<DOC>
[110th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:33754.wais]
FISCAL CHALLENGES AND THE
ECONOMY IN THE LONG TERM
=======================================================================
HEARING
before the
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
HEARING HELD IN WASHINGTON, DC, FEBRUARY 28, 2007
__________
Serial No. 110-10
__________
Printed for the use of the Committee on the Budget
Available on the Internet:
http://www.gpoaccess.gov/congress/house/budget/index.html
______
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COMMITTEE ON THE BUDGET
JOHN M. SPRATT, Jr., South Carolina, Chairman
ROSA L. DeLAURO, Connecticut, PAUL RYAN, Wisconsin,
CHET EDWARDS, Texas Ranking Minority Member
JIM COOPER, Tennessee J. GRESHAM BARRETT, South Carolina
THOMAS H. ALLEN, Maine JO BONNER, Alabama
ALLYSON Y. SCHWARTZ, Pennsylvania SCOTT GARRETT, New Jersey
MARCY KAPTUR, Ohio THADDEUS G. McCOTTER, Michigan
XAVIER BECERRA, California MARIO DIAZ-BALART, Florida
LLOYD DOGGETT, Texas JEB HENSARLING, Texas
EARL BLUMENAUER, Oregon DANIEL E. LUNGREN, California
MARION BERRY, Arkansas MICHAEL K. SIMPSON, Idaho
ALLEN BOYD, Florida PATRICK T. McHENRY, North Carolina
JAMES P. McGOVERN, Massachusetts CONNIE MACK, Florida
BETTY SUTTON, Ohio K. MICHAEL CONAWAY, Texas
ROBERT E. ANDREWS, New Jersey JOHN CAMPBELL, California
ROBERT C. ``BOBBY'' SCOTT, Virginia PATRICK J. TIBERI, Ohio
BOB ETHERIDGE, North Carolina JON C. PORTER, Nevada
DARLENE HOOLEY, Oregon RODNEY ALEXANDER, Louisiana
BRIAN BAIRD, Washington ADRIAN SMITH, Nebraska
DENNIS MOORE, Kansas
TIMOTHY H. BISHOP, New York
[Vacancy]
Professional Staff
Thomas S. Kahn, Staff Director and Chief Counsel
James T. Bates, Minority Chief of Staff
C O N T E N T S
Page
Hearing held in Washington, DC, February 28, 2007................ 1
Statement of:
Hon. John M. Spratt, Jr., Chairman, House Committee on the
Budget..................................................... 1
Hon. Paul Ryan, a Representative in Congress from the State
of Wisconsin............................................... 2
Hon. Ben S. Bernanke, Chairman, Board of Governors, Federal
Reserve System............................................. 5
Prepared statement of.................................... 10
Response to Ms. Kaptur regarding the fees paid to Wall
Street firms for underwriting Treasury debt............ 31
FISCAL CHALLENGES AND THE
ECONOMY IN THE LONG TERM
----------
WEDNESDAY, FEBRUARY 28, 2007
House of Representatives,
Committee on the Budget,
Washington, DC.
The committee met, pursuant to call, at 10:00 a.m., in room
210, Cannon House Office Building, Hon. John M. Spratt, Jr.
(Chairman of the committee) presiding.
The Committee met, pursuant to call, at 10:00 p.m., in room
210, Cannon House Office Building, Hon. John M. Spratt, Jr.
(Chairman of the committee) presiding.
Present: Representatives Spratt, Cooper, Allen, Schwartz,
Kaptur, Becerra, Doggett, Blumenaur, Berry, McGovern, Andrews,
Scott, Etheridge, Hooley, Moore, Bishop, Ryan, Barrett, Bonner,
Garrett, Hensarling, McHenry, Campbell Tiberi, Alexander,
Smith.
Chairman Spratt. The hearing will come to order.
I am pleased today to welcome the Federal Reserve Chairman,
Dr. Ben Bernanke, to the first appearance he has made before
the House Budget Committee for a hearing on fiscal challenges
and the economy over the long term.
I am pleased for many reasons not least of which is the
fact that Dr. Bernanke is from Dillon, South Carolina, which is
in my congressional district.
So I claim among other things the value of having his
presence here today but also the bragging rights for what he
has accomplished at the Fed where over a year's time, he has
won high marks for his short hand at the helm.
Despite historically high budget deficits, interest rates
and inflation are relatively low and our economy has been
growing at a fairly good clip or healthy pace even if that rate
has been slowing down recently.
Six years ago, we were in surplus. Our budget was in
surplus and black for the first time in 30 years, not just in
the year 2000, but in 1998 and 1999 as well. As a result, the
federal government paid down nearly $400 billion of debt held
by the public.
And President Bush came to office with an advantage that
few Presidents have enjoyed, a budget in balance and surplus by
$236 billion a year before he took office and in balance that
year, 2000, without including the Social Security Trust Fund.
As a consequence, a number of members took up a new idea
that had a corny name, lock box, but has a serious substantive
core to it. Basically the idea was that we would quit using the
Social Security surplus to buy up new Treasury debt and instead
use it to buy down outstanding Treasury debt.
The idea was that if we pursued this policy diligently,
religiously, by 2020 or thereabouts, when 77 million baby
boomers begin claiming their Social Security and Medicare
benefits, Treasury would be less encumbered by public debt,
more solvent, and thus better able to meet the claims of the
baby boomers.
And by buying down existing Treasury debt, we would add to
national savings, roll the cost of capital, and make the
economy more productive and free us from dependence on foreign
capital.
After all, one way to make entitlements more affordable,
this will make our people more productive, and that was part of
the idea behind the so-called lock box.
We said to the President when he began to unveil his
proposal, which took a different turn and he was relying upon
projected surpluses of $5.6 trillion, that while we may be
sitting on an island of surpluses, we were surrounded by a sea
of debt, long-term debt, and that should be taken into account
now that we have the wherewithal to begin doing something about
the problem.
