increase between 2004 and 2010, as a result of the

elimination of double taxation.

Although it seems the Congress may choose a combination tax

rate of 15 percent for both capital gains and dividends, I continue

to prefer the original model presented by the President.

Reducing maximum noncorporate business tax rates to the 35

percent corporate rate is essential to provide an optimum increase

in jobs for American workers.

Thank you.

Senator BUNNING. Thank you, Mr. Angell.

Mr. Stuckert.

STATEMENT OF JAMES W. STUCKERT

CHAIRMAN AND CHIEF EXECUTIVE OFFICER

J.J.B. HILLIARD AND W.L. LYONS, INC.

Mr. STUCKERT. Mr. Chairman and Members of the Committee,

my name is James W. Stuckert and I am Chairman and CEO of

Hilliard Lyons, based in the beautiful Bluegrass State of Kentucky.

Hilliard Lyons is a full-service investment firm with one goal: To

help individuals reach their investment objectives. Since investment counseling is our only business, increasing investment in the

equity markets is vital to us. I am also Chairman of the Security

Industry Association’s, SIA, Regional Firms Committee, which represents the interests of regional-firm members. I thank the ChairVerDate 11-MAY-2000 09:07 Apr 21, 2004 Jkt 000000 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 93128.TXT SBANK4 PsN: SBANK4
15

man and the Committee for the opportunity to present my views

on how to jumpstart the economy and increase investment in the

equity markets.

Established in 1854, Hilliard Lyons is a member firm of the New

York, American, and Chicago stock exchanges, National Association

of Securities Dealers, and Securities Investors Protection Corporation. The firm offers one-on-one advice about stocks, bonds, options,

retirement plans, money market funds, mutual funds, trust and estate planning, and investment management. We also research the

investment potential of various companies and industries and we

underwrite bonds for public improvements such as schools and

highways, obviously, better known as municipals. Hilliard Lyons, a

PNC Advisors company, has 550 financial consultants in 85

branches in Arkansas, Georgia, Illinois, Indiana, Kentucky, Michigan, Mississippi, North Carolina, Ohio, South Carolina, Tennessee,

Virginia, and West Virginia.

Over the past 25 years, the securities industry has faced and has

overcome many challenges. And these include processing everincreasing volumes of trades, converting to a shorter settlement

period, the development of many new investment vehicles, the

globalization of markets, and a terrorist attack that affected our financial systems like no other seen in our time. While the transition

to an era of fear and uncertainty is not a future we would have

chosen for our country, that is the reality that faces us today. With

a pragmatism that is uniquely American, we have tackled these

new realities head-on and have done everything feasible to mitigate

loss and confusion. Regaining the public’s trust and confidence in

the greatest capital markets in the world is critical to jumpstarting

our economy.

One of the most important things we can do to restore confidence

is to get the economy and markets rolling again. Indeed, as the

markets go, so goes public trust and confidence. The monthly UBS/

Gallup Index of Investor Optimism hit an all-time low of just 5

points in March 2003, but it surged 61 points in April, just as the

markets began creeping upward. That increase presented the largest one-month jump in the Index’s history, which started in 1996.

Some of the increase in confidence may be due to the tough new

regulations, protections, and sanctions mandated by the SarbanesOxley Act. We are, however, unlikely to see a sustained restoration

of investor confidence, investment, or economic growth, however,

unless we as an industry continue to put the customer first.

Congress can also help boost the economy and the markets by

passing President Bush’s jobs and growth package. The elimination

of the double tax on dividend income—the centerpiece of the plan—

would enhance the long-term growth potential of the U.S. economy,

promote job creation and higher wage growth, strengthen corporate

governance, and put the United States on a much more equal footing with our major trading partners.

Current tax policy encourages corporations to rely too heavily on

debt rather than equity financing because interest is deductible,

while dividends are not. The bias favoring debt over equity financing, for example, led many companies to take on high levels of debt

that left them vulnerable to the economic downturn. The President’s proposal would improve the performance of our economy by

16

relieving numerous distortions caused by the current corporate tax

regime, including the income tax code’s general bias against savings and investment.

The President’s economic package has undergone many revisions

as it has worked its way through the legislative process, and even

today, a new version of the package is being discussed. Even so, the

best route to renewed economic vitality is the complete elimination

of the double taxation on dividends.

Ending the double taxation of dividends would help move our tax

system to one that taxes income only once. This, in turn, promotes

savings and investment, increased capital formation, job creation,

and economic expansion. The increased economic activity would

generate additional tax revenues that could offset a significant portion of the tax revenues foregone by the proposal.

The immediate impact of eliminating the tax on dividends would

be an annual tax savings of approximately $30 billion, or 0.3 percent of our current GDP. This savings would be distributed broadly

and shared by the more than 50 percent of U.S. households that

own stock. Moreover, in the case of the tax cut on dividends, there

are additional factors that would help boost the economy in the

long run. Because the after-tax value of dividends would increase,

investments in stocks would become more attractive. It has been

estimated that the value of the equity market would increase by as

much as 5 to 10 percent. And this increase in equity values would

provide further economic stimulus through the wealth effect, for

example, people spend more as their net worth increases. It is

no accident that a rising stock market is a leading indicator of

economic growth.

The initial approximately $30 billion in tax savings is actually a

very conservative estimate because it assumes no change in the

current dividend policies of U.S. companies. But it is likely that

even more companies would issue dividends. Now that a tax cut on

dividends has been proposed, companies that have previously retained large amounts of cash have said they may distribute some

of that cash to shareholders.

As useful as a tax cut on dividends would be in reviving the current sluggish economy, the main benefits would be long-term. The

double taxation of corporate earnings reduces companies’ return on

capital and therefore increases the cost of capital. Lowering the

cost of capital by eliminating taxes on dividends would encourage

companies to invest more in plants, equipment, and other capital

stock, enhancing long-term growth and leading to more jobs and

higher wages.

Importantly, eliminating the double tax on equity-financed investments would bring U.S. tax policy more in line with our major

trading partners. With the exception of only the United States, all

G7 countries provide protection against the double tax on dividends. In addition, the United States has the second highest dividend tax rate among the 30 OECD nations. Twenty-seven of the 30

OECD countries have adopted one or more ways of alleviating the

double tax. Whether competing at home or abroad, the double tax

makes it more difficult for a U.S. company to compete successfully

against a foreign competitor.

17

According to the most recent IRS data, 34.1 million tax returns—

or 26.4 percent of total tax returns, representing 71 million people—reported some dividend income in the year 2000. Of all taxpayers that claimed some dividend income in 2000, nearly half—

45.8 percent—earned less than $50,000 in adjusted gross income,

including dividends. This proposal would also benefit more than

13.1 million small-business owners or self-employed taxpayers. Importantly, almost half of all savings from the dividend exclusion

would go to taxpayers 65 and older, thereby giving retirees an additional reliable, long-term source of income to supplement their

Social Security earnings and other retirement savings. Also, it is

estimated that the average annual tax savings for the 9.8 million

seniors receiving dividends would be $936.

Perhaps the greatest long-term benefit from the elimination of

the double taxation of dividends would be the incentives for companies to return to the principles of sound financial management.

With half of American families invested in the stock market, nothing is more important to the securities industry than restoring the

public’s trust in the strongest capital markets in the world. While

we cannot blame the bubble of the late 1990’s and its painful aftermath on the tax system, the current system did little to reign in

the excesses and in some cases contributed to them. From the

standpoint of both shareholders and the health of our economy,

companies should be encouraged to concentrate on real earnings.

In that vein, encouraging companies to pay dividends would limit

excesses because dividends offer proof of real profits. The payment

of dividends by a company may give investors a strong signal of the

company’s underlying financial health and profitability. Indeed, a

firm cannot pay dividends for any length of time unless the company has the earnings to support such payments. In an environment where reported earnings are viewed with some skepticism,

cash dividends will bolster the credibility of earnings reports. Moreover, the payment of dividends would better align the interests of

shareholders and managers by allowing shareholders to participate

in decisions regarding corporate investment. Finally, because dividends serve as a stronger foundation for long-term value, companies that pay them will have fewer motives to artificially inflate

profits just to cause temporary increases in stock prices.

SIA correctly forecast the sub-par performance of the U.S. economy in the first quarter of 2003, as well as the further weakening

in the current quarter. The depth and length of the downturn is

uncertain, and will be determined by several interrelated variables.

Among them are the expense of the reconstruction in Iraq, the direction of oil prices, how quickly consumer and investor sentiment

rebounds, and whether the recent resumption of growth in business

fixed investment will continue.

The SIA’s view is that it is critical that we focus on stimulating

business fixed investment, which contradicted traditional recessionary patterns by leading the economy into a downturn while

consumption remained relatively strong. In this vein, not all fiscal

stimuli are created equal, and the tax measures that are focused

on investment are much more important than those that provide

a short-term, transient boost to consumption. President Bush has

focused on the dividend proposal as key to job creation. Capital forVerDate 11-MAY-2000 09:07 Apr 21, 2004 Jkt 000000 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 93128.TXT SBANK4 PsN: SBANK4
18

mation, spending on machinery and equipment, and plant and facilities will stimulate job creation more than spurring incremental

consumption.

Mr. Chairman, I commend you for holding a hearing to review

the economic situation on how to jumpstart the equity markets.

Our number one goal is regaining the public’s trust and confidence

in our industry and our capital markets, and we are doing everything we can to ensure that our customers’ interests always come

first. Sound economic policy, as embodied in the President’s jobs

and growth package, is also critical to reinvigorating our economy.

I urge Congress to pass it quickly.

Thank you.

Senator BUNNING. Thank you, Mr. Stuckert.

Mr. Zandi.

STATEMENT OF MARK ZANDI

CHIEF ECONOMIST AND CO-FOUNDER

ECONOMY.COM

Mr. ZANDI. Thank you, Mr. Chairman.

I have prepared remarks that mostly center on the dividend tax

proposal. They seem a little less relevant today compared to yesterday, since it looks like we are going to get an agreement. So what

I thought I would do, if you think this is a good idea, I will just

introduce myself. I have that written down here. And then I will

just make five points that I think are important in regard to this.

Senator BUNNING. That’s fine.

Mr. ZANDI. Good. My name is Mark Zandi. I am Chief Economist

and Co-Founder of Economy.com.

Economy.com is an independent provider of economic, financial,

country, and industry research designed to meet the diverse planning and information needs of businesses, governments, and professional investors worldwide.

My marketing guy actually wrote this.

[Laughter.]

Senator BUNNING. That’s all right.

Mr. ZANDI. It doesn’t go off my tongue as quickly as it probably

should.

We have over 500 clients in 50 countries, including the largest

commercial and investment banks, insurance companies, financial

services firms, mutual funds, manufacturers, utilities, industrial

and technology clients, and governments at all levels. In fact, the

State of Kentucky is a very good client. We provide them the economic inputs that drive their revenue projections, although we are

not responsible for their budget problems.

Senator BUNNING. Shortfall?

Mr. ZANDI. Yes.

[Laughter.]

We have it right. Economy.com was founded in 1990, and we are

an employee-owned corporation. We are headquartered in West

Chester, Pennsylvania, a suburb of Philadelphia. We also have an

office in London and one in Sydney, Australia.

Let me make five points.

First, the economy is struggling. I think it is on the precipice of

recession, if it is not already in recession.

19

Mr. Angell made a good case that it has never left recession. Not

only is the economy’s problems long-lived, but also they are very

broad-based.

If you look across industries, these are industries that are laying

off workers. All of manufacturing, from aerospace to vehicle manufacturing, commercial construction, wholesaling, distribution, retailing, investment banking, and now State governments are laying

off as well. They have only done that three times since the Great

Depression, and this is one of those times.

The problems are evident across the country, from coast-to-coast.

I am just going to name some big economies from east-to-west that

I think are still in recession by any metric. I do not think there

is much debate. Boston and New York City in the Northeast; Atlanta and Dallas in the South; Detroit and St. Louis in the Midwest; Denver, the Bay Area of California, and Seattle in the West.

All are in very severe, deep recessions. No sign of any let-up.

Interestingly enough, just for your own personal interest, Kentucky is struggling, but it is held up quite well relative to most

other economies. It has performed much, much better than I would

say most of the State economies across the country.

Senator BUNNING. Small business.

Mr. ZANDI. Small business, they certainly have been hurt very

badly, yes.

Senator BUNNING. No, but that is the reason it is held up.

Mr. ZANDI. Yes, that is a very good point. Actually, most of the

difficulties in our economy, interestingly enough, have been at

large companies, large, big, publicly traded companies, I think for

various reasons. Small businesses have struggled, but they have

actually held up, you are right, a lot better than most.

Senator BUNNING. Lay-offs have not been as big.

Mr. ZANDI. Yes. The second point is that I do think that the economy is poised to grow. I do think that the excesses borne of the

stock market bubble around Y2K have largely been worked off.

There was significant investment, excess investment in information technology. I think businesses have done a very good job of

getting that back in line. In part, it is just due to the rapid pace

of technology.

The average economic life of a piece of IT equipment is a little

less than 4 years. For computer hardware and software, it is a little less than 2 years. If you just think back, most of that investment was done more than 2 years ago and now the economic life

of the stuff is evaporating. And if businesses want to maintain

their productivity gains that they have worked so hard to garner,

they are going to have to start investing pretty soon.

We have started to see some pick-up in investment. Computer

hardware and software investment has actually risen over the past

year, modestly, but it has risen.

So, I do think that we are poised for growth. I think that our

main problem now is a lack of confidence; and even on that front,

I feel a little bit better, post-Iraq.

Confidence has improved. Consumer confidence has rebounded.

The financial markets have seen a rather dramatic improvement.

Equity prices are up 15 percent from their March nadir.

20

Even more importantly, the corporate bond market has enjoyed

a very powerful rally. Spreads between corporate yields and Treasury bills have narrowed dramatically. That is a very good measure

of the angst of investors. The narrowing in spreads have been most

substantive in the lowest quality corporate bonds, junk bonds. And

that is indicative of a rather sharp improvement in confidence.

Business confidence as well has improved. We have a survey that

we conduct off of one of our websites of businesses across the country in many industries, in many different parts of the country, and

that has improved dramatically since its low a couple of months

ago. So, I think we are poised for growth.