The President, however, took a different path. He proposed
a budget that over time included tax cuts close to $2 trillion.
The numbers that were projected in 2001 did not obtain. They
were seriously wide of the mark.
And so six years and $3 trillion in debt later, we find
ourselves on a path that is described everywhere as
unsustainable, deficit down a bit, down to $248 billion last
year. That is good news.
But, Dr. Bernanke, you warn in your testimony that this
could very well be the lull before the storm. We are glad to
have you here today to help us understand the perils of the
path we are now taking and how we can employ the federal
budget, which constitutes 20 percent of our GDP, to shore up
our shortfall in savings and to move our economy and our
country back towards long-term solvency.
We look forward to your testimony, and we appreciate your
coming today.
Before turning to you for your statement, though, I would
like to recognize Mr. Ryan, our Ranking Member, for a statement
of his own.
Mr. Ryan. I thank the Chairman for yielding, and I am
pleased to have Chairman Bernanke here today. It is nice to
have you with us.
I just wanted to quickly go on the area where the Chairman
went to. If you could call up chart one, please.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Mr. Ryan. We are here to discuss in the Budget Committee
how we balance the budget, and that is a very important and
worthy goal. But if we simply just balance the budget without
addressing the underlying fundamentals of our budget issues, it
will be a temporary thing. If we do not balance the budget
without actually addressing the systemic spending problems
underneath our budget, that is the problem that we are
experiencing.
If you take a look at entitlement spending under the Bush
Administration, under the Clinton Administration, under
Republican Presidents, Democrat Presidents, Republican
Congresses, Democratic Congresses, we have had this problem in
front of us for quite some time.
As you can see, all other spending is getting crowded out
and we are piling on interest and entitlement spending. And we
are going to hear a lot of talk about the tax cuts as perhaps
the route to fix and balance the budget.
But if we balance the budget without addressing the
underlying, unsustainable growth rates of entitlement spending,
we will only balance the budget temporarily and go quickly back
into deficits because of the growth of entitlements.
If you go to chart two, please.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Mr. Ryan. This chart, I think, does a good job of
illustrating the situation we have in front of us. This looks
at spending in relation to tax revenues, which shows us in two
ways.
First, if we keep the current tax laws in place just as
they are, current tax rates, current child tax credit, current
marriage penalty relief, and so on, that is the lower line, the
blue line.
If we allow all those tax cuts to go away at the end of the
decade as they are scheduled to expire, meaning a tax hike of
$153 billion in 2011, tax hike of $254 billion in 2012, and
larger amounts thereon after, that is the red line. These
automatic tax increases are insumed in CBO's current law
baseline.
Notice that either way, with or without the tax cuts,
making them permanent or allowing them to expire, they do not
come anywhere close to balancing the budget over the long run.
They are quickly outpaced by the spending that we are on auto
pilot right now with our entitlement programs.
So clearly what we face is an immense problem of spending.
This is the problem right at hand right now and it is not going
away.
Members of both sides of the aisle are going to debate
about how just to accomplish and address these challenges. But
I think it is very important that as we look at the performance
of our economy, as we look at whether or not high tax rates on
capital, high tax rates on families and businesses is the right
way to go to a balanced budget or not, even if we go down the
route of letting all the tax cuts expire, it does not come
anywhere close to solving our fiscal problems, which is
unsustainable entitlements.
And that is the issue that I think we ought to be
addressing, and that is the issue I would love to get your
opinions on, Chairman Bernanke.
Also, I will just simply say we had an interesting day in
the stock market yesterday with the precipitous drop. I know
all of us are very concerned about that, and I think we would
love to get your reflections should you care to share them with
us on that point as well.
And with that, I would like to yield back the balance of my
time. Thank you, Chairman.
Chairman Spratt. Thank you, Mr. Ryan.
Dr. Bernanke, thank you again for coming.
Before proceeding, let me ask unanimous consent that all
members be allowed to submit an opening statement for the
record at this point.
In addition, Dr. Bernanke, we will be glad to make your
statement a part of the record so that you can summarize parts
of it if you please.
The floor is yours. Thank you again for coming.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS,
FEDERAL RESERVE SYSTEM
Mr. Bernanke. Thank you.
Chairman Spratt, Representative Ryan, and other members of
the Committee, I am pleased to be here to offer my views on the
federal budget and related issues.
At the outset, I should underscore that I speak only for
myself and not for my colleagues necessarily at the Federal
Reserve.
My testimony will focus on the long-term budget outlook and
will draw on the most recent set of long-term projections from
the Congressional Budget Office issued in December 2005.
The CBO constructed its projections based on the
assumptions that real gross domestic product would rise about
three and a half percent per year in 2005 and 2006 and at the
rate of 2.9 percent per anum from 2007 to 2015.
The growth projections through 2015 were in turn based on
the assumptions that trend labor force growth will average 0.8
percent per year and that trend labor productivity growth in
the nonforeign business sector will average 2.4 percent per
year.
The CBO has since updated those assumptions for the
purposes of other analyses, but the revisions were not large
enough to materially alter the broad contours of the fiscal
outlook.
As to the longer-term outlook, the CBO assumed that the
growth rate of real GDP will average about two percent per year
starting around 2020. While such projections are subject to
considerable uncertainty, the CBO's assumptions provide a
sensible and useful starting point for assessing the budget
situation over the long run.
Before discussing the longer-run outlook, I will comment on
recent budget developments. As you know, the deficit in the
unified federal budget declined for a second year in fiscal
year 2006, falling to $248 billion from $318 billion in fiscal
2005.
So far in fiscal 2007, solid growth in receipts, especially
in collections of personal and corporate income taxes, has held
the deficit somewhat below year earlier levels. Of course, a
good deal of uncertainty still surrounds the budget outcome for
the year as a whole.
Federal government outlays in fiscal 2006 were 20.3 percent
of nominal gross domestic product. Receipts were 18.4 percent
of GDP and the deficit, the difference of the two, was 1.9
percent of GDP. These percentages are close to their averages
since 1960.
The on budget deficit, which differs from the unified
budget deficit, primarily and excluding receipts and payments
of the Social Security system, was $434 billion or 3.3 percent
of GDP in fiscal 2006.
As of the end of fiscal 2006, federal government debt held
by the public, which includes holdings by the Federal Reserve,
but excludes those by the Social Security and other trust
funds, amounted to 37 percent of one year's GDP.
Official projections suggest that the unified budget
deficit may stabilize or moderate further over the next few
years. Unfortunately, we are experiencing what seems likely to
be the calm before the storm. In particular, spending on
entitlement programs will begin to climb quickly during the
next decade.
In fiscal 2006, federal spending for Social Security,
Medicare, and Medicaid together totaled about 40 percent of
federal expenditures or eight and a half percent of GDP.
In the medium-term projections released by the CBO in
January, these outlays increase to ten and three-quarters
percent of GDP by 2017, an increase of about two percentage
points of GDP in little more than a decade. And they will
likely continue to rise sharply relative to GDP in the years
after that.
As I will discuss, these rising entitlement obligations
will put enormous pressure on the federal budget in coming
years.
The large projected increases in future entitlement
spending have two principal sources. First, like many other
industrial countries, the United States has entered what is
likely to be a long period of demographic transition. The
result, both of the reduction in fertility that followed the
post World War II baby boom and of ongoing increases in life
expectancy.
Longer life expectancies are certainly to be welcomed, but
they are likely to lead to longer periods of retirement in the
future even as the growth rate of the workforce declines.
As a consequence of these demographic trends, the number of
people of retirement age will grow relative both to the
population as a whole and to the number of potential workers.
Currently people 65 years and older make up about 12
percent of the U.S. population, and there are about five people
between the ages of 20 and 65 for each person 65 and older.
According to the intermediate projections of the Social
Security Trustees, in 2030, Americans 65 and older will
constitute about 19 percent of the U.S. population and the
ratio of those between the ages of 20 and 64 to those 65 and
older will have fallen to about three.
Although the retirement of the baby boomers will be an
important milestone in the demographic transition, the oldest
baby boomers will be eligible for Social Security benefits
starting next year.
The change in the nation's demographic structure is not
just a temporary phenomenon related to the large relative size
of the baby boom generation. Rather, if the U.S. fertility rate
remains close to current levels and life expectancies continue
to rise as demographers generally expect, the U.S. population
will continue to grow older even after the baby boom generation
has passed from the scene.
If current law is maintained, that aging of the U.S.
population will lead to sustained increases in federal
entitlement spending on programs that benefit older Americans,
such as Social Security and Medicare.
The second cause of rising entitlement spending is the
expected continued increase in medical costs per beneficiary.
Projections of future medical costs are fraught with
uncertainty. But history suggests that without significant
changes in policy, these costs are likely to continue to rise
more quickly than incomes, at least for the foreseeable future.
Together with the aging of the population, ongoing
increases in medical costs will lead to a rapid expansion of
Medicare and Medicaid expenditures.
Long-range projections prepared by the CBO vividly portray
the potential effects on the budget of an aging population and
rapidly rising healthcare costs.
The CBO has developed projections for a variety of
alternative scenarios based on different assumptions about the
evolution of spending and taxes. The scenarios produce a wide
range of possible budget outcomes reflecting the substantial
uncertainty that attends long-range budget projections.
However, the outcomes that appear most likely in the
absence of policy changes involve rising budget deficits and
increases in the amount of federal debt outstanding to
unprecedented levels.
For example, one plausible scenario is based on the
assumptions that federal retirement and health spending will
follow the CBO's intermediate projection, defense spending will
drift down over time as a percentage of GDP, other noninterest
spending will grow roughly in line with GDP, and federal
revenues will remain close to their historical share of GDP,
that is about where they are today.
Under these assumptions, the CBO calculates that by 2030,
the federal budget deficit will approach nine percent of GDP,
more than four times greater as a share of GDP than the deficit
in the fiscal year 2006.
A particularly worrisome aspect of this projection and
similar ones is the implied evolution of the national debt and
the associated interest payments to government bond holders.
Minor details aside, the federal debt held by the public
increases each year by the amount of that year's unified
deficit. Consequently, scenarios that project large deficits
also project rapid growth in the outstanding government debt.
The higher levels of debt in turn imply increased
expenditures on interest payments to bond holders which
exacerbate the deficit problem still further.
Thus, a vicious cycle may develop in which large deficits
lead to rapid growth in debt and interest payments which in
turn adds to the subsequent deficits.
According to the CBO projection that I have been
discussing, interest payments on the government's debt will
reach four and a half percent of GDP in 2013, nearly three
times their current size relative to national output.
Under this scenario, the ratio of federal debt held by the
public to GDP would climb from 37 percent to roughly 100
percent in 2030 and would continue to grow exponentially after
that.
The only time in U.S. history that the debt to GDP ratio
has been in the neighborhood of 100 percent was during World
War II. People at that time understood the situation to be
temporary and expected deficits and the debt to GDP ratio to
fall rapidly after the war as, in fact, they did.
In contrast, under the scenario I have been discussing, the
debt to GDP ratio would rise far into the future at an
accelerating rate. Ultimately this expansion of debt would
spark a fiscal crisis which could be addressed only by very
sharp spending cuts or tax increases or both.
The CBO projections by design ignore the adverse effects
that such high deficits would likely have on economic growth.
But if government debt and deficits were actually to grow at
the pace envisioned by the CBO's scenario, the effects on the
U.S. economy would be severe.
High rates of government borrowing would drain funds away
from capital formation and thus slow the growth of real incomes
and living standards over time.
Some fraction of the additional debt that would likely be
financed abroad would lessen the negative influence on domestic
investment. However, the necessity of paying interest on the
foreign held debt would leave a smaller portion of our nature's
future output available for domestic consumption.