Now having said that, my third point is that I think that fiscal

stimulus is definitely needed. And I agree with you. I think the bigger, the better.

I think we are at a very fragile point and if things do not go

exactly as scripted, we are going to have a big problem. Monetary

policy, regardless of what the monetary theories are saying, is now

treading in waters that they have never tread before, and it is

going to create a great deal of—so far, everything is working. And

the comments that the Chairman made a couple of weeks ago

worked their magic. But I am not sure how many times he will be

able to do that if the economy does not soon turn the corner. Again,

I think the economy is at a very fragile point. Nothing can go

wrong here.

Fiscal stimulus is very important. I would have much rather seen a much larger tax package myself. But I think a $350 billion

tax package is a reasonable attempt. I think the potpourri of tax

cuts that were included were a reasonably good effort at trying to

get the economy going. All I can say is I hope it gets passed quickly

and that stimulus is provided very quickly to the economy.

Now let me say something about the elements of the package.

And this goes to my fourth point.

I personally think eliminating, as in the case of this package,

scaling back the dividend taxation is neither here nor there for the

economy in the near-term. It is not going to provide stimulus to

this economy this year, or even next. And unfortunately, because

of the sunset provisions, I think that reduces the efficacy in the

long-run as well.

We are talking about investor confidence. How can investors

have any confidence about values if they do not know what the tax

policy is going to be?

Now everyone says, well, there is a very high probability that

these sunset provisions will get the dividend tax extended long into

the future. But investors just cannot attach 100 percent probability

to it, particularly because they know we are running very large

budget deficits. At some point, that is going to be a problem. And

it may just very well be the case that that problem will become

most evident when one of those sunset provisions are expiring.

I think the sunset provisions significantly reduces the efficacy of

any benefit. I think the benefit, even if it were completely eliminated with no sunset provisions, is minor.

The value of eliminating dividend taxation completely is equal to

the present value of the future stream of tax savings. Simple calculation—apply a reasonable discount rate. At most, you get 10

21

percent pop to the market. No, I think 10 percent is great, but it

is down 40 percent, as you pointed out, from its peak. Now, I am

not sure that investors really believe that even a 10 percent pop

would change behavior very quickly. So, I am very skeptical that

dividend tax reduction would do anything for the economy nearterm. And as structured, because of the sunset provisions and other

aspects of it, I am very skeptical that it is going to do anything for

the economy longer-run, either. I think that is one part of the legislation that is—there is no downside to it, but it is neither here, nor

there for the economy, long-run or short-run.

Then, finally, let me end with this.

Here are a couple of things that I think you should do very

quickly. First, you should extend unemployment insurance benefits.

The Federal program is expiring at the end of the month. That

would be a huge mistake not to extend that one more time.

The pain in the labor market is very significant. The length and

duration of unemployment is now 20 weeks. It is now longer than

it was in the 1991 recession. You have a lot of very, very distressed

households. Personal bankruptcy filings are at a record high and

rising very rapidly. Delinquency rates on credit cards are at record

highs. Mortgage foreclosure rates are at record highs. Auto delinquency and repossession rates are at record highs.

If that is not extended, that would severely exacerbate credit

quality problems and may induce a contraction in consumer spending, and that is exactly what we do not need at this point.

Another thing I would do, and this is where I disagree with you.

I think aid to State governments is vitally necessary. I think the

contraction that will occur because of State government cuts that

we are seeing now in jobs and programs and now tax increases, is

going to significantly offset the economic benefit that you are now

providing to the economy through these tax cuts, through the Federal fiscal stimulus.

I really do not see the downside to it, and I do not bind to the

arguments that State governments overdid it in the boom times. If

you look at State government spending as a share of GDP, it is no

higher today than it was 30 years ago. If you look at State government employment as a share of total employment, it is lower today

than it was 30 years ago. Government is no bigger, State government is no bigger than it was.

Then, moreover, the arguments that there is a moral hazard

problem I think are specious. The idea being that if you help States

out today, that they will get into a bigger trouble down the road,

I think that that is a rather minor issue.

And frankly, in times of crises, we have always looked aside regarding moral hazard problems. We did that with Korea. We did

that with Mexico. What is wrong with doing that with California,

Kentucky, and Massachusetts?

So, I really do not see that argument at all. I think providing a

check to a State government today would be a tremendous boost to

the economy precisely because those programs are in place. The

monies would go to the people who need it most very, very rapidly.

Finally, let me end with this. Another thing that we should think

about, we are all focused on lowering the cost of capital. But in the

same breath, we are all talking about jobs. We want to promote

22

jobs, right? We want to get the economy to create jobs. Well, how

do you do that? You lower the cost of labor. And what are the most

important costs to businesses with respect to labor? Health care

costs and pension costs.

My health care premiums for my employees is rising at a doubledigit pace and it has been doing that for 3 years. Frankly, it is getting to be a very significant problem. And the real problem is there

is no end in sight. If I do a calculation of the health care costs that

I am going to face as a small business owner, it is prohibitive because I do not see any end to 10 percent, 15 percent health care

premium increases for the next 10 to 15 years. As a result, you add

that up. That is a very significant cost to businesses, particularly

small businesses who are struggling to shoulder these health care

benefit costs.

So, I think it is critical, vital that Congress quickly begins to address this more carefully because this is going to be a very significant problem. And frankly, I think that is one of the key reasons

why businesses are more likely to invest in a piece of computer

equipment, software or telecom equipment before they invest in a

person. So even when the economy does improve, it will take a long

time before we see any significant improvement in job creation.

Thank you.

Senator BUNNING. Thank you, Mr. Zandi.

First of all, thank you all very much for being here.

On accelerated tax depreciation, there is a 50 percent bonus depreciation for property acquired between May 1, 2003 and January

1, 2005. That is about 20 months. That is from May to December

2003 and all of 2004.

Small business expensing, we now have a $25,000 investment ex- pensing. That is increased to $100,000 for 2003, 2004, and 2005.

Capital gains and dividend—unfortunately, we did not do what

the Senate did. We did what the House did. So, we have a 15/5 capital gains tax rate, and that applies only after sales of May 6, 2003,

and it sunsets the end of 2009. The dividend treatment is the same

as the House bill, where it is 5 and 15. It applies to dividends from

domestic corporations and certain foreign corporations. And that

also sunsets in the year 2009.

Now let me get to some questions. That is just a rundown that

my staff gave me out of the meeting that the President just had

with those who are going to pass the bill tomorrow.

Governor Angell, you and I have agreed on a lot of things. But

what do you believe will happen if we would not pass the stimulus

package?

Mr. ANGELL. Mr. Chairman, I believe that not passing this stimulus package runs the risk of some very bad things happening.

Number one, we are going to go for a long, long time before we

increase output at a rate in excess of the growth of labor productivity and, consequently, the jobless recovery can go on and on and

on, wasting precious resources. To me, that is the biggest waste we

can ever have, is to not have the opportunity for people that would

like to have jobs, have jobs.

Our entire educational system is adversely impacted when students do not see graduates able to use their studies and to develop

the kind of income that they would like to have.

23

The second very bad risk is a risk to U.S. global economic leadership. We have done a great thing in terms of formulating trade

policies that leave us with almost a perfect capital competitive

market. That is, real capital goods globally are very, very integrated. But fluctuating exchange rates can play havoc on what occurs. I just do not like to see the United States, who is in a better

position to ward off deflation than any other countries, using this

beggar-thy-neighbor policy of a lower exchange value for the dollar.

So, I strongly dislike the risk we are currently taking and I am

not in agreement with the U.S. Treasury’s position today.

Senator BUNNING. Talking down the dollar.

Mr. ANGELL. No. I just think that turns back—when I was a

Member of the Board of Governors of the Federal Reserve System,

we had a little bout of that when someone in the Administration

thought that we could sell more cars if somehow or other we could

get the dollar’s value to go down. And for a country that relies

upon the entire world’s willingness to invest in our country, that

is a very risky affair.

I advise central banks in Asia, monetary authorities in Singapore

and Hong Kong. And when I am there, the one question they want

to ask is should we maintain a high concentration in U.S. dollars?

Now when I was going over there as a member of the Bear,

Stearns team, I was able to tell them, yes, you should. But today,

I wouldn’t be able to provide that kind of message.

So, to me, it is a very risky affair for world economic power with

world economic leadership to be relying so heavily on interest rate

reductions. Mr. Zandi can talk all he wants to about the higher interest rates. The fact of the matter is that interest rates are going

to go lower, not higher. But these low interest rates, without the

promise of a tax bill that will promote U.S. economic growth, and

thereby, the rate of return on capital will rise, the dollar could be

in significant trouble. And that is a huge, huge risk, not for just

us, but for the entire global economy.

Senator BUNNING. We are going to pass the bill. I just wanted

you to give me your opinion.

Mr. ANGELL. Well, I am pleased you are going to pass it.

Senator BUNNING. We have bought enough votes to do that.

Mr. ANGELL. Okay.

[Laughter.]

Senator BUNNING. We have at least 51. We may have 52.

Mr. Stuckert, just because you left Louisville, did not mean that

you thought that you were going to get out of the rain. You brought

it with you from Kentucky.

[Laughter.]

Mr. STUCKERT. You are right.

[Laughter.]

Senator BUNNING. In your testimony, you talked extensively

about the President’s dividend proposal. Now that you know some

of the other factors that are in the proposal, would you like to comment on them?

Mr. STUCKERT. Well, I certainly share your comments earlier,

Senator Bunning, relative to the fact that there is some tax on the

dividends that you prefer not be there.

24

I am pleased that it will last until the end of the year 2009, and

15 percent being the maximum, should generate some people buying the dividend-paying stocks, of course. And hopefully, those particular companies, their cost of capital will be reduced.

I personally think, as we try to consult with individuals, that the

total tax policy of the United States of America has been against

investment and against savings.

It always appalls me that when we try to guide individuals in

their financial well-being for retirement plans and all, there is no—

with the exception of a little bit of an expanded IRA, which is not

really going to be enough to attract major monies for retirement—

people feel that they have been put upon by the fact that they have

to pay a lot of taxes, number one, on their income; and in turn,

when they invest into anything, they have to pay taxes again, not

only to the Federal Government, but also the State.

That is obviously why the 401(k) plans have grown dramatically,

because those are tax-free until they are taken out.

Actually, the dividend and the capital gains, I think that anything that aids investments and savings in particular for individuals, the Federal Government cannot take care of everybody.

At some point, taxation policy has to be such that it is very easy

for the baby boomers—maybe it is too late for them—but the Gen

Xers and all the rest of them, somebody has to sit down and say,

this is a good deal for me. I will start saving money and not be

penalized for doing so, and have the dividends and the interest

that I am receiving from my savings be just taxed away from me.

So if this is the beginning, I just think it is a wonderful start.

I think that, overall, our American economy is at a disadvantage

vis-a`-vis the G7, the OECD countries. These people have, relatively

speaking, no double taxation on dividends.

I think that the elimination of the tax on dividends down to 15

percent will probably help corporations pay monies out to the

stockholders and then they in turn will spend it in the best interests of their particular likes and dislikes. I just think that that will

help. That is something to me that will revive confidence and revive the American economy in the process.

Senator BUNNING. Do you realize that the last time we lowered

capital gains rates from 28 to 20, that the first year we did that,

we had a spike of $75 billion in revenue. We finally have gotten

the CBO and the OMB to score a reduction in the capital gains

rate as a positive rather than a negative.

We used to have a terrible time with the OMB and the CBO trying to get that scored positive. Over 10 years, it kind of is a wash

now, because people usually make that capital gains sale in the

first or second year of a situation where they do have—not too

many people have capital gains, and that is a big problem. But at

least some do. And this will stimulate, in my opinion, some portion

of the economy by creating new dollars to spend on other things.

Mr. Zandi, you were quoted in The Wall Street Journal by Alan

Murray on January 28, 2003, saying: ‘‘A necessary condition for

any improvement in the economy is getting Iraq behind us. It

would be nice to get both, an end-of-the-war related uncertainty

and a stimulus package. But the first is the most important.’’

Well, do you consider the war with Iraq behind us?

25

Mr. ZANDI. Oh, yes. And it was very successful.

Senator BUNNING. Okay. The next in line is a stimulus package.

You have heard the broad outlines of the stimulus package. Do

you think that this is going to be a stimulus, or do you think that

it is not? By the way, I want you all to know that in the Senate

budget resolution, we put in the ability to front-load any kind of

a reconciliation package by $190 billion in the first 2 years. And

that is the reason that we have been able to construct this package

for job growth the way it is constructed.

If we hadn’t had that in there, it would have been pushed back over a 10-year period. If you do $190 billion in the first 2 years,

that is a lot better, and have the $160 billion over the next 8

years——

Mr. ZANDI. I think the stimulus package is very positive, and it

was a very good effort. It is a hodgepodge of different things. But

I think when you add it all up, in totality, it will help. I am very

happy that it passed as quickly as it did.

I would have been hopeful that it would have been passed a little

bit quicker, but I think the war got in the way of that. Everyone

was busy with lots of other things.

But I think policymakers have done a great job here. I think it

will be very helpful.

Now let me say this. I wouldn’t stop here.

Senator BUNNING. No, we are currently working on an international bill, also.

Mr. ZANDI. Yes. I do think that the economy is still very fragile,

and nothing can go wrong. Everything has to go well. We need a

little bit of luck in addition to the end of the war and the stimulus

package to get through this without finding ourselves in some difficult straits.

Senator BUNNING. By the way, on the unemployment benefits

that you suggested, we are working very hard to get either a 13-

week or a 26-week addition before they expire.

Mr. ZANDI. That is great. And let me say one more thing about

the stimulus package.

It is not so much the dollars and cents that matter. They do matter. I do not mean to downplay that. But what matters perhaps

even more is the sense among business people and consumers that

you are working hard at trying to do something, that you recognize

that the economy is a problem.

Even if people have jobs, they are hanging on. Many are just

hanging on—part-time jobs, self-employed because they have no

other options. They are stepping out of the labor force altogether

because there is just nothing suitable.

Just the mere fact that you are working hard and discussing and

debating these things I think is very valuable.

I wouldn’t let the debate and discussion end here. I think I would

start talking about what is next, because all of us economists are

all sitting here telling you, we are poised for growth. But, frankly,

it is faith-based forecasting at its best.