Moreover, uncertainty about the ultimate resolution of the
fiscal imbalances would reduce the confidence of consumers,
businesses, and investors in the U.S. economy with adverse
implications for investment and growth.
To some extent, strong economic growth can help to mitigate
budgetary pressures and all else being equal, fiscal policies
that are supportive of growth would be beneficial.
Unfortunately, economic growth alone is unlikely to solve
the nation's impending fiscal problems. Economic growth leads
to higher wages and profits and thus increases in tax receipts.
But higher wages also imply increased Social Security benefits
as those benefits are tied to wages.
Higher incomes also tend to increase the demand for medical
services so that indirectly higher incomes may also increase
federal health expenditures.
Increased rates of immigration could raise growth by
raising the growth rate of the labor force. However, economists
who have looked at the issue have found that even a doubling in
the rate of immigration into the United States from about one
million to two million immigrants per year would not
significantly reduce the federal government's fiscal imbalance.
The prospect of growing fiscal imbalances and their
economic consequences also raises essential questions of
intergenerational fairness. As I have noted, because of
increasing life expectancy and the decline in fertility, the
number of retirees that each worker will have to support in the
future, either directly or indirectly, through taxes paid to
support government programs will rise significantly.
To the extent that federal budgetary policies inhibit
capital formation and our increases net liabilities to
foreigners, future generations of Americans will bear a growing
burden of the debt and experience slower growth in per capita
incomes than would otherwise have been the case.
An important element in ensuring that we leave behind a
stronger economy than we inherited as in virtually all previous
generations in this country will be to move over time towards
fiscal policies that are sustainable, efficient, and equitable
across generations.
Policies that promote private as well as public saving
would also help us to leave a productive economy to our
children and grandchildren. In addition, we should explore ways
to make the labor market as accommodating as possible to older
people who wish to continue working as many will as longevity
increases and health improves.
Addressing the country's fiscal problems will take
persistence and a willingness to make difficult choices. In the
end, the fundamental decision that the Congress, the
Administration, and the American people must confront is how
large a share of the nation's economic resources to devote to
federal government programs, including transfer programs, such
as Social Security, Medicare, and Medicaid.
Crucially, whatever size of the government is chosen, tax
rates must ultimately be set at a level sufficient to achieve
an appropriate balance of spending and revenues in the long
run.
Thus, members of the Congress who put special emphasis on
keeping tax rates low must accept that low tax rates can be
sustained only if outlays, including those and entitlements,
are kept low as well.
Likewise, members who favor a more expansive role of the
government, including relatively more generous benefits
payments, must recognize the burden imposed by the additional
taxes needed to pay for the higher spending, a burden that
includes not only the resources transferred from the private
sector but also any adverse economic incentives associated with
higher tax rates.
Achieving fiscal sustainability will require sustained
efforts and attention over many years. As an aid in charting
the way forward, the Congress may find it useful to set some
benchmarks against which to gauge progress towards key
budgetary objectives.
Because no single statistic fully describes the fiscal
situation, the most effective approach would likely involve
monitoring a number of fiscal indicators, each of which
captures a different aspect of the budget and its economic
impact.
The unified budget deficit projected forward a certain
number of years is an important measure that is already
included in the congressional budgeting process. However, the
unified budget deficit does not fully capture the fiscal
situation and its effect on the economy for at least two
reasons.
First, the budget deficit by itself does not measure the
quantity of resources that the government is taking from the
private sector. An economy in which the government budget is
balanced but in which government spending equals 20 percent of
GDP is very different from one in which the government's budget
is balanced but its spending is 40 percent of GDP as the latter
economy has both higher tax rates and a greater role for the
government.
Monitoring current and prospective levels of total
government outlays relative to GDP or a similar indicator would
help the Congress to ensure that the overall size of the
government relative to the economy is consistent with members'
views and preferences.
Second, the annual budget deficit reflects only near-term
financing needs and does not capture long-term fiscal
imbalances. As the most difficult long-term budgetary issues
are associated with the growth of entitlement spending, a
comprehensive approach to budgeting would include close
attention to measures of the long-term solvency of entitlement
programs, such as long horizon present values of unfunded
liabilities for Social Security and Medicare.
To summarize, because of demographic changes and rising
medical costs, federal expenditures for entitlement programs
are projected to rise sharply over the next few decades.
Dealing with the resulting fiscal strains will pose difficult
choices for the Congress, the Administration, and the American
people.
However, if early and meaningful action is not taken, the
U.S. economy could be seriously weakened with future
generations bearing much of the cost.
The decisions the Congress will face will not be easy or
simple, but the benefits of placing the budget on a path that
is both sustainable and meets the nation's long-run needs would
be substantial.
Thank you again for allowing me to comment on these
important issues, and I would be glad to take your questions.
Thank you again.
[The prepared statement of Ben S. Bernanke follows:]
Prepared Statement of Hon. Ben S. Bernanke, Chairman, Board of
Governors of the Federal Reserve System
Chairman Spratt, Representative Ryan, and other members of the
Committee, I am pleased to be here to offer my views on the federal
budget and related issues. At the outset, I should underscore that I
speak only for myself and not necessarily for my colleagues at the
Federal Reserve.
My testimony will focus on the long-term budget outlook and will
draw on the most recent set of long-term budget projections from the
Congressional Budget Office (CBO), issued in December 2005. The CBO
constructed its projections based on the assumptions that real gross
domestic product (GDP) would rise about 3\1/2\ percent per year in 2005
and 2006 and at a rate of 2.9 per cent per annum from 2007 through
2015. The growth projections through 2015 were in turn based on the
assumptions that trend labor force growth will average 0.8 percent per
year and that trend labor productivity growth in the nonfarm business
sector will average 2.4 percent per year. The CBO has since updated
those assumptions for the purposes of other analyses, but the revisions
were not large enough to materially alter the broad contours of the
fiscal outlook.\1\ As for the longer-term outlook, the CBO assumed that
the growth rate of real GDP will average about 2 percent per year
starting around 2020. While such projections are subject to
considerable uncertainty, the CBO's assumptions provide a sensible and
useful starting point for assessing the budget situation over the
longer run.