All the data—I cannot point to a statistic that will say, proof

positive that that is going to happen. We could all be dead wrong,

and of course, we have been dead wrong in the past. So, I think

I would be——

26

Senator BUNNING. The big thing I want you all to know, and Mr.

Angell knows this probably better than most, is that the employment numbers always lag by about 6 to 9 months. But we have to

see some upswing shortly, or we have to level off on the loss of jobs

before we can start gaining jobs. The numbers usually in any kind

of recessionary period or downturn, the last thing we see positive

is job growth. We have to get some of that ready to go before we

can see the unemployment numbers, instead of growing at 61⁄4 or

6.1, we have to see and do things that are necessary to be done.

One other thing you brought up and I want to talk to you a little bit about sending $20 billion to the States.

There is a law in Kentucky, whether you know it or not——

Mr. ZANDI. I did not know it.

Senator BUNNING. —that limits employment by State government. It is a law, at 33,000 employees. They have 38,500 employees

in State government. If they just did it by attrition, we wouldn’t

be in the pickle we are in in Kentucky. And we are not in a big

one like some others are. We wouldn’t be spending more than we

take in.

Now all the States are having that problem. But for the Federal

Government to hand out checks and think that we are going to continue to hand out checks to offset their shortfalls is not, in my

opinion, a good policy to get into, because we cannot do it next year

or the following year.

And so, they are going to have to look at their internal problems,

particularly their Medicaid problems. Kentucky has 42 different

participations in Medicaid. They are only required to do 15. Those

are the mandated programs. Our Medicaid shortfall in Kentucky is

horrendous, comparatively speaking. And I think other States are

very similarly disposed.

Mr. Angell, I want to ask you a loaded question. If you were the

Fed Chairman, what would you have done differently with the

monetary policy of this great country?

Mr. ANGELL. Well, Mr. Chairman, first of all, before I answer the

question, I want you to know that, in my opinion, Chairman Greenspan has been an inordinate help to this country because I know

central bankers all over the world. And I know that even though

Alan did not act as fast as I would have preferred he acted in the

last half of 2000, what he did and what he stayed with was far better than any other central banker that I know about.

Senator BUNNING. I won’t dispute that. I agree with that.

Mr. ANGELL. So my view, which has been predominated by an

index of core commodity prices, has never failed me in terms of indicating whether monetary policy is tight or easy.

This view for me suggests that monetary policy has been a lot

tighter over this last 18 months that the Fed has been pleading its

case that it is accommodative.

I always become very uncomfortable when a central bank evaluates itself and says, we want you to know that we have a policy

that is accommodative. In my experience, central banks that say

they are accommodative generally are not. I listened to the central

bank of Japan say that for 8 of the last 12 years, they finally gave

up even trying to say that, and the central bank in Japan is still

too tight.

27

The Japanese central bank must tell the Japanese people what

they want the exchange value of the yen dollar to be at the end

of 2006. And they have not been willing to do that.

So, I am a hawk on inflation. I proved that during my voting

years at the Board of Governors. But I am also a hawk against deflation. And recognizing this deflation risk is something that I

think was sorely needed.

I give Alan Greenspan great praise for his decision to indicate

that there is a great risk of deflation, disinflation being too steep,

than the risk of inflation. And because of that, we have had a

movement upward in 10-year Treasury bond prices and 5-year

Treasuries and 2-year Treasuries and that is doing us a lot of good.

Senator BUNNING. The market is reflecting that in the return

on those.

Mr. ANGELL. Yes. Now, Mr. Chairman, you did not ask me for

a forecast, but I will give you one, anyway.

[Laughter.]

Senator BUNNING. Okay.

Mr. ANGELL. If this equity market does not indicate that it really

is a bona fide, recognizable bull market by the time of the June 25

and 26 FOMC meeting, I think the FOMC will undoubtedly take

the correct step of lowering the target Fed funds rate.

Senator BUNNING. I do, too. By 50 basis points.

Mr. ANGELL. I hope by 50 basis points. What many do not understand is that the demand for money is such that lowering the target Fed funds rate by 50 basis points will require a tremendous

quantitative injection of reserves. I like that on all accords, except

I would like it a lot better if the Treasury Secretary was being

more committed to a strong dollar.

Senator BUNNING. Sometimes we can overcome what Secretaries

of Treasury say. We did it, if you remember correctly, when Secretary Baker tried to talk down the dollar during his tenure as the

Treasury Secretary, and we were able to overcome that. And I

think we can overcome whatever anybody says by action. This

stimulus package will, in my opinion, overcome our Secretary of

the Treasury’s misstatements about the dollar and the value of the

dollar in regards to other currencies.

Mr. ANGELL. Mr. Chairman, I commend you for your optimism.

I share that kind of optimism. I appreciate particularly the work

that many of you have done in regard to achieving the results of

this tax cut package that you have now achieved.

Senator BUNNING. Last, but not least, Mr. Zandi. You mentioned

your problem with medical and furnishing insurance. It is a big

problem not only you have, but also it is across the board in every

company and every corporation.

What do you think about the proposals that are before the Congress on medical liability and the correction that we would like to

see in that regard?

Mr. ZANDI. You are referring to the liability caps?

Senator BUNNING. I am referring to the ability to control in some

manner the cost of medical liability.

Mr. ZANDI. I think that needs to be addressed. I think that is a

big part——

28

Senator BUNNING. There is one that has already passed the

House. The Senate has not acted. And I am just wondering how

you feel.

Mr. ZANDI. I do think that the accelerating cost of medical liability is a large contributing factor to the rapid rise in health care

costs, and obviously, health care premiums that businesses and all

of us are paying. Therefore, I think that that is a place where Government can step in and should work to try to limit those costs.

Senator BUNNING. Gentlemen, I thank you all for your testimony.

This hearing is adjourned.

Mr. ZANDI. Thank you.

Mr. ANGELL. Thank you.

Mr. STUCKERT. Thank you.

[Whereupon, at 11:50 a.m., the hearing was adjourned.]

[Prepared statements submitted for the record follow:]

29

PREPARED STATEMENT OF SENATOR JIM BUNNING

I would like to welcome Senator Schumer and all of my colleagues to the first

hearing of the Economic Policy Subcommittee of the 108th Congress. I would also

like to thank all of our witnesses for testifying today.

Today, we have the first of a series of hearings titled; ‘‘Jumpstarting the Economy.’’ I am very concerned with the state of our economy. I am very worried about

the possibility of a double-dip recession. I know that puts me at odds with more

optimistic economic experts, like Chairman Greenspan, but we have disagreed before. We are not growing like we can, and we are not creating jobs. There are many

reasons for this.

I believe Chairman Greenspan acted way to slow to cut rates back in early 2001.

He should have cut them in the fall of 2000. The corporate governance scandals

have hurt trust in the markets. Sarbanes-Oxley and other actions have helped, but

it will take a long time for corporate America to rebuild that trust. September 11

had a devastating effect on our economy. The two wars we have had since then have

also not helped.

The reason why most of these events have been so harmful to this economy is

because they have created uncertainty in our markets. If there is one thing that

shakes the markets, it is uncertainty. I am hopeful that our witnesses today will

help us find a way to bring some certainty back to our markets.

Since the height of the bull market in March 2000, the stock markets’ market

value has been reduced by about $8.5 trillion. At the market’s high back in early

2000, the market cap of the Wilshire 5000 totaled $17 trillion. By the time of the

market’s low in early October, the Index’s market cap had shrunk by about half that

amount, or about $8.5 trillion. We have a $10 trillion economy. We have had stock

losses of $8.5 trillion in 3 years. It is not surprising that investors are skittish.

Therefore, if we are going to grow this economy, we have to get people investing

again. We need to create capital so businesses have the ability to invest and grow.

Before we adjourn for Memorial Day, we will be voting on a growth package. I think

it is crucial that we send a package to the President for his signature. I wish the

package was bigger, I hope $350 billion is enough to move a $10 trillion economy.

But we must make this start. We must create jobs and we must make sure our

economy grows.

We must bring some certainty back to the markets if we are ever going to grow

this economy and prevent a double-dip.

Once again, I thank all of our witnesses for testifying today.

—————

PREPARED STATEMENT OF PETER R. FISHER

UNDER SECRETARY FOR DOMESTIC FINANCE

OFFICE OF PUBLIC AFFAIRS

U.S. DEPARTMENT OF THE TREASURY

MAY 22, 2003

Chairman Bunning, Ranking Member Schumer, and Members of this Subcommittee, I am pleased you have chosen to hold this hearing on a top economic

priority for our Nation, both now and for decades to come: Increasing investment.

For the immediate future, our challenge is to rebuild business appetite for taking

risks on the future and thus for creating jobs. Looking farther into the 21st Century,

a major challenge for our society is to pay for the collective retirements of my generation and those that follow, while keeping commitments to current retirees and

those near retirement. Over both horizons, the central task for Government and for

the private sector is boosting savings and investment. First, Government must

examine and remove legal and regulatory obstructions to savings and investment.

The President has focused our attention on the need to reduce the biases against

equity investment. Second, to bolster investor confidence, shareholders should demand and firms should do a better job of disclosing their key indicators of business

and financial performance and prospects—the ones they actually use in managing

their businesses.

Our key macroeconomic challenge today is to face the aftermath of the extraordinary events of the 1990’s. Federal Reserve monetary policy, global economic integration, and telecommunications advances combined to fuel real prosperity and

higher productivity, but investors’ overestimation of their impact contributed to a

stock market bubble. We continue to live with the consequences of these events and

the destruction of trillions in household wealth as the bubble burst.

30

Business investment began slowing in 2000, causing demand for labor to soften.

Let’s be clear where jobs come from. New jobs come from investment—the willingness of investors and entrepreneurs to put capital at risk in a business venture. The

President has focused us precisely on that point: Sharpening the incentives for

investors and entrepreneurs to invest in the most productive ventures. And higher

productivity means higher wages and a stronger economy for everyone.

The task before us is much the same throughout this new century: To enhance

incentives for private sector savings and investment. We are going to pay for the

retirement and health care of the baby boom generation one way or another. We

can increase private savings and investment, or we will reach lower standards of

living in the future than we would otherwise.

How can Government and business achieve these goals now and in the future?

The President has clarified the main task for us in Government: To remove the

legal, tax, and regulatory distortions that discourage savings and investment.

There is no better example than the current double taxation of corporate dividends. No one defends this bias from first principles; and no other major industrial

nation taxes profits at such a punitive effective rate. By taxing dividends twice, our

tax code encourages companies to retain earnings instead of paying them to shareholders; to raise excessive levels of debt; and to dedicate some of America’s leading

minds to tax minimization instead of job creation. And by imposing a high marginal

rate on profit, our tax code thins the vital blood of economic growth: Risk capital.

We are encouraged by the good progress being made on the President’s Jobs and

Growth proposal, including progress toward lowering tax barriers to savings and

investment. We are working with the Congress to obtain the best package possible,

as quickly as possible. The President has made clear that the sooner we get this

done, the sooner we can create jobs and put people back to work.

Boosting savings and investment in America will also require restoring investor

confidence. Congress passed Sarbanes-Oxley, and the SEC and Justice Department

are successfully implementing its provisions to improve corporate governance. But

companies too have responsibilities to lead—to provide investors with meaningful,

high-quality information. This is not principally a task for Government to achieve.

Our securities markets are extremely efficient at pricing and allocating capital on

the basis of all available information. Unfortunately, important information is too

often not available to shareholders. We will not restore our investor confidence until

shareholders truly can see the companies in which they invest through the eyes of

their agents in management, until they can see the real, economic leverage and the

key indicators of business value that insiders can.

When investors have a picture of the real, economic leverage employed, regardless

of the distractions of off- vs. on-balance sheet distinctions, attention will naturally

turn to cash flow: To how management expects to pay down the leverage and still

have some income left over for the shareholders. Exposing true leverage—contractually obligated net present value—is the only way that shareholders and creditors

can judge true performance and can distinguish profit from business operations and

from financial engineering.

Private sector leaders must transform the practice of corporate disclosure, to set

a new class of best practices that will genuinely inform investors about the risk/

reward prospects of the firms in which they invest. I wish that Government could

set best practices by fiat; I do not think it can. Only the private sector—corporate

executives, lawyers, accountants, bankers, analysts, and money managers—can

make it happen.

The President has urged us to focus on this top national economic priority: Encouraging investment. Sharpening the tax incentives and improving corporate disclosure are crucial steps toward that goal—both to create jobs now and to generate

the wealth later to pay for our collective retirement.

—————

PREPARED STATEMENT OF WAYNE D. ANGELL

FORMER FEDERAL RESERVE GOVERNOR

MAY 22, 2003

Mr. Chairman and Members of the Subcommittee, thank you for the opportunity

to testify today on the subject of the use of economic policy to speed up economic

growth in an economy that has been mired too long in recession. This is a very welcome opportunity to address the particular difficulties faced by an economy in the

throes of a capital goods cycle beset by risks of deflation. Half-way measures are

handicapped at the outset by a tendency to underestimate the lingering power of

31

previous episodes of restraint. Both monetary policy and fiscal policy are likely to

be deemed to be stimulative or accommodative even while policy continues to retard

economic growth. If policy had been accommodative then economic performance

would not long be regarded as a problem.

We would not be hearing warnings about the risk of deflation if monetary policy

had not been less accommodative than reported. We would not be beset by such a

rapid and prolonged decline in equilibrium interest rates if fiscal policy had

switched from restraint to stimulation. This problem is so severe that at the outset

we need to define fiscal stimulus as a fiscal policy that would produce a Federal

budget deficit even when labor and capital goods resources are fully employed. The

current Federal budget deficit is not stimulative as the deficit only exists due to the

reduction of tax receipts forthcoming from an economy seriously underutilizing its

precious resources.

First, a question arises as to whether or not an economic policy response would

be an efficient remedy to the current recession. But before we get to that question

let’s take a look at what incoming data are telling us about this downturn.

• This is the longest employment recession since the 1930’s. Non-farm payroll

employment has declined in 24 of the last 25 months to bring April employment

as a percent of peak employment to the lowest level of the recession. Chart 1

compares the slow and the persistent decline in employment in this cycle as a percent of the peak employment to the steeper yet shorter decline in the 1981–1982

recession. • Labor markets continue to be weak as business managers are able to reduce labor

costs by capital investments and restructuring—labor productivity has continued

to post sizable gains. Weekly unemployment claims show no sign that this employment recession has ended. • Although long in duration the decline in employment has been only 60 percent

as deep and the decline in output only 70 percent as deep as in the 1981–1982

recession. See Chart 2. • This is a capital goods downturn rather than a typical inventory cycle. As depicted

in Chart 3 the total index of industrial production has declined, so far, only 6.7

percent from its April 2003 peak, whereas, the index of business equipment production stands 18.5 percent below the peak month—and indeed, this is a capital

goods cycle. • Six months after the March 2001 employment peak economic activity was hammered by the September 11 terrorist attacks on the World Trade Center and the

Pentagon. Recovery from the terrorist event gave a false impression of economic

recovery. • Another misleading indicator of economic recovery emerged in 2002 as solid gains

in labor productivity enabled output to expand while employment and hours

worked declined.

Second, it is important to have a clear understanding as to how the 1991–2000

expansion came to an end. Was it simply that we had an unprecedented coincidence

of bad events such as Y2K and an over-exuberant stock market or was there an economic policy failure that was decisive?

• Sometimes the makers of economic policy become convinced that the best way to

avoid an unwelcome event is to engage decisively in a new economic plan. That

is exactly what happened in the late 1990’s when voices of alarm predicted that

a low saving rate in the United States would result in an unsustainable increase

in imports in excess of exports until our indebtedness to the rest of the world

would produce a global economic collapse. The chosen remedy was to pursue a

large enough Federal budget surplus to offset deficient private sector saving.

• In the four quarters to the second quarter of 2000 individual income tax payments

to the IRS rose exactly twice as fast as the growth rate of personal income: 11.4

versus 5.7 percent.

• The engine that had been driving our prosperity was an unprecedented capital

goods boom that matched up with an unprecedented surge in capital goods technology. Disposable personal income took such a hit from the 11.4 percent increase

in individual income tax payments that there was simply not a sufficient increase

in disposable income to enable households to buy what had been produced.

• In the turning point year 2000 a second, third, and fourth quarter slowdown in

the growth of personal consumption expenditure coincided with such a high rate

of increase in capital goods capacity that the return on capital goods plummeted.

While interest rates on real capital were plunging in the second half of 2000,

FOMC action in lowering the target Fed funds rate was not begun until January

3, 2001. Even though the January 3rd cut in the target Fed funds rate was followed by an unprecedented volley of rate cuts through the year 2001, it was not

32

sufficient to have avoided an employment recession. But without the FOMC action

results would have been worse.

• Although a tax rate cut was proposed by President Bush in early 2001, its enactment came in a compromise form that distributed nonincentive tax rebates in the

third and fourth quarters of 2001 and implemented a phased in tax rate reduction

in fiscal years 2002, 2004, and 2006.

• Even though the monetary policy and tax rate policy response was far from ideal,

it seems appropriate to credit the FOMC and the Congress for alleviating the rate

of decline in employment and output. The half scale tax remedy did not prevent

a recession, but it cushioned the recession’s rate of decline.

Third, let’s consider some facts to be learned about deficits and debt from a review

of the data from the Federal Reserves Flow of Funds statistical base:

• Economic growth in current dollars ($GDP) averaged 5.0 percent from 1991 to

2002 matching the growth of total sector borrowing as a percent of total sector

debt which averaged 5.2 percent by an arithmetic mean and by 5.1 percent by a

median. Total sector borrowing rates during these 12 years is considerably lower

than the 7.8 percent average for 37 years from 1965 to 2002—a lower inflation

rate reduces the rate of growth of debt necessary to sustain an expansion. Think

how much worse this decline would have been if we had entered the recession

with a 12 percent rate of inflation.

• When Federal borrowing as a percent of Federal debt actually declined at a 3 percent annual rate as it did from 1998 to 2001 then borrowing from non-Federal

sectors must necessarily have increased enough to make up for negative Federal

borrowing contribution. Household borrowing as a percent of household debt increased to a 7.7 percent rate up from the 12-year average of 6.8 percent. And business borrowing surged from its 12-year average as a percent of business debt from

5.1 to 8.8 percent.

• But the problem with requiring a surge in household borrowing and business borrowing to offset a decline in Federal borrowing is that households and businesses

are not able to sustain such a high increase in borrowing as a percent of debt.

The result was not only a 2002 slowdown in business borrowing as a percent of

business debt to 2.8 percent, but also a slowdown in total borrowing to a level

insufficient to maintain an expansion of output. Give credit to the FOMC for providing sufficient liquidity to enable the price of houses and condominiums to continue to move somewhat higher and thereby provide a sufficient level of equity

extraction to enable households to continue a spending pace sufficient to keep output growth positive.

Fourth, is the stimulus of Federal borrowing offset by a crowding-out effect on

private borrowing? Or, put another way, does an increase in Federal borrowing put

upward pressure on interest rates?

• The answer to the first question is ‘‘No.’’ Crowding out occurs only when Government expenditures require resources in competition with the production of private

sector goods. A reduction in tax rates increases incentives to invest and to produce

by leaving buying power in the private sector. There is no crowding-out.

• The answer to the second question is ‘‘Yes.’’ But it is a far different matter to

push the natural rate of interest up to 1 percent than to push it up to 10 percent.

The problem today is that interest rates are too low to provide a meaningful reward for saving and too low to provide an adequate safe fixed income for people

facing retirement or currently retired.

• There is not likely to be any crowding-out effect from tax rate reductions. For example in the 1981–1982 recession, a tax rate cut worked to create jobs without

any crowding-out effect as the average monthly employment gain was 367,000 per

month in the 22nd, 23rd, and 24th months after the July 1981 peak in employment. In contrast, the average monthly employment change was minus 87,000 per

month in the 22nd, 23rd, and 24th months after the March 2001 peak in employment. If economic policy should be geared toward an increase in employment then

the 1981–1982 model warrants emulation.

• Given that the FOMC has now recognized that the risk of deflation exceeds the

risk of inflation, interest rates are more likely to remain too low for several years.

It is a time to understand that economies besieged by a disinflation to deflation

risk are likely to be in a low-interest rate environment for many years to come.

The only likely escape is through the incentives of tax rate reduction.

Fifth, is monetary policy likely to work in a deflationary environment?

• Monetary policy always works as long as the target variable chosen is countercyclical. The FOMC has the choice of selecting one of three target variables: A

33

target Fed funds rate, a target growth of reserve bank credit or a target price

level. Any one of these target variables could work to counter deflation.

• The FOMC has chosen to target the Fed funds rate as a way to measure out the

amount of monetary liquidity additions and subtractions. Consequently, I will confine my focus to selecting a target Fed funds rate that is likely to increase the

growth rate of real economic output to a level sufficient to stimulate employment

growth. The problem with monetary policy in long-cycle periods is not that monetary policy runs out of ammunition, but that the monetary authority quite often

misjudges the degree of economic restraint contained within a chosen target Fed

funds rate.

• Persistent economic growth rates below the growth rate of the labor force and the

growth rate of capital goods capacity is a clear indication that the chosen target

Fed funds rate has been too high to accommodate the money hoarding preference

of households and business. Selecting a lower target Fed funds rate will require

an increased injection of monetary liquidity into the banking system.

• A reduction of the target Fed funds rate from 1.25 to 0.75 percent would require

a significant injection of liquidity to bring a supply of liquidity consistent with a

0.75 percent rate. It is monetary nonsense to argue that ‘‘quantitative easing’’ can

provide more liquidity at the existing Fed funds rate. Any increase in the supply

of reserves would result in a lower Fed funds rate. As long as the Fed funds rate

is positive the FOMC is likely to want to measure its quantitative easing by the

extent of the change in the Fed funds rate.

Sixth, could monetary policy restore the desired price level and thus the desired

economic growth rate without changing tax rates?

• The pragmatic answer is ‘‘not likely’’ in a capital goods contraction as compared

to a recession driven by an inventory correction. A persistent failure of the price

level and the growth of output and employment to respond to significant cuts in

the target Fed funds rate is evidence of fiscal restraint. Whereas, inventory recessions tend to be followed by a motive to increase production more than the increase in sales, in order to reverse previous inventory rundowns, capital goods recessions are not prone to such a predictable end. After a labor market has passed

the ‘‘soft market’’ stage to a stage where labor market uncertainty has a cumulative depressing effect on ‘‘lifetime income perceptions’’ then monetary easing

alone is likely to be transmitted only through disruption of global exchange rates.

• My advice is to choose a tax rate reduction that is likely to increase the expected

economic growth rate of the United States sufficient to keep the dollar strong and

stable. Monetary policy alone runs a danger of providing ‘‘beggar thy neighbor’’

remedy to domestic deflation. In other words, the more than moderate 2003 decline in the exchange value of the U.S. dollar against the Euro is likely to have

simply transferred deflationary pressures from the United States to Europe and

Japan. That is less than acceptable economic policy leadership.

Seventh, what tax rate proposal do I favor?

• The elimination of the double taxation of corporate income paid out in dividends

is far better than any other proposal as it reduces our highest effective tax rates.

• There is more bang for the buck in eliminating double taxation as no other proposal will make common stock ownership so much more attractive. Not only does

it eliminate the pernicious double taxation but also it is likely to have the greatest

effect in modifying corporate executive branch behavior to perfectly align the

CEO’s interest with shareholder interest. Why would top management wish to

distribute the fruits of their labor in any other way than in paying dividends.

• The exclusion of qualified income from taxation will first increase the dividend

payout ratio then it will alter the choice of employed workers to reduce the

amount of income deferred from taxation into company retirement plans in favor

of direct stock ownership. And for retired workers it will encourage withdrawing

funds from retirement programs, paying the income tax, and then securing tax

free income. I am convinced that Federal tax receipts would increase between

2004 and 2010 as a result of the elimination of double taxation.

• Although it seems the Congress may choose a combination tax rate of 15 percent

for both dividends and capital gains, I continue to prefer the original model presented by the President as it is much more likely to provide the surge in common

stock values. We have never moved from recession to recovery without first seeing

a new bull market in common stocks.

• Reducing maximum noncorporate business tax rates to the 35 percent corporate

rate is essential to provide an optimum increase in jobs for American workers.

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35

36

37

PREPARED STATEMENT OF MARK ZANDI

CHIEF ECONOMIST AND CO-FOUNDER, ECONOMY.COM

MAY 22, 2003

Mr. Chairman and Members of the Subcommittee, my name is Mark Zandi, I am

the Chief Economist and Co-Founder of Economy.com.

Economy.com is an independent provider of economic, financial, country, and industry research designed to meet the diverse planning and information needs of

businesses, governments, and professional investors worldwide. We have over 500

clients in 50 countries, including the largest commercial and investment banks; insurance companies; financial services firms; mutual funds; manufacturers; utilities;

industrial and technology clients; and governments at all levels.

Economy.com was founded in 1990. We are an employee-owned corporation, that

is headquartered in West Chester, Pennsylvania, a suburb of Philadelphia. We also

maintain an office in London.

I will make three points in my remarks. First, the economy is struggling significantly, and a well-designed fiscal stimulus plan that is passed quickly would be useful in jumpstarting the economy and by extension the equity market. Second, while

the elimination of the double taxation of corporate income is a laudable economic

objective, doing so will provide only a small boost to the equity market, and do little

to support the economy’s near-term prospects. This is particularly true of the current proposals to simply scale-back dividend income taxes for a limited period.

Third, the long-term economic benefits of the proposals to scale-back dividend income taxes are also small, as any gains to economic efficiency are all but offset by

the economic drag resulting from larger budget deficits and higher interest rates.

Fiscal Stimulus

The need for more fiscal policy stimulus is motivated by the struggling economy

that is operating well below its potential. The economy is posting gains in real GDP,

but those gains are barely half those necessary to support any meaningful job

growth and a stable unemployment rate.

Adding to the pernicious character of the economy’s current problems is that they

are extraordinarily broad-based. Industries as wide-ranging as manufacturing, commercial construction, travel, retailing, investment banking, and now State governments are reducing payrolls. The economy’s difficulties are also widespread from

coast-to-coast. Large economies ranging from Boston and New York in the Northeast, to Atlanta and Dallas in the South, to Chicago and Detroit in the Midwest,

to the Bay Area of California and Denver in the West, are engulfed in full-blown

recessions.

Near-Term Impacts

Fiscal stimulus is needed to jumpstart the economy and by extension the stock

market, but such stimulus must be well-designed and it must be provided quickly.

Scaling back dividend taxation, particularly as envisaged under the plans currently

being debated, will provide at best only marginal support to the economy this year

and early next, when it needs it most.

The link between scaling-back dividend taxation and the economy’s near-term performance is largely through stock prices. Stock values will rise by an amount equal

to the present value of the stream of future tax savings. With approximately only

one-half of individual dividend income excluded from taxation, under the current

plans, stock values will receive an estimated boost of no more than 5 percent. The

increase in stock prices will occur quickly as investors discount the tax benefit. Indeed, at least part of this benefit may already be discounted in current stock prices,

as investors have likely attached some probability to some reduction in dividend

income taxes.

A key conduit through with higher stock prices affect the economy is through the

positive wealth effects on consumers. The wealth effect postulates that households

consider all their financial resources when deciding how much to spend and save.

When household net worth rises, households are more willing and able to increase

their spending out of income and thus save less. Conversely, when household net

worth is falling, households are more anxious about their financial well-being and

are less willing and able to spend out of income and thus save more.

The wealth effect from a change in stock values is estimated to be almost 2.5

cents. That is, for every permanent dollar increase in stock values, consumer spending ultimately increases by 2.5 cents. This wealth effect is distributed over nearly

3 years and is very small in the first year given that households must expect that

any increase in wealth is permanent before changing their spending and saving behavior in response.

38

Higher stock prices also support the economy through a lower cost of equity capital for businesses. Businesses are able to issue new equity at lower cost to finance

their growth, supporting stronger business investment.

The economic benefit of a positive wealth effect and lower cost of equity capital

occurs with long lags. The lags are likely to be even longer in the current economic

environment, which is characterized by a high degree of consumer and business

angst and uncertainty. Given the approximately 40 percent plunge in stock values

during the past 3 years, households will be skeptical that any increase in the value

of their stock portfolios represents a permanent increase in the value of their portfolios. Without that expectation, households will be slow to increase their spending

in response. Businesses will also be unlikely to quickly raise more equity capital to

finance increased investment in response to any rise in stock prices. The equity

market remains particularly unreceptive at this time to companies looking for capital to expand, and businesses remain exceedingly cautious in taking risks given

heightened geopolitical concerns.