Before discussing that longer-run outlook, I will comment on recent
budget developments. As you know, the deficit in the unified federal
budget declined for a second year in fiscal year 2006, falling to $248
billion from $318 billion in fiscal 2005. So far in fiscal 2007, solid
growth in receipts, especially in collections of personal and corporate
income taxes, has held the deficit somewhat below year-earlier levels.
Of course, a good deal of uncertainty still surrounds the budget
outcome for the year as a whole. Federal government outlays in fiscal
2006 were 20.3 percent of nominal gross domestic product (GDP),
receipts were 18.4 percent of GDP, and the deficit (equal to the
difference of the two) was 1.9 percent of GDP. These percentages are
close to their averages since 1960. The on-budget deficit, which
differs from the unified budget deficit primarily in excluding receipts
and payments of the Social Security system, was $434 billion, or 3.3
percent of GDP, in fiscal 2006.\2\ As of the end of fiscal 2006,
federal government debt held by the public, which includes holdings by
the Federal Reserve but excludes those by the Social Security and other
trust funds, amounted to 37 percent of one year's GDP.
Official projections suggest that the unified budget deficit may
stabilize or moderate further over the next few years. Unfortunately,
we are experiencing what seems likely to be the calm before the storm.
In particular, spending on entitlement programs will begin to climb
quickly during the next decade. In fiscal 2006, federal spending for
Social Security, Medicare, and Medicaid together totaled about 40
percent of federal expenditures, or 8\1/2\ percent of GDP.\3\ In the
medium-term projections released by the CBO in January, these outlays
increase to 10\3/4\ percent of GDP by 2017, an increase of about 2
percentage points of GDP in little more than a decade, and they will
likely continue to rise sharply relative to GDP in the years after
that. As I will discuss, these rising entitlement obligations will put
enormous pressure on the federal budget in coming years.
The large projected increases in future entitlement spending have
two principal sources. First, like many other industrial countries, the
United States has entered what is likely to be a long period of
demographic transition, the result both of the reduction in fertility
that followed the post-World War II baby boom and of ongoing increases
in life expectancy. Longer life expectancies are certainly to be
welcomed. But they are likely to lead to longer periods of retirement
in the future, even as the growth rate of the workforce declines. As a
consequence of the demographic trends, the number of people of
retirement age will grow relative both to the population as a whole and
to the number of potential workers. Currently, people 65 years and
older make up about 12 percent of the U.S. population, and there are
about five people between the ages of 20 and 64 for each person 65 and
older. According to the intermediate projections of the Social Security
Trustees, in 2030 Americans 65 and older will constitute about 19
percent of the U.S. population, and the ratio of those between the ages
of 20 and 64 to those 65 and older will have fallen to about 3.
Although the retirement of the baby boomers will be an important
milestone in the demographic transition--the oldest baby boomers will
be eligible for Social Security benefits starting next year--the change
in the nation's demographic structure is not just a temporary
phenomenon related to the large relative size of the baby-boom
generation. Rather, if the U.S. fertility rate remains close to current
levels and life expectancies continue to rise, as demographers
generally expect, the U.S. population will continue to grow older, even
after the baby-boom generation has passed from the scene. If current
law is maintained, that aging of the U.S. population will lead to
sustained increases in federal entitlement spending on programs that
benefit older Americans, such as Social Security and Medicare.
The second cause of rising entitlement spending is the expected
continued increase in medical costs per beneficiary. Projections of
future medical costs are fraught with uncertainty, but history suggests
that--without significant changes in policy--these costs are likely to
continue to rise more quickly than incomes, at least for the
foreseeable future. Together with the aging of the population, ongoing
increases in medical costs will lead to a rapid expansion of Medicare
and Medicaid expenditures.
Long-range projections prepared by the CBO vividly portray the
potential effects on the budget of an aging population and rapidly
rising health care costs. The CBO has developed projections for a
variety of alternative scenarios, based on different assumptions about
the evolution of spending and taxes. The scenarios produce a wide range
of possible budget outcomes, reflecting the substantial uncertainty
that attends long-range budget projections.\4\ However, the outcomes
that appear most likely, in the absence of policy changes, involve
rising budget deficits and increases in the amount of federal debt
outstanding to unprecedented levels. For example, one plausible
scenario is based on the assumptions that (1) federal retirement and
health spending will follow the CBO's intermediate projection; (2)
defense spending will drift down over time as a percentage of GDP; (3)
other non-interest spending will grow roughly in line with GDP; and (4)
federal revenues will remain close to their historical share of GDP--
that is, about where they are today.\5\ Under these assumptions, the
CBO calculates that, by 2030, the federal budget deficit will approach
9 percent of GDP--more than four times greater as a share of GDP than
the deficit in fiscal year 2006.
A particularly worrisome aspect of this projection and similar ones
is the implied evolution of the national debt and the associated
interest payments to government bondholders. Minor details aside, the
federal debt held by the public increases each year by the amount of
that year's unified deficit. Consequently, scenarios that project large
deficits also project rapid growth in the outstanding government debt.