Mitigating the economic boost of scaling-back dividend income taxation is the

higher long-term interest rates that will result. Like equity investors, fixed income

investors will quickly discount the implications of such a change, most importantly

being the larger long-term Federal budget deficits that will result from the lost tax

revenues. As is evident historically, larger long-term deficits result in higher long-term interest rates. During the first half of the 1980’s, when the Federal debt was expanding at over a double-digit pace, real 10-year Treasury yields were over 8 percent.

As debt growth slowed during the 1990’s and fell during the later half of the decade,

real Treasury yields were halved.

Interest rates on tax-free bonds such as municipal bonds will be under added

pressure, as they compete for investable funds against the stocks of dividend paying

companies.

Higher interest rates raise the cost of debt capital to businesses, at least partially

offsetting the boost to investment provided by the lower cost of equity capital. The

higher rates also constrains consumer spending on consumer durables and housing

demand. This in turn weighs on near-term growth in house prices and housing

wealth, at least partially offsetting the boost to consumer spending provided by the

increase in stock wealth. The wealth effect out of housing wealth is an estimated

4.5 cents over a 3-year period. This is larger than the wealth effect out of stock

wealth given the substantially broader ownership of housing. Well over two-thirds

of households own their home, while not quite one-half of households own stocks.

Of all the tax cuts currently being considered by policymakers, scaling-back dividend taxation provides the smallest near-term economic stimulus. The near-term

economic bang for the buck, or 1-year change in real GDP provided for a given dollar of lost tax revenue, is only 9 cents. This compares to a near-term economic bang

for the buck of 59 cents for rolling forward the marginal personal tax rate cuts now

legislated to occur next year and in 2006, for example, and 124 cents for providing

direct aid to hard-pressed State governments, and 173 cents for extending emergency Federal unemployment insurance benefits.

Long-Term Impacts

The elimination or scaling back of dividend taxation does result in several important long-term economic benefits. Most importantly, it reduces the disadvantage the

corporate sector now faces in the competition for capital. Under current law, some

corporate income is taxed twice, but most small businesses are taxed only once at

the personal level, and the imputed income on housing is not taxed at all. These

differences in tax treatment lead to less investment in the corporate sector than is

economically optimal.

Eliminating or scaling-back dividend taxation also reduces the current tax incentive businesses have to use debt over equity to finance their operations. The resulting over-leveraging of businesses does make them more vulnerable to financial problems during recessions, forcing them to undertake more draconian cost-cutting and

thus exacerbating the downturn.

There are also long-term economic benefits as businesses will devote a higher

share of their corporate income to paying dividends. Businesses will thus find it

more difficult to temporarily lift their stock prices through stock repurchases and

other financial engineering techniques. These strategies, which were very popular

during the equity market boom of the late 1990’s, likely result in inefficient corporate decisionmaking.

These economic benefits, however, are ultimately significantly offset by the higher

actual and anticipated future budget deficits that result. As previously discussed,

larger persistent deficits result in higher long-term interest rates. This weighs on

39

business investment and ultimately productivity growth and the economy’s longterm potential growth. Indeed, the economic drag of higher interest rates ultimately

outweighs the economic benefits of eliminating or scaling-back dividend taxation.

The long-term economic bang for the buck, or 10-year increase change in real

GDP provided for a given dollar of lost tax revenue, is estimated to be 20 cents. The

most significant economic bang for the buck occurs 3 to 5 years after taxes are reduced, but due to the pernicious economic effects of higher interest rates, real GDP

is lower by year 8.

Conclusions

The economy is struggling and while it is expected to avoid another recession

given the very successful military action in Iraq, more Federal fiscal stimulus is

needed. The fiscal stimulus plan policymakers are currently coalescing around is a

good effort to provide that stimulus, although it must soon become law to be of significant help.

Scaling back dividend income taxation, however, will do little to jumpstart the

economy. There are longer-term economic benefits to scaling-back dividend taxation,

but they are significantly diluted under the plans being considered by the resulting

higher budget deficits and long-term interest rates. The benefits of dividend tax cuts

would thus be significantly enhanced if they were coupled with broader corporate

tax reform that would result in a fiscally neutral change.

While such tax reform is laudable, it is a complex and thus time-consumer endeavor, and thus should not be included as part of the current fiscal stimulus plan.

(41)

JUMPSTARTING THE ECONOMY:

RURAL AMERICA

WEDNESDAY, JUNE 25, 2003

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, SUBCOMMITTEE ON ECONOMIC POLICY, Washington, DC.

The Subcommittee met at 2 p.m. in room SD–538 of the Dirksen

Senate Office Building, Senator Jim Bunning (Chairman of the

Subcommittee) presiding.

OPENING STATEMENT OF SENATOR JIM BUNNING

Senator BUNNING. The Subcommittee will come to order. It is 2

o’clock, and I like to start things on time. A lot of people do not

realize that.

I would like to welcome all of our witnesses to the second hearing

of the Economic Policy Subcommittee of the 108th Congress. I am

very happy that we have three of my fellow Kentuckians on the

panel today.

Since our first hearing in May on increasing investment in equity

markets, the Dow has gone up over 590 points, and the Nasdaq has

risen over 115 points. I understand a tax bill might have passed

that day, but I give full credit to our hearing. Hopefully, Chairman

Greenspan will not mess things up today and will cut rates another

50 basis points. We will know in about 15 minutes. We want to

bring the same results we brought to the equity markets to rural

America.

For our second hearing, I would like to focus on the economics

of rural America. During the tech boom of the 1990’s, our economy

experienced rapid growth. Productivity has increased at historic

rates. The equity markets grew to record levels, so much so that

there were many examples of janitors at tech companies becoming

millionaires because of their stock options. I hope now they sold

those stocks before the bubble burst.

Rural America, for the most part, did not experience that rapid

growth. The tech boom did help, especially to increase productivity.

Many farmers use global positioning systems, called GPS’s, to assist in running their farms. The Internet has also been a huge help

to make farmers more productive. But rural America did not experience the same highs many other parts of America did during the

1990’s. Fortunately, they also have not experienced the same lows

of this last recession, but they still lag behind.

I would like to talk about where we are today in rural America.

What the state of the economy is currently, and what we see for

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its future. I would also like to talk about what we can do to help

grow the rural economy. In many parts of Kentucky and the rest

of the country, our young people are leaving the rural areas because they do not believe that they will be able to get jobs. Now,

we must change that.

I am very happy to have the Administrator of the Rural Utilities

Service, Hilda Legg, here today; also the Dean of the Kentucky

School of Agriculture, Scott Smith; we also have the Vice President

of the Kentucky Farm Bureau, Mark Haney. I used my Chairman’s

prerogative to stack the deck with Kentuckians. I am very thankful

you agreed to take time out of your busy schedules to testify here

today, and I look forward to hearing your testimony.

Ms. Legg, if you would like to start us off? And we will make all

of your full statements part of the record, so you do not have to

worry about that.

STATEMENT OF HILDA GAY LEGG

ADMINISTRATOR, RURAL UTILITIES SERVICE

RURAL DEVELOPMENT MISSION AREA

U.S. DEPARTMENT OF AGRICULTURE

Ms. LEGG. Thank you, Chairman Bunning, for this opportunity

to participate in a hearing that, of course, I feel passionately and

personally very committed to. It is a public forum for us to understand the problems and the challenges that rural America faces

and to seek answers to those challenges. So, I am grateful for this

opportunity.

As the Administrator of the Rural Utilities Service and as a part

of USDA’s Rural Development team, I work with our programs

that provide financing for the infrastructure construction for electric power, telecommunications, and water and waste disposal services. I come from a background that includes building economic development in Kentucky, as well as with the Appalachian Regional

Commission.

Our focus in the Rural Development mission area is to help rural

areas achieve economic and social gains that are solid and long

lasting.

The Federal Reserve Bank of Kansas City’s Center for the Study

of Rural America reports in their May Overview, that the rural

economy continues to hold steady, with rural jobs very slightly

gaining 0.7 percent in February compared to a year ago. Job

growth is increasing at a very slightly higher percentage in rural

areas compared to growth in metropolitan areas, according to the

Bureau of Labor Statistics. And while no one is claiming this is a

boom cycle, it appears that in the rural economy, at least we are

heading in some of the correct directions.

Rural America is an eclectic mix of races, ethnic groups, terrain,

climate, amenities, businesses, and institutions. While agriculture

is certainly prominent, no one industry dominates the rural landscape as it did a couple of centuries ago, nor does a single pattern

of population decline or growth exist for all rural areas. Diversity

then presents opportunities for some creative answers and unique

partnerships.

At the beginning of the 21st Century, according to the U.S. Census and the USDA’s Economic Research Service, rural America

43

comprises 2,305 counties, contains 80 percent of the Nation’s landmass, and is home to 56 million people.

In Secretary Ann Veneman’s book ‘‘Food and Agriculture Policy,’’

she stated that despite the fact that seven out of eight rural counties are now dominated by nonfarming activities, that in no way

diminishes the importance of ranching and farming in rural areas.

However, in many communities, this diversity provides a strength

that can help us to sustain through those times of not enough rain

or too much rain, as recently.

Our challenge that we face from the infrastructure program is

that while we have seen a serious downturn in the infrastructure

development, especially in the telecom field recently in the more

national picture, in our rural areas we do not have the problem of

lots of dark fiber. That does not exist in rural America.

The fact is we have had to relearn an old lesson, that it really

takes a good business plan, no matter what the technology that you

are trying to deploy. High-speed telecommunications are absolutely

mandatory for new job creation, not just for the future of rural

America but also for today. Just like a good road, high-speed telecommunications requires a use for it to be beneficial, it must add

to the economic structure of a rural area. There is no doubt that

without that infrastructure being built, they will not come. Just to

install broadband telecommunications capability without a plan of

how to use it is a high stakes rolling of the dice.

Rural America finds itself in the midst of a revolution of change

in the areas of telecommunications and electric infrastructure programs. The Telecommunication Act of 1996 has created an interesting and complicated landscape. While many of the larger providers

have chosen to place their resources in the more densely populated

areas of the country, but we see a vast number of entrepreneurs,

from small traditional telecom companies to new start-up businesses, are stepping bravely into this new and hopefully competitive market in rural America. The general investment community

is very hesitant today to finance telecommunications development

needs, especially in rural communities. Therefore, the challenge of

USDA is to provide funding for high-speed telecommunications development while continuing our history of high-quality loans that

are a good use of taxpayers’ dollars entrusted to us, Senator, by the

Congress.

Clean, safe drinking water and ecologically sound waste disposal

are equally vital aspects of both rural health needs and quality of

life for rural citizens. There is no more basic human need than that

of clean, safe drinking water.

In the electric infrastructure program, the development of renewable energy is not only improving the availability of energy to rural

residents, but we are also seeing the development of what we call

‘‘power farming’’ as a potential new crop for farms and rural residents. Ethanol, solar, and wind are the most economically competitive energy sources, while bioenergy projects continue to improve

the economic future for farms and rural businesses.

As a Nation, we are only as strong as our weakest link. It is always easy to look at the national numbers and percentages while

forgetting the individual needs of rural citizens and communities.

44

Low percentages of unemployment sound a little hollow to that person who is unemployed. To him, it is 100 percent unemployment.

USDA, like any other Federal agency, does not have easy answers. We do find that by working with our rural partners and the

community leaders, we can make gains in rural communities. And

by one degree at a time maybe we can turn that ship around and

in a different positive direction. The USDA Rural Development

field staff, in State and local offices, still serves as our frontline in

working directly with rural leaders for stronger communities.

Building quality infrastructure, housing, and businesses based on

long-term plans and good business models, that is what will make

our economy grow. Local leadership and citizens commitment is a

key ingredient to making these programs work.

To create a new competitive edge for rural industries will require

access to strong education to keep up with the changing world. It

will require available capital for business development. And maybe

most importantly, it will require strong rural leadership to make

these things happen at that local level.

Thank you, Senator Bunning, for the opportunity, and I will be

glad to answer questions whenever appropriate.

Senator BUNNING. Thank you, Ms. Legg.

Mr. Smith.

STATEMENT OF M. SCOTT SMITH

DEAN AND DIRECTOR, COLLEGE OF AGRICULTURE

UNIVERSITY OF KENTUCKY

Mr. SMITH. Thank you, Chairman Bunning, for the opportunity

to share these remarks on rural economic development. In serving

as Dean of the University of Kentucky College of Agriculture and

also the Director of the Kentucky Cooperative Extension Service, I

can assure you that rural economic issues play a very large part

in shaping the mission of our organizations.

Rural counties and small cities in Kentucky, and throughout the

Nation, face some significant economic challenges. The recent economic slowdown compounded with significant changes in the agriculture economy threaten job and income security in many rural

areas. In some important ways, the current economic climate has

had a relatively greater negative impact on some rural areas compared to metropolitan areas. Most notably, very recent downturns

in rural manufacturing combined with some troubles in the farm

economy are laying a combined one-two punch on many rural

areas. For example, national manufacturing employment from 2002

declined by over 10 percent in rural areas of America compared

with approximately 7 percent in metropolitan areas. Almost 140

rural factories closed last year.

Meanwhile, the rural service sector and rural construction activity would probably best be described as flat. Rural recreation and

tourism apparently has not fully recovered from 9/11. And layered

on top of this, in tobacco States like Kentucky, the shrinking quota

and the changing tobacco program will continue to have dramatic

effects, truly dramatic effects, not just on farmers but on entire

rural communities.

Although the farm economy was widely described as recovering

in 2001 and 2002, much of this advance was due to transfer payVerDate 11-MAY-2000 09:07 Apr 21, 2004 Jkt 000000 PO 00000 Frm 00048 Fmt 6601 Sfmt 6601 93128.TXT SBANK4 PsN: SBANK4
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ments. We all appreciate the uncertainty and the undesirability of

relying on farm programs to sustain the rural economy. But even

in the best of times for agriculture, farm-level profitability, while

remaining crucial, cannot by itself support the full weight of rural

development. Consider, for example, that an increasing fraction of

farm families in Kentucky and elsewhere are economically dependent upon the opportunities for off-farm rural employment. And you

understand that farm and rural nonfarm economies continue to be

ever more interconnected.

Unfortunately, the potential declines, of which there are some

signs, in the rural manufacturing sector could make business recruitment a realistic option for fewer and fewer rural communities.

In such circumstances, retaining local businesses, creating new

local enterprises, and adding value to local products, be they farm

products or otherwise, these become indispensable measures for

sustaining the local economy. To do this in both rural businesses

and farms, we will need to have innovative leadership, as Ms. Legg

said, and greater technical assistance to identify new income opportunities and enhance their products and services.

Rather than speak today about specific policy strategies or issues

in economic development, I would like to take this opportunity to

comment on the general characteristics of at least one promising,

very promising, rural economic development initiative in Kentucky.

One Kentucky program taking an integrative and comprehensive

approach is the Kentucky Agricultural Development Fund. Unique

among the States, Kentucky has invested 50 percent of its share

of the National Tobacco Settlement, well over $100 million to date,

in programs supporting both agricultural and, therefore, rural development. This massive and innovative program has benefited

from the full participation of State government, farm and community organizations like Farm Bureau, the University’s Land Grant

system, and hundreds, maybe thousands of local leaders. Beyond

investing in on-farm profitability and diversification, the Fund has

supported projects in value-added and alternative products, agritourism, rural infrastructure, entrepreneurship and leadership development, marketing, and resource conservation. This is surely

one of the Nation’s most comprehensive and ambitious rural development initiatives.

Complex, multidimensional economic problems demand integrative, comprehensive strategies. And programs like this acknowledge

that multiple ingredients must be assembled for economic success:

Infrastructure, leadership and entrepreneurship, access to capital,

a skilled and productive workforce, access to and ability to use new

technologies.

I would be happy to comment more and answer any questions

about the ag development programs in Kentucky as time permits,

but I want to conclude by touching on the role of organizations like

mine, the land grant colleges, in rural economic development.

As many public universities around the Nation, including the

University of Kentucky, are mandated to become an even greater

force for economic development, a few States are pursuing a new

and broader mission for the traditional land grant system of Cooperative Extension and the Experiment Station. This new land grant

approach fosters R&D and technology transfer in a wide array of

46

enterprises, including farming, of course, but certainly not limited

to agricultural production. So in Kentucky, we are building rural

research and extension partnerships in everything from engineering to fine arts. In one major initiative, we teamed up the university medical center, State health agencies, and county extension

agents to greatly expand health education and information access

in rural areas.

In another multistate consortium, we are working to grow a

manufacturing engineering extension service to better support

rural factories. And in the planning stages, and perhaps of interest

to this Committee, is a project with Kentucky housing. They intend

to require high-speed Internet connectivity in all units that they finance. A nongovernment IT firm is committed to creating a specialized web resource system. And the extension service will provide

content on family and consumer issues: Health, nutrition, personal

finance, and other topics specifically configured for this particular

audience.

Our diverse partners in such programs understand the power of

a Statewide, county-level extension network for rural development

and the ability to connect this network to the University, State,

and Federal level information and expertise. So just as the land

grant institutions supported the dramatic advancement of the Nation’s farming economy in the last century, they can well serve the

broader mission of rural economic development in years to come.

I thank you for the opportunity to comment and for the Banking

Committee’s thoughtful deliberations on this crucial and very challenging topic.

Senator BUNNING. Thank you very much, Mr. Smith.

Mark Haney, would you like to proceed?

STATEMENT OF MARK HANEY

VICE PRESIDENT

KENTUCKY FARM BUREAU FEDERATION

Mr. HANEY. Thank you, Mr. Chairman.

I again thank you for the opportunity to represent my fellow

Farm Bureau members to speak on the current status of the agriculture community and rural America. And thank you for allowing

a member of the farm community to be able to come and testify.

We have lots of advantages and disadvantages living in the rural

community, but I think the advantages outweigh the disadvantages

by a lot. However, I do want to kind of talk about the current status of the agriculture community in rural America and in rural

Kentucky.

We came off of kind of a tough year in 2002 for a variety of reasons, one being weather related. Net farm income was off from

about $45 billion down to about $30 billion. Farm policy was in

transition. Falling grain prices were part of the factor. And that

$15 billion loss not only hit farm families in rural America but also

hurt small businesses, lending institutions, and made for a somewhat sluggish economy.

That was not necessarily all the things that contribute to maybe

sluggish conditions in the rural economy in America, and you will,

I guess, hear somewhat of a common theme among the panelists

today. Some of the things that I mentioned they have also.

47

It is very important that we in rural America have communications, telecommunications in particular. We find ourselves sometimes in need of better communication facilities. We struggle to

deal with the new infrastructure in rural America for telecommunications, specifically broadband Internet service, cellular towers. We

need cellular towers in rural America almost as bad as we need

four-lane highways. We desperately have to have communication.

We also find ourselves a bit behind in physical infrastructure.

We read about many State legislatures coping with economic woes,

and we find ourselves in rural America with bridges and highways

in constant need of repair. We have to have the physical infrastructure to get our crops to market, do the things that we really have

to do to be able to market the crops that we grow.

To keep a highway system going, it is constantly—we have to do

that on a continual basis, and we cannot take breaks in that because there is a need of economic input.

We also find ourselves in rural communities dealing with other

topics like solid waste. It can be a real problem. Trash pick-up is

not really a luxury in rural America, but it is a problem. We have

trash just like everyone else. I live in an area in southern Kentucky, or southeastern Kentucky somewhat, where we are really

fortunate. We have Congressman Hal Rogers and his PRIDE program that is making tremendous gains in this field. He is restoring

pristine waters to our community. We are able to clean up dumps,

illegal dumps, health hazards, all the things that need to be going

on, inspiring people with a feeling of pride in their daily lives. I

think if we could do that on a national basis, similar type programs, I think it would be very, very good.

Another problem we have in rural Kentucky is not necessarily

just our problem, but it is a real problem in rural Kentucky, and

that is affordable health care. Rural Kentucky is made up of small

businesses, and being a farmer, I consider myself a small businessman. I have a brother that is a partner. We operate a 450-acre

farm that has been in our family for more than 130 years. We have

fifth generation living on our farm right now. Health care is a problem for everyone, especially small businesses. Small businesses

make up most of rural America, and it is a problem for them to

provide their family with affordable health care, much less their

employees. So, we find that that is a real need in rural America.

Also, we find that long-term care for our seniors is a big problem

in rural Kentucky. In my county, I have people that I know personally that have a senior family member that maybe has to be in an

institution in a different county, maybe two or three counties away,

as much as maybe 100 miles, to be able to house that individual.

I think that is a real problem, especially if we want to keep people

living in rural America, living in rural Kentucky.

We do have an advantage, I think, in rural Kentucky. Most of

our assets are fixed assets. Our savings are invested in fixed assets—land, buildings, equipment—not necessarily so much in the

market that you spoke about, the stock market or in equities. So

even though we may be slow to gain wealth in rural America, we

are slow to lose wealth though. Those farms, those buildings, are

there for generations, and they provide stability in our people, in

48

our citizens. I think that is one of the biggest pluses that we have

in rural America.

To keep people involved in agriculture, to keep people involved

living in rural America, I think we need to make business advantageous to small businesses. That is what, in my opinion, is going

to keep people living in rural America. Where we live, where I live

in particular, there is a lot of off-farm income that allows people

to operate small family farms and have a way of life in a rural setting. I think that is a very positive thing, and I think that is a

thing that we need to strive.

One other comment that I would like to make deals more in particular with Kentucky agriculture. Kentucky is made up of a high

number of small farms. Kentucky is the fourth largest State in the

number of farms. However, our farms are small farms. In Kentucky, the average size of a farm is 150 acres. The national average

is about 430 acres. But what has been able to sustain those small

farms has been tobacco. For pretty much of the 20th Century, the

tobacco warehouses, tobacco auction markets were as prevalent

throughout the small communities in Kentucky as post offices

were. It has just been a tradition and a way of life.

However, we find that it is beginning to change. Because tobacco

is a management system, we have a quota. And we find the quota

beginning to shrink. The quota from 1997 was over 700 million

pounds. The quota for 2003 is about 290 million pounds. So, we can

see how many people are actually getting out of the business or,

more specifically, trying to stay in until they find stability in what

the tobacco market is going to be.

In the last few years, we find quota lease prices going from 25,

30 cents a pound to—it is not unheard of to hear 60, 70, 80 cents

a pound for people to be able to purchase quota or lease quota just

to be able to maintain in the tobacco industry until they see what

is going to happen.

So there is talk of a buyout that we in Kentucky are very much

in support of. We think it will give stability to the people that want

to continue in the business. Many, many farms are waiting to find

out what they can do. They are in a transition period right now.

They are ready to transition the farm, the family farm into the

next generation, but they are waiting for the buyout. Not only will

it help the farm economy, but it will also have a nationwide health

benefit if it is tied to the FDA’s regulation of tobacco products.

If there are any questions about the buyout or anything about

Kentucky agriculture, I would be happy to entertain those. Again,

I want to thank you for the opportunity to come and testify today.

Senator BUNNING. Thank you, all three of you, for your testimony. We will have just a few questions for you. Not too many.

Ms. Legg, in recent years, the number of employees that telecommunicate to work has been on the rise. Employees are able to

work from their homes and avoid the long commutes and higher

prices of living that occur in cities. This being said, there has still

not been a lot of employees migrating to rural areas to take advantage of this telecommunications. What can be done to notify more

businesses and telecommunicators to the benefits of rural America

and add other value-added enterprises to farms?

49

Ms. LEGG. That is an excellent question. I think what it is going

to take is a combination of efforts.

First of all, the high-speed connection has to be there, not just

Internet access, because if you are really going to do business from

home, the dial-up modem, which is the most prevalent accessibility

of Internet is not competitive. If you are doing business in a global

marketplace, you have to have the high speed.

We have at USDA in our rural development program a broadband program to try to build out that infrastructure, as Mr. Haney

mentioned, to try to get high-speed access into those rural communities. But as in any program of economic development in rural

America, it is economies of scale. How does the private sector build

out in a more densely populated area and have enough take rate,

if you will, to pay back a loan, even a low-interest, Governmentbacked loan? So, you have to look at the economies of scale.

What I think we have to do, the number one thing, is to help

drive the market, help to create the awareness of what that highspeed connection can do. As you pointed out, telecommuting, members of your business working from home, yes, that is somewhat of

a culture shift from some of us that are much more traditional

workplace-bound. But that is why it takes leadership. That is why

it takes education. It is the awareness of what that connectivity

can do for your business or for you as an individual if you are allowed to work at home.

So it is a combination. We do have to have financial resources,

but we almost have to have a willingness to change the way we

have traditionally approached many aspects of our life in order to

recruit that. And then I think we have to do maybe a stronger emphasis on the whole aspect of business development because if you

are going to sustain job growth and retention in rural America, it

is going to be your small- to medium-size businesses, by and large,

for long-term stability. Mr. Haney mentioned five generations. It is

doing that kind of thing.

I think the emphasis has to be on some entrepreneurial aspects

within our culture, how you can make a living in rural America,

but you must have that infrastructure capability to connect you to

the global marketplace. And we have examples of how we try to do

that and are doing it with our rural development programs. But,

again, it comes back to the business piece of it as well, being able

to repay those investment loans.

Senator BUNNING. To follow up, how do we convince our small

entrepreneurs and our small business people to buy into that type

of set-up? Because if I want to live in Somerset or if I want to live

somewhere in rural—and I do not consider Somerset rural—it is

one of the major cities in Pulaski County, maybe the largest city

there. But if I wanted to live in Inez in Martin County—and that

is rural—how do we convince an entrepreneur to buy into the fact

that people actually can perform valuable work through high-speed

Internet connecting and they do not have to report to work every

day to do it?

Ms. LEGG. And that they will be actually working.

Senator BUNNING. That they will be. I mean, you can check on

the connection.

50

Ms. LEGG. It really is a culture shift, and what we have to do,

again, I was appreciative of Dr. Smith here talking about the leadership. We have to lead by doing. You are doing that by presenting

this public forum. We have to get out there and—actually what I

call the three A’s of technology: First, just to be aware of what it

is, which many of our rural residents still do not know what ‘‘Surfing the Net’’ is; and, second, we have to have access—that is the

infrastructure; and the third thing it has to have is application. It

has to be applicable. It has to make business sense. We, as a

whole, I think, have to do a better job of how we educate our businesses and our entrepreneurs about how it makes their business

more efficient if they have telecommuting employees or if they have

high-speed bandwidth and do global marketing. It is a matter of

demonstrating that.

And through some of our rural business development programs

at RUS and certainly through some of our marketing efforts with

the rural utilities program, we are trying to get that—it is about

the application and the business advantage. It is like the old REA

I use all the time the analogy of. When we first began to put electricity, if you were used to baking on a wood stove—you may not

have ever done that, Senator, but I do remember that in my household. You did it, chopped the kindling. It was a part of your daily

activity. Your recipes were geared to baking on a wood stove. Why

did you need to buy a new stove? Why did you need to do this?

Why did you need a monthly electric bill? Your life was going on

pretty much the way it was. But we went out at the old REA and

actually did demonstrations. They took the circus on the road. They

showed housewives in rural America how to use an electric stove

or an iron or washing machine. It was a huge cultural shift.

I do not think that analogy could be lost in today’s technology.

How do we help people learn how it helps them make their lives

and their businesses better?

Senator BUNNING. Dr. Smith, you mentioned some things that

the extension program was getting into. Can they also get into this

type of educational program that I was just speaking about?

Mr. SMITH. Yes, absolutely. And, in fact, some initial efforts have

been made, not just in Kentucky, but also in other States. Ms. Legg

mentioned entrepreneurship, and we believe that entrepreneurship

can be cultivated and taught. There are programs in Appalachian

Ohio which focus on entrepreneurship development that are partnerships of the State government and the extension service. We

have a small program that is about to start in the Morgan County,

Menifee County area, around the IT Center in Morgan County,

that focuses on development of an entrepreneurial nucleus in those

counties and building the networks, providing them with the information resources. And as part of that, building the awareness and

the access to that culture of leadership and entrepreneurship.