The higher levels of debt in turn imply increased expenditures on
interest payments to bondholders, which exacerbate the deficit problem
still further. Thus, a vicious cycle may develop in which large
deficits lead to rapid growth in debt and interest payments, which in
turn adds to subsequent deficits. According to the CBO projection that
I have been discussing, interest payments on the government's debt will
reach 4\1/2\ percent of GDP in 2030, nearly three times their current
size relative to national output. Under this scenario, the ratio of
federal debt held by the public to GDP would climb from 37 percent
currently to roughly 100 percent in 2030 and would continue to grow
exponentially after that. The only time in U.S. history that the debt-
to-GDP ratio has been in the neighborhood of 100 percent was during
World War II. People at that time understood the situation to be
temporary and expected deficits and the debt-to-GDP ratio to fall
rapidly after the war, as in fact they did. In contrast, under the
scenario I have been discussing, the debt-to-GDP ratio would rise far
into the future at an accelerating rate. Ultimately, this expansion of
debt would spark a fiscal crisis, which could be addressed only by very
sharp spending cuts or tax increases, or both.\6\
The CBO projections, by design, ignore the adverse effects that
such high deficits would likely have on economic growth. But if
government debt and deficits were actually to grow at the pace
envisioned by the CBO's scenario, the effects on the U.S. economy would
be severe. High rates of government borrowing would drain funds away
from private capital formation and thus slow the growth of real incomes
and living standards over time. Some fraction of the additional debt
would likely be financed abroad, which would lessen the negative
influence on domestic investment; however, the necessity of paying
interest on the foreign-held debt would leave a smaller portion of our
nation's future output available for domestic consumption. Moreover,
uncertainty about the ultimate resolution of the fiscal imbalances
would reduce the confidence of consumers, businesses, and investors in
the U.S. economy, with adverse implications for investment and growth.
To some extent, strong economic growth can help to mitigate
budgetary pressures, and all else being equal, fiscal policies that are
supportive of growth would be beneficial. Unfortunately, economic
growth alone is unlikely to solve the nation's impending fiscal
problems. Economic growth leads to higher wages and profits and thus
increases tax receipts, but higher wages also imply increased Social
Security benefits, as those benefits are tied to wages. Higher incomes
also tend to increase the demand for medical services so that,
indirectly, higher incomes may also increase federal health
expenditures. Increased rates of immigration could raise growth by
raising the growth rate of the labor force. However, economists who
have looked at the issue have found that even a doubling in the rate of
immigration to the United States, from about 1 million to 2 million
immigrants per year, would not significantly reduce the federal
government's fiscal imbalance.\7\
The prospect of growing fiscal imbalances and their economic
consequences also raises essential questions of intergenerational
fairness.\8\ As I have noted, because of increasing life expectancy and
the decline in fertility, the number of retirees that each worker will
have to support in the future--either directly or indirectly through
taxes paid to support government programs--will rise significantly. To
the extent that federal budgetary policies inhibit capital formation
and increase our net liabilities to foreigners, future generations of
Americans will bear a growing burden of the debt and experience slower
growth in per-capita incomes than would otherwise have been the case.
An important element in ensuring that we leave behind a stronger
economy than we inherited, as did virtually all previous generations in
this country, will be to move over time toward fiscal policies that are
sustainable, efficient, and equitable across generations. Policies that
promote private as well as public saving would also help us leave a
more productive economy to our children and grandchildren. In addition,
we should explore ways to make the labor market as accommodating as
possible to older people who wish to continue working, as many will as
longevity increases and health improves.
Addressing the country's fiscal problems will take persistence and
a willingness to make difficult choices. In the end, the fundamental
decision that the Congress, the Administration, and the American people
must confront is how large a share of the nation's economic resources
to devote to federal government programs, including transfer programs
such as Social Security, Medicare, and Medicaid. Crucially, whatever
size of government is chosen, tax rates must ultimately be set at a
level sufficient to achieve an appropriate balance of spending and
revenues in the long run. Thus, members of the Congress who put special
emphasis on keeping tax rates low must accept that low tax rates can be
sustained only if outlays, including those on entitlements, are kept
low as well. Likewise, members who favor a more expansive role of the
government, including relatively more-generous benefits payments, must
recognize the burden imposed by the additional taxes needed to pay for
the higher spending, a burden that includes not only the resources
transferred from the private sector but also any adverse economic
incentives associated with higher tax rates.
Achieving fiscal sustainability will require sustained efforts and
attention over many years. As an aid in charting the way forward, the
Congress may find it useful to set some benchmarks against which to
gauge progress toward key budgetary objectives. Because no single
statistic fully describes the fiscal situation, the most effective
approach would likely involve monitoring a number of fiscal indicators,
each of which captures a different aspect of the budget and its
economic impact. The unified budget deficit, projected forward a
certain number of years, is an important measure that is already
included in the congressional budgeting process. However, the unified
budget deficit does not fully capture the fiscal situation and its
effect on the economy, for at least two reasons.
First, the budget deficit by itself does not measure the quantity
of resources that the government is taking from the private sector. An
economy in which the government budget is balanced but in which
government spending equals 20 percent of GDP is very different from one
in which the government's budget is balanced but its spending is 40
percent of GDP, as the latter economy has both higher tax rates and a
greater role for the government. Monitoring current and prospective
levels of total government outlays relative to GDP or a similar
indicator would help the Congress ensure that the overall size of the
government relative to the economy is consistent with members' views
and preferences.
Second, the annual budget deficit reflects only near-term financing
needs and does not capture long-term fiscal imbalances. As the most
difficult long-term budgetary issues are associated with the growth of
entitlement spending, a comprehensive approach to budgeting would
include close attention to measures of the long-term solvency of
entitlement programs, such as long-horizon present values of unfunded
liabilities for Social Security and Medicare.
To summarize, because of demographic changes and rising medical
costs, federal expenditures for entitlement programs are projected to
rise sharply over the next few decades. Dealing with the resulting
fiscal strains will pose difficult choices for the Congress, the
Administration, and the American people. However, if early and
meaningful action is not taken, the U.S. economy could be seriously
weakened, with future generations bearing much of the cost. The
decisions the Congress will face will not be easy or simple, but the
benefits of placing the budget on a path that is both sustainable and
meets the nation's long-run needs would be substantial.
Thank you again for allowing me to comment on these important
issues. I would be glad to take your questions.
ENDNOTES
\1\ According to the latest estimates of the Bureau of Economic
Analysis (BEA), real GDP growth was 3.2 percent in 2005 and 3.4 percent
in 2006, both figures stated on an annual-average basis. The figure for
2006 is the BEA's ``advance'' estimate; a revised estimate is scheduled
for release today.