I think that it is a very important opportunity and responsibility

of the extension service, of the community and technical college

system, and of State government and the Federal Government as

well. The development districts and others, small business development centers can all be a part of this, and they all need to be.

But extension, because of our trusted position in every county seat

51

has a unique role to play, and we intend to begin exploring that

opportunity.

Senator BUNNING. Mr. Haney, you mentioned the tobacco buyout,

and I want to pursue that to a degree. The tobacco Senators here

in the U.S. Senate have been meeting off and on since the beginning of this session, trying to come up with some kind of viable

piece of legislation. And we keep running into the same problem.

How are we going to pay for it? I think we can solve the problem

of the buyout if we can find the dollars to do it.

Does somebody from your community and/or your organization

have an idea where we can find the dollars to—now, I do not want

to get back to Phase 1 and Phase 2 because that is ancient history

and it is water over the dam. We had an opportunity 5 years ago,

and some of our leading spokesmen for buyout at that time—Senator McConnell said do not leave this on the table. Unfortunately,

everybody in the farming community thought that the quotas

would not be now 40 percent of what they were at that time, and

that is about where they are at.

Can you advance some type of system where we can go to buyout

at the levels that we have talked about, 12 and 8, and take care

of everybody that is involved in growing burley and dark-leaf tobacco in Kentucky?

Mr. HANEY. Yes, sir, I think—you mentioned the 8 and 4, and

I think that is kind of stuck in rural Kentucky. Anywhere you go

in the State of Kentucky or most any tobacco State, they are talking about $8 and $4 being the value of the quota, depending on if

you are a quota owner or if you are a grower.

I personally do not see any way to have a quota buyout without

it being tied to FDA legislation. I know that some people would like

to think about other ways of doing that, and, of course, we are open

to talk about it anyway. But we think FDA legislation is probably

the most legitimate way to fund this, and it would be a user fee,

an assessment on the product, all tobacco products, not just a few

but all tobacco products sold in the United States.

Senator BUNNING. And part of that you think can be sold because

those who fought us so vigorously in the past as far as growing

tobacco would be amenable to the buyout because of the FDA’s involvement in the controlling of that growing on the farm? Is that

why you think that they may be willing?

Mr. HANEY. Yes, sir. I think there is a lot of people that have

been opposed to tobacco production over the years that would like

to see Federal regulation of that industry or especially those products. I guess with the entrepreneurial spirit of rural America and

many farmers that I know, when you have somebody really wanting to have Federal regulation of tobacco, and there are people that

really need a tobacco buyout, then I think it is time to sit down

and talk and maybe negotiate.

Senator BUNNING. Let me ask you the question that constantly

comes up in our meetings. Do farmers in Kentucky and in the

other tobacco States expect to have a program that is still there to

back up after a buyout occurs?

Mr. HANEY. I think there is a need for not the program per se

that we have right now. I do not think anyone says that the program that is existent is the one that we need in the future. It is

52

not exactly filling the need right now, and that is the need for some

change.

However, I think there is a need for a structure, some structure

of the industry, especially through a transition period. I just cannot

hardly describe what tobacco and tobacco production, the importance it plays in rural Kentucky, especially, Senator, in the northeastern counties of Kentucky.

Senator BUNNING. You do not have to. I used to represent all

those counties.

[Laughter.]

Mr. HANEY. I know that, sir. And even in eastern Kentucky and

where I live, it is very important to a lot of people. Now, I know

you think maybe I live in urban America, but I really do not. Somerset is a nice size town, but I live out in a little town called

Nancy, agriculture-based. I have been in the fruit production all

my life, and tobacco has been grown in my family for years and

years and years.

However, where we live in Kentucky, light industry is now there.

The medical industry is a huge employer. People are able to have

off-farm income, not necessarily dependent upon tobacco production. We live in a community that is so fortunate to be able to do

that. But as you know, most communities, especially in eastern

Kentucky, where small farms are there, no industry, those people

are so dependent upon the tobacco production. So for at least a

transition period—we all know that tobacco production is down and

going to stay down. Domestic use is on the decline, and domestic

purchasing is on the decline. We see the handwriting on the wall.

But we do need help in a transitioning period.

Senator BUNNING. Dr. Smith, do you see the conversion of the

rural economy from—I will give you an example. Robertson County

is 85 percent dependent on tobacco; Mason County that I represented is right around 80 percent dependent on tobacco. Do you

see the ability of our rural counties in Kentucky to convert, bring

in small business people and have those entrepreneurs that you are

talking about take at least a portion of that economy on rather

than the—believe me, I understand the grip and the heritage that

was brought from Virginia to Kentucky at the beginning, and that

heritage is still there on growing burley tobacco in Kentucky and

other kinds of tobacco products. But do we have the ability?

Mr. SMITH. Yes, I believe we do. I painted a fairly negative picture of nonfarm employment in rural America, but opportunities

remain. And throughout most of the 1990’s, nonfarm employment

in rural areas was a success story through rural manufacturing

and other enterprises.

Counties like the ones you mentioned have to diversify. Regardless of the outcome of the tobacco programs and tobacco production

in those areas, they will either become commuting locations where

people go to Cincinnati or northern Kentucky for jobs, or they will

find ways to diversify. And I think they have many opportunities:

Small businesses, different agriculture and natural resource-related opportunities. Forestry and value-added timber production is

a developing success story in parts of eastern Kentucky.

There are opportunities like that in many parts of the State.

There will be no single answer that works for each location in each

53

geographical area. It will depend very much on the entrepreneurship, the leadership, and the initiative coming from those homegrown enterprises. I think that we cannot emphasize enough the

importance of not relying totally on recruitment of outside businesses, that we have to grow our own in Kentucky and encourage

and support those counties as they attempt to do.

Senator BUNNING. I have just been informed that the Federal Reserve lowered the Fed fund rate by one-quarter of a point. Unfortunately for us, it should have gone 50 basis points instead of 25. But

Alan Greenspan is not right all the time.

[Laughter.]

Let me ask, and you brought this up, Mr. Haney, about prescription drugs and health care for our seniors in rural Kentucky and

rural America. We are working on a bill, as you well know, that

will for the first time in over 30 years do something to Medicare

that will allow a prescription drug benefit to be added to not only

Medicare Part B, but also we will have other options. They will all

be private sector options, and it will give what I consider a generous benefit to the neediest of the needy in not only Kentucky but

all over this country. From 160 percent of poverty down, the most

we will charge, starting in 2006, is a 10 percent premium. That is

all you will have to pay, down to 2.5 percent if you are in the 100

percent of poverty to 74 percent.

If you are below 74 percent, Medicaid will have a wrap-around that will pick up those prescriptions for $1 and $3. That is all the

cost that the poorest of the poor seniors will have.

One thing I want you to know, we have looked at long-term care,

and that is the real bogeyman, or whatever you want to call it, because of the cost to whoever is footing the bill, whether it be the

State government, local government, Federal Government. The cost

of long-term care, as you well know, is footed by Medicaid in some

instances right now to a degree, but generally by the individuals

that are supporting the person that is in long-term care, the family.

We do not have a solution for that right now. We are looking for

solutions. We are even looking at what we call tax incentives, to

incentivize in the Tax Code the ability to buy long-term care and

have it pretaxed dollars. In other words, if you pay for it, you do

not have to pay income tax on the dollars you spend on Medicare

or for long-term care for your family member, whether they are a

senior or whether they are not. Some people are not always senior

when they go into long-term care. We have quite a few people, in

fact, that are not senior citizens. However, generally speaking, they

mostly are.

We hope we can get that job done. I know we are going to get

the Medicare prescription drug bill out of the Senate on Thursday

evening of this week, unless some catastrophe befalls us, and we

will get it out of the House sometime Friday morning by 3 a.m. or

4 a.m., and we will get it to conference. And that is where the

sticky part starts to get a bill that we can bring out of conference

and everybody can continue to vote for.

Presently, I think we have about 80 votes in the Senate or up

to 80 votes for the bill that is on the floor. And I think it is very

important to our seniors to understand what we are trying to do.

You brought that out, and I thought I would just mention that.

54

I appreciate you all coming because rural America sometimes

gets left behind and left out, particularly as far as economics is

concerned. They have been there forever. They did their thing the

same way, and they are the hardiest of the hardy. The salt of the

earth are the people that live in rural America. And in Kentucky,

we have an unusually large portion of our families that live in

rural America. Your ideas and your thoughts on this subject are

deeply appreciated.

Thank you all for coming. This hearing is adjourned.

Ms. LEGG. Thank you, Senator.

Mr. SMITH. Thank you.

Mr. HANEY. Thank you very much.

[Whereupon, at 2:50 p.m., the Subcommittee was adjourned.]

[Prepared statements supplied for the record follow:]

55

PREPARED STATEMENT OF HILDA GAY LEGG

ADMINISTRATOR, RURAL UTILITIES SERVICE

RURAL DEVELOPMENT MISSION AREA

U.S. DEPARTMENT OF AGRICULTURE

JUNE 25, 2003

Chairman Bunning and Members of the Committee, thank you for the opportunity

to participate in this hearing, ‘‘The Economy in Rural America,’’ the second in a series of hearings entitled: ‘‘Jumpstarting the Economy.’’ You are to be commended

for this careful and thoughtful approach to creating a public forum for both understanding the problems and the challenges that we face and seeking answers to those

challenges.

As Administrator of the Rural Utilities Service and as a part of the USDA Rural

Development team, I work with our programs that provide financing for infrastructure construction for electric power, telecommunications, and water and waste disposal services. I come from a background that includes building economic development in Kentucky and working with the Appalachian Regional Commission. The

programs of the Rural Utilities Service are just a part of the Rural Development

mission area that also finances Rural Housing, Community Facilities, Rural Business and Cooperative Services programs.

Our focus in the Rural Development mission area is to help rural areas achieve

economic and social gains that are solid and long lasting. When you are working

to build jobs and economic development in small rural communities, you are always

looking for the home run that brings in hundreds of new jobs. But we must be mindful that quite often, the long-term gains are made with adding a few jobs to a small

business or helping local business leaders target industries that add value to the

existing community.

The Federal Reserve Bank of Kansas City’s Center for the Study of Rural America

reports in their May Overview, that the rural economy continues to hold steady,

with rural jobs growing slightly by 0.7 percent in February compared with a year

earlier. Job growth is increasing at a slightly higher percentage in rural areas compared to job growth in Metropolitan areas according to the Bureau of Labor Statistics. The overall economy appears to be gaining strength, and unemployment in both

metro and nonmetro areas can be expected to decline as growth picks up this year

and next year.

While no one is claiming we are in a boom cycle again, it appears that the rural

economy is heading in the right direction. President Bush’s initiatives on tax cuts,

business growth, and energy are all a vital part of this equation.

There are a number of things that can be done to help stimulate rural economic

growth. There is no one answer for fostering rural economies because like the rest

of the Nation, rural America is very diverse. Rural America is an eclectic mix of

races, ethnic groups, terrain, climate, amenities, businesses, and institutions. While

agriculture is certainly prominent, no one industry dominates the rural landscape,

nor does a single pattern of population decline or growth exist for all rural areas.

Diversity presents opportunities for creative answers and unique partnerships.

At the beginning of the 21st Century, according to the U.S. Census and the

USDA’s Economic Research Service, rural America comprises 2,305 counties, contains 80 percent of the Nation’s landmass, and is home to 56 million people. Seven

out of eight rural counties are dominated by manufacturing, services, and other employment not related to the production of food and fiber.

In Secretary of Agriculture Ann Veneman’s book ‘‘Food and Agriculture Policy,’’

published last year, it is pointed out that despite seven out of eight rural counties

being dominated by nonfarming activities, this in no way diminishes the importance

of ranching and farming in many rural areas. However, in many communities, this

diversity provides a strength that will hold up in times of too much rain or not

enough rain.

The economic resources of many rural communities draw from three basic assets:

Natural attractions for tourism and retirement; low-cost, high-quality labor and

land for manufacturing; and natural resources for farming, forestry, and mining.

This is quite different from a half a century ago when a quarter of our population

was engaged in farming and ranching.

The role of the Rural Development mission area of USDA is to provide an effective

set of tools to help these diverse rural communities improve their economic growth.

One challenge we face is infrastructure. On the national level, we have seen a serious downturn in infrastructure development, especially in the telecommunications

field. In more urban areas, there was a great deal of ‘‘dark’’ or unused fiber optic

56

laid with the belief that ‘‘if you build it, they will come.’’ On the other hand, very

little dark fiber exists in rural America.

The fact is we had to relearn an old lesson, that a good business plan is necessary,

no matter what the technology. High-speed telecommunications services are mandatory for new jobs for not only the future, but also today. Just like a good road, fiber

optics requires a use for it to be beneficial to add to economic structure of a rural

area. There is no doubt, without that infrastructure being built, ‘‘they will not

come!’’ Modern infrastructure is necessary to bring in many things that are needed:

Businesses, quality housing, modern schools, quality health care, dependable electric

power, safe drinking water, and ecologically sound waste disposal. In the same manner, without houses, businesses and strong communities, there is no need for modern infrastructure. Just to install broadband telecommunications capability without

a plan for its use, it is high stakes rolling of the dice.

Rural America finds itself in the midst of a revolution of change in the areas of

telecommunications and electric infrastructure. The Telecommunications Act of 1996

has created an interesting and complicated landscape. Many of the larger providers

have chosen to place their resources in the more densely populated areas of the

country. But we see a vast number of entrepreneurs, from the small traditional telecommunications companies to new start-up businesses, stepping bravely into this

new and hopefully competitive marketplace. The general investment community is

very hesitant today to finance any telecommunications development needs, and this

has made our job at the USDA far more challenging. We want to provide funding

for high-speed telecommunications development, but we also want to continue our

history of high-quality loans that are a good use of taxpayer dollars entrusted to

us by the Congress.

Today’s high-speed telecommunications offer as much new opportunity to rural

communities, businesses, schools, and health care facilities as the availability of

electric power and telephone service did some half century ago. Along with this infrastructure is the need for high-quality education. If rural America is to continue

to provide a high-quality workforce, a base of customers with good incomes, then

educating and training that workforce is vital to economic development.

We are seeing examples of economic development that is making a difference in

the lives of rural citizens. When Secretary Veneman and Under Secretary Tom Dorr

announced the new Broadband Loan program this January, we heard testimony via

telecommunications video conferencing with a businessman and a farmer in Kansas

as to what the availability of high-speed technology meant to them.

For Osborne Industries, a local agricultural services manufacturing company, a

high-speed connection better enables them to manage and market their products

competitively in domestic and international markets far from Osborne, Kansas. The

local farmer told how he was not only better able to follow markets and weather

information, but also his wife was able to further her education through telecommunications without long drives and time away from her family. Use of telemedicine is bringing improved quality health care that is often life saving to rural

citizens.

Clean, safe drinking water and ecologically sound waste disposal is an equally

vital aspect of both rural health needs and quality of life for rural citizens. There

is no more basic human need than clean, safe drinking water. USDA, through the

Rural Utilities Service, provides loans and grants to over 8,000 small municipal and

rural water systems. If you are going to recruit a business to a small community,

the first question they will ask is in regard to the availability of water and waste

infrastructure. If the business involves manufacturing, the need is ever greater.

We see the development of renewable energy not only to improve the availability

of energy to rural residents, but also as a rising economic opportunity. The future

development of ‘‘power farming’’ will be a new crop in many cases for farms and

rural residents. Ethanol, solar, and wind are the most economically competitive energy sources at this time, but development of bio-energy projects continues to improve the economic future for farms and rural businesses. Use of traditional farm

crops such as soybeans and corn for industrial bio-products will increase the demand for those crops over time.

The challenges remain. Some areas of rural America are seeing population growth

and with it, economic development. Other areas, such as the Great Plains and parts

of Appalachia continue to experience out-migration. This places strains on local

economies and under cuts the tax base for local and State government. Many of our

Native American tribal reservations, as well as other pockets of other rural areas,

still face high unemployment and poverty, coming from isolation, lack of infrastructure, and the need for innovative leadership. As a Nation, we are as strong as our

weakest link. Low percentages of unemployment sound a little hollow to that person

that is unemployed. That person’s unemployment level is 100 percent.

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It is always easy to look at national numbers and percentages, while forgetting

the individual needs of rural citizens and communities. USDA, like any other Federal agency, does not have easy answers. We do find that by working with our rural

partners of community leaders, we can make gains in rural communities and that

turns that big ship in a different direction, one degree at a time. The USDA Rural

Development field staff, in State and local offices, still serves as our front line in

working directly with rural leaders for stronger communities.

Building quality infrastructure, housing and businesses based on long-term plans

and good business models makes an economy grow. Local leadership and citizen

commitment is a key ingredient to making these programs work.

In an article in the Economic Review, First Quarter of 2003, Jason Henderson and

Nancy Novack do a good job of summing up what must be done in rural areas for

economic growth to occur. ‘‘To compete in the future, rural industries will need to

be innovative in finding business solutions that go well beyond low-cost land and

labor. Success will depend on management skills in addition to production capabilities. New products will need to be developed. New technologies will need to be

adopted to increase production efficiencies and create a new competitive edge for

rural industries.’’

This will require strong education to be available to keep up with a changing

world. It will require available capital for business development. And it will require

strong rural leadership to make these things happen at the local level. Partnerships

with other local communities, on a regional basis, and often with the larger metropolitan areas will be key in rural economic growth of the future.

I appreciate Chairman Bunning’s leadership and the support of Congress as you

work to continue to make rural America a strong and vital place to live and work.

Thank you.

—————

PREPARED STATEMENT OF M. SCOTT SMITH

DEAN AND DIRECTOR, COLLEGE OF AGRICULTURE, UNIVERSITY OF KENTUCKY

JUNE 25, 2003

Mr. Chairman and Members of the Subcommittee, thank you for the opportunity

to share these remarks on rural economic development. I serve as the Dean of the

University of Kentucky’s College of Agriculture and the Director of the Kentucky

Cooperative Extension Service. Rural economic issues largely define the mission of

our organizations.

Rural counties and small cities in Kentucky, and throughout the Nation, face

daunting economic challenges. The recent economic slowdown compounded with significant changes in agriculture are threatening job and income security. The current

economic climate has had a particularly negative effect on rural areas compared to

metropolitan areas, and on rural economies like Kentucky’s compared to the rest of

the United States.

• Nationally, manufacturing employment from 2000–2002 has declined 10.1 percent

in rural areas, compared to 7.3 percent in metro areas. (Drabenstott, 2003)

• The rural service sector is also struggling to maintain employment.

• Rural construction activity is slow.

• And rural recreation and tourism has not fully recovered from 9/11.

• On top of this, in tobacco states like Kentucky, the shrinking quota and the

changing program will continue to have dramatic effects, not just on farmers but

on entire rural communities.

Although the farm economy was generally described as recovering in 2001 and

2002, much of this advance was due to transfer payments. We all appreciate the

uncertainty and undesirability of relying on farm programs to sustain the rural

economy. However, even in the best of times for agriculture, farm-level advancement, while remaining crucial, cannot by itself support the full weight of rural development. Consider that an increasing fraction of farm families are economically

dependent upon off-farm rural employment opportunities. Farm and rural nonfarm

economies are more than ever interconnected.

Unfortunately, declines in the manufacturing sector could make business recruitment a realistic option for fewer and fewer rural communities. In such circumstances, retaining local businesses, creating new local enterprises, and creating new

sources of local income become indispensable to improving the local economy. To do

this both rural businesses and farms will need greater technical assistance to identify new income opportunities and enhance their products and services.

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Integrative, Comprehensive Strategies

Rather than speak about the specific policy strategies or the economic issues in

rural development, I would like to take this opportunity to comment on the general

characteristics of at least one promising rural economic development initiative in

Kentucky.

Complex, multidimensional problems demand integrative, comprehensive strategies. Multiple ingredients must be assembled for success: Infrastructure, leadership

and entrepreneurship, access to capital, a skilled and highly productive workforce,

access to and ability to use information age technology. Service, manufacturing,

Government, and farming sectors all have to be considered. New bridges between

new partners will be essential.

One Kentucky program meeting this description is the Kentucky Agricultural Development Fund. Uniquely among the States, Kentucky has invested 50 percent of

its share of the National Tobacco Settlement, well over one hundred million dollars

to date, in programs supporting agricultural and rural development. This massive

and innovative program has benefited from the full participation of State government, farm and community organizations, the University’s Land Grant system and

hundreds of local leaders. Beyond investing in the on-farm profitability and diversification, the Fund has supported projects in value added and alternative products,

agri-tourism, rural infrastructure, entrepreneurship and leadership development,

marketing, and resource conservation. This is surely one of the Nation’s most comprehensive and ambitious rural development initiatives.

Broadening the Land Grant Mission

Finally, I want to touch on the role of organizations like mine, the Land Grant

colleges, in rural economic development. As many public universities around the Nation, including the University of Kentucky, are mandated to become an even greater

force for economic development, some States are implementing a new and broader

mission for the Land Grant system of Cooperative Extension and Experiment Station research. This new Land Grant approach fosters research and development and

technology transfer in a wide array of enterprises including, but certainly not limited to, farming. In Kentucky, we are building rural research and extension partnerships in engineering, health, business management, and even fine arts. Our diverse

partners in these areas understand the power of the Statewide, county level Cooperative Extension network for rural development and the connection of this network

to University information and expertise. Just as the Land Grant institutions led the

advancement of the Nation’s farming economy in the last century, they can serve

the broader mission of rural economic development in years to come.

I thank you for the opportunity to comment and for your thoughtful deliberations

on the crucial and challenging issue of rural economic development.

—————

PREPARED STATEMENT OF MARK HANEY

VICE PRESIDENT, KENTUCKY FARM BUREAU FEDERATION

JUNE 25, 2003

Mr. Chairman and Members of the Subcommittee, I appreciate the invitation to

make brief comments on the status of the rural economy to the Subcommittee on

Economic Policy. My name is Mark Haney, I am Vice President of the Kentucky

Farm Bureau and I am also a Board Member on the Monticello Banking CompanySomerset Bank. I own and operate a 70-acre apple and peach orchard in Somerset,

Kentucky, where we manufacture and market our own value-added frozen apple

pies. My farming operation also entails 90-head cow/calf operation and a 38,000

pound tobacco allotment. Somerset lies in southeastern Kentucky.

I am excited that the Members of the Subcommittee chose to have a separate

hearing on the status of the rural economy. Because rural America enjoys different

advantages but also different challenges in building a vibrant economy.

Let me briefly mention the current status of agriculture since the well-being of

rural economies depends so heavily on that sector. Because of poor crop yields and

shifting farm policy, farmers are coming off of a very difficult year in 2002, in which

U.S. net farm income fell from $45.7 billion dollars to $30.2 billion dollars. Please

consider that this total loss of $15.5 billion is not just a loss to farm families but

also to many rural financial institutions.

Fortunately, economic aspects of the 2003 crop year seem to be looking up on a

national scale. Since this point last year, grain prices have been on the rise. Last

month’s projections estimate that U.S. net farm income is expected to rebound 53

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percent to $46.2 billion in 2003. While this short-term increase should make many

bankers smile, please consider that it is an increase to already unacceptable levels

we have seen in the last decade.

While agriculture is one segment of the rural economy that is not thriving, other

factors are contributing to its current sluggish conditions. First, rural America is

struggling to equip itself with the Nation’s newest form of infrastructure, telecommunications. In this era, access to broadband Internet service and mobile cellular towers is nearly as important in securing jobs and recruiting business as four

lane roads. Many State legislatures are considering programs to enhance the ability

of rural residents to gain greater access to telecommunications, but while we wait,

large businesses find it a difficult choice to locate in rural areas.

Second, the physical infrastructure of rural America needs improvement. While

State legislatures deal with slumping budgets, improvements to roads and bridges

wait. Proponents of many worthwhile new projects are being told to wait for years

until economies balance. Examples such as weekly garbage collection, animal removal, and maintenance of roadside vegetation that seem insignificant to most

Americans is not available in many rural areas. Eastern Kentucky has placed great

emphasis on maintaining the environment through the leadership of Congressman

Hal Rogers and his PRIDE program. With this project, we have done a good job of

cleaning up unsafe dumps and litter. I think that we need to consider a greater nationwide focus on these kinds of ideas.

Last, the lack of availability of affordable health care plagues rural communities,

but I know that rural America does not suffer from this alone. Rural America is

built on small business that often cannot afford group policies to insure their employees. The Kentucky Farm Bureau strongly believes the Associations Health Plans

legislation that recently passed in the House will help to remedy this burden. Also,

I think we must pay attention to the lack of adequate long-term care for seniors;

since outlets for special needs assistance in nursing homes are sometimes hours

from rural communities.

Despite burdens that make it difficult for rural economies to be vigorous; rural

areas do have some advantages not provided to our urban friends. Rural investments tend to be more stable than the fluctuating stock market more commonly

used in urban areas. Rural Americans typically have their savings tied to fixed assets such as land, buildings, and equipment. In other words, we do not get rich

quick but we do not get poor quick either.

The sense of community in rural America helps its residents endure tough economic situations. The hard times do not come and go as often in rural areas but

stay longer when they hit. Although agriculture can be a very competitive business

you will frequently see farmers working together to help each other get their crops

planted or harvested before seasonal deadlines hit. The entrepreneurial spirit is also

creating new ideas and strategies for enhancing economic development through

tourism and other value-added businesses in rural communities across the United

States.

Finally, our natural resources provide us opportunities not granted to urban

areas. From coal in the Appalachian region to oil fields in the southwest, but most

obviously the fertile land from which we derive the world’s food supply, our resources provide the backbone for our economies. That is why it is evermore important to be mindful of the impact unreasonable environmental regulations can have

on rural America. What works for downtown Philadelphia, Pennsylvania, does not

always work for Inez, Kentucky. Some environmental regulations can strip rural

communities from the staple of their economies.

Please allow me one minute to mention an issue that is of utmost importance to

the rural economy in Kentucky and other States in the Southeast region of the

country. The status of the tobacco industry is in complete disarray. Tobacco, historically, the States largest cash crop has had a profound effect on the State’s rural

economy. Kentucky is a rural State. And agriculture is the largest economic contributor to the State’s economy. According to most recent statistics, 13.6 of 25.4 million

acres, or 53 percent, is declared farmland. The average farm size in Kentucky is

155, compared to the same national statistic of 436. These numbers indicate Kentucky to be a very small-scale agricultural State. Kentucky ranks fourth in the

United States in total number of farms. All characteristics of Kentucky’s agriculture—size, scale, and frequency of farms—is largely influenced by a strong reliance on the production of tobacco.

Kentucky’s geographical characteristics, climate, and soil types; especially in the

eastern portion of the State, are an ideal match for the very specific requirements

in the production of the crop. Throughout Kentucky’s history, the production of

tobacco has been the strongest financial resource to a vast majority of rural communities throughout the Commonwealth. For most of the 20th Century, tobacco marVerDate 11-MAY-2000 09:07 Apr 21, 2004 Jkt 000000 PO 00000 Frm 00063 Fmt 6621 Sfmt 6621 93128.TXT SBANK4 PsN: SBANK4
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kets and warehouses were as prevalent as U.S. Post Offices in the downtown areas

of rural Kentucky.

Rural communities in Kentucky are currently witnessing a dramatic revolution.

Due to a variety of factors, the demand for tobacco has decreased from 704.5 million

pounds in 1997 to 289.5 million pounds in 2003. This is a 59 percent decline over

7 years. Since tobacco production operates within a supply management, quota system, lease costs have skyrocketed from a 26 cents per pound average to a 62 cents

per pound average over a similar time period. Current concepts for Federal legislation can take a large step in helping stabilize the tobacco industry and thus rural

economies throughout the Bluegrass State. It would give farmers the resources to

retire or venture into more promising industries while still being able to remain in

the rural areas that they were born and raised in. Tobacco buyout legislation will

not only help our economies but also can have a nationwide health benefit if it is

tied to the FDA’s regulation of tobacco products. I will not spend anymore of your

time on the details of tobacco buyout legislation, but I encourage you to work with

the Senators from tobacco States who will most assuredly be contacting you about

this issue.

Thank you again, Mr. Chairman, for the opportunity and for taking an interest

in rural areas. I look forward to answering any questions you or the Members of

the Subcommittee have.