\2\ Excluding the operations of both Social Security and Medicare
Part A, the budget deficit in fiscal year 2006 was $459 billion, or 3.5
percent of GDP. Like Social Security, Medicare Part A pays benefits out
of, and receives a dedicated stream of revenues into, a trust fund.
\3\ Net of Medicare premiums paid by beneficiaries and amounts paid
by states from savings on Medicaid prescription drug costs, these
outlays were equal to 8 percent of GDP.
\4\ For example, in 2030, five of the six scenarios imply deficits
ranging from 1\1/2\ percent of GDP to nearly 14 percent of GDP; a sixth
scenario is capable of producing a surplus, but it relies on the
confluence of a very favorable set of assumptions.
\5\ For more information about this scenario, see the description
of Scenario 2 in Congressional Budget Office (2005), The Long-Term
Budget Outlook, December, pp. 5-13 and 48-49, www.cbo.gov/ftpdocs/69xx/
doc6982/12-15-LongTermOutlook.pdf. Consistent with the assumptions used
by the Medicare trustees, the CBO's intermediate projections for
Medicare and Medicaid are based on the assumption that, over the long
run, per beneficiary health expenditures will increase at a rate that
is 1 percentage point per year greater than the growth rate of per
capita GDP. Over the past twenty-five years, however, per beneficiary
Medicare spending has actually exceeded per capita GDP growth by about
2\1/2\ percentage points per year. Thus, a significant slowing in the
growth of medical costs per beneficiary will be needed to keep
expenditures close to those projected in this scenario.
\6\ To give a sense of the magnitudes involved, suppose--for the
sake of illustration only--that the deficit projected for 2030 in the
CBO scenario were to be eliminated entirely in that year, half through
reductions in discretionary spending and half through increases in non-
payroll taxes. (Of course, in reality the fiscal adjustment would
likely not occur in one year, but this hypothetical example is useful
for showing the magnitude of the problem.) This fiscal adjustment would
involve a cut in discretionary spending (including defense) of nearly
80 percent (relative to its baseline level) and a rise in non-payroll
taxes of more than 35 percent. The need for such painful measures could
be diminished by beginning the process of fiscal adjustment much
earlier, thereby avoiding some of the buildup in outstanding debt and
the associated interest burden.
\7\ CBO (2005), The Long-Term Budget Outlook, p. 3.
\8\ I discussed this issue in Ben S. Bernanke (2006), ``The Coming
Demographic Transition: Will We Treat Future Generations Fairly?'',
speech delivered before the Washington Economic Club, Washington,
October 4, www.federalreserve.gov/boarddocs/speeches/2006/20061004/
default.htm.
Chairman Spratt. Dr. Bernanke, you will receive questions
on this subject anyway, so I will give you the opportunity to
take the first pitch.
Yesterday, we had severe disruption in the stock markets.
Would you care to make any statement or reflection upon what
happened yesterday and whether or not it has any connection to
our fiscal situation?
Mr. Bernanke. There did not seem to be any single trigger
of the market correction we saw yesterday. I do not think it
would be useful for me to try to parse the movement into the
components associated with different pieces of news or pieces
of information.
I will say that the Federal Reserve in collaboration with
the President's Working Group has been closely monitoring the
markets. They seem to be working well and normally.
We have also, of course, been closely monitoring the
economy, looking at new data and trying to evaluate their
implications for the forecast.
And my view is that taking all the new data into account
that there is really no material change in our expectations for
the U.S. economy since I last reported to Congress a couple
weeks ago in the Humphrey Hawkins hearings.
Chairman Spratt. Do you expect the growth rate in the
economy to decline slightly?
Mr. Bernanke. We are looking for moderate growth in the
U.S. economy going forward. And I would add parenthetically
that the downward revision of the fourth quarter GDP numbers we
got this morning is actually more consistent with our overall
view of the economy than were the original numbers.
So we expect moderate growth going forward. We believe that
if the housing sector begins to stabilize and if some of the
inventory corrections are still going on and manufacturing
begins to be completed that there is a reasonable possibility
that we will see some strengthening of the economy sometime
during the middle of the year.
Chairman Spratt. Turning now to a different topic. We have
difficulty explaining to the American public why the deficit is
such a serious matter. You just touched upon and every
eloquently touched upon the intergenerational equity aspects of
the problem.
But we do not see or feel the effects of it now, and that
is even more true for the long-term debt, which is substantial.
When it is discounted back to present value, you can understand
it in those terms. But, nevertheless, we do not see the
consequences of it.
Traditionally it was believed that the federal government
would, by running large deficits, crowd out private borrowers
in the credit markets and run up interest rates. We have not
seen any unusual increase in relative interest rates, and that
appears to be a result of the fact that we are financing a lot
of our debt with foreigners.
Is that a correct perception and, if so, what are the
consequences of being reliant for financing the federal
government on foreign capital markets?
Mr. Bernanke. Mr. Chairman, in the short run, budget
deficits tend to reduce national saving. And that leads to two
possible outcomes. One is that domestic investment will fall
accordingly along with saving. The other possibility is that
investment will be maintained, but in order to finance that
investment, we have to borrow essentially abroad, which results
in a large current account deficit.
In recent years, it seems more of the latter has been
happening. We have been borrowing abroad to finance domestic
investment, and so we have seen not a very significant increase
in real interest rates. In fact, real interest rates are
generally low around the world.
But what we have seen on the other side of the equation, we
have seen large increases in our foreign debt and in our
current account deficit.
Looking forward to the longer run, I guess the analogy I
would make here is that this is sort of like a snowball rolling
down the hill. It is already a pretty big snowball, but it is
going to get a lot bigger a lot faster, and we have an
opportunity now to try and prevent that cumulative process that
will go on if we do not take some action.
In particular, because deficits feed into debt which feed
into deficits, this could really get out of control over a long
period of time, and it would have very significant consequences
for capital formation and for foreign debt and for the
financial security of Americans, particularly the next
generation who will be saddled with this growing debt.
So it is a very significant problem. The real consequences
will be felt to a greater degree over time and more so a few
years from now than today, but it is that very fact that we
have the opportunity to move today that we can perhaps put
ourselves on a better path and avoid what would have to be much
more severe and draconian responses ten, fifteen, or twenty
years down the road.
Chairman Spratt. One reason we resort to foreign borrowing
is that we have at the present time a dismally, abysmally low
savings rate ourselves in the United States.
What do you think we should do to improve to shore up the
savings rate in the United States?
Mr. Bernanke. Well, that is a challenging question.
Certainly improving budget balance both at the federal and, to
some extent also, of course, at the state and local levels.
Chairman Spratt. Because that by itself is dis-saving. If
you correct that, that in itself----
Mr. Bernanke. That is correct.
Chairman Spratt [continuing]. Corrects part of the problem.
Mr. Bernanke. So the borrowing to finance deficits, if you
think of it is as being taken out of the pool of saving done by
the private sector, leaving less left over for capital
investment. So one way to add to national saving is to try to
reduce deficits as much as possible.
The other is, of course, to try and increase saving in the
private sector. And we have in our country relatively low, in
fact currently negative, household saving rates.
There is quite a debate among economists about how best to
increase those saving rates. I would just point to one
direction that was included in the recent pension bill that the
Congress passed and the President signed which is to allow opt
out 401k programs among employers.
We have a lot of evidence that people, if they are required
to opt out of a savings program, that the inertia will win out
and they will save more. And that is really one of the ways in
which we probably could increase saving at the private level.
Beyond that, there are a number of possibilities, including
tax policies, including financial literacy and others, which I
can discuss in more detail. I am sure there will be questions.
But we do not really have a silver bullet for household saving,
and we should, I think, though, try to encourage it as much as
possible.
Chairman Spratt. One final question from me. You made a
speech recently in which you addressed a concern. To some
extent, you touched upon it today when you discussed the
intergenerational equity of deficits. You were concerned about
the disparities in income in our economy.
To what extent is this a problem for the economy itself,
for the country, and what would you recommend that we do about
that? Are you recommending more progressive tax policies or----
Mr. Bernanke. Mr. Chairman----
Chairman Spratt [continuing]. What do we need to do to
address that problem, and how severe is the problem in your
estimation?
Mr. Bernanke. Mr. Chairman, this is not a new issue. We
have seen increasing income inequality in the United States for
at least three decades and, according to some measures, maybe
four or five decades.
In my speech, I discussed a number of possible sources of
that increase in inequality. I think one of the most important
is technology which is increasing the returns to higher
education. So people who have more education or greater skills
are seeing much higher incomes relative to those with less
education and lower skills. And that is generating greater
inequality in the economy.
I think this is an important problem both because we do not
want to see excessive inequality and we do not want to see
people at the lower end of the ladder not enjoying, you know,
some of the benefits of our economic growth.
I think it is also a problem because in order to continue
to grow, we need to have public buy-in to a continued open and
flexible economy. And I am afraid that if people begin to feel
that the economy is not benefiting them, then they will, you
know, resist the flexibility and dynamism that is so important
to our economic growth.
I think the most likely approach for arresting this trend,
the most beneficial approach would be to strengthen our
educational and training systems as much as possible and to
encourage people to get the skills they need to earn higher
incomes.
Chairman Spratt. Thank you very much.
Mr. Ryan.
Mr. Ryan. Thank you, Mr. Chairman and Mr. Chairman.
Some people believe that yesterday's market corrections are
due to a liquidity crunch and they compare it to the
corrections in 1987 and 1998.
Do you believe or agree that there is a liquidity problem
in the world today?
Mr. Bernanke. No, I do not think so.
Mr. Ryan. Some also have been pointing to a concern about
subprime lending. And just yesterday, Freddie Mac said that it
would tighten its lending standards.
It seems to some of us that this is a small part of the
market and unlikely to cause major problems, but I would be
curious about your take on that.
Mr. Bernanke. There certainly have been some concerns
raised about the health of the subprime sector. We have seen
increasing rate of default. We have seen financial distress on
the part of lenders. And so that is a concern.
We are monitoring that situation very carefully, and it was
one of the factors, I think, which has contributed to some
unease about the economy, about the market.
Our assessment, though, while this is a very important
problem and an issue obviously for many people who are facing
foreclosure, our assessment is that there is not much
indication at this point that subprime mortgage issues have
spread into the broader mortgage market, which still seems to
be healthy, and the lending side of that still seems to be
healthy.
So it is a concern. But at this point, we do not see it as
being a broad financial concern or a major factor in assessing
the course of the economy.
Mr. Ryan. I want to ask a question about sort of fed
governance. For the 1960s and the 1970s, the fed and central
banks around the world really sort of used a Phillip's curve to
dictate monetary policy. And it seems that the evidence, which
obviously is lagging and takes a while to build up, has come in
and has more or less clearly debunked the Phillip's curve as a
primary driver of monetary policy. And there seems to be a
growing body of evidence that unemployment and inflation are
not nearly as linked as the Phillip's curve would suggest.
Do you agree with that, and do you believe that commodity
prices are a better indicator of inflation and of inflationary
expectations?
Mr. Bernanke. It is true that the empirical evidence
suggests that the link is looser, that there is less
responsiveness of inflation to employment conditions than there
perhaps may have been in past decades.
My own view is that we should take a very eclectic approach
in thinking about inflation. I look at the state of the economy
and try to assess whether demand is exceeding supply in some
sense, whether the financial conditions are promoting growth
and demand which is greater than the productive capacity of the
economy. But I also look at a wide variety of indicators
including commodity prices, including financial indicators like
bond rates and inflation compensation.
I do not think we can rely on any single indicator,
particularly one like the natural rate of unemployment concept.
It is very difficult to know if--even if there is such a
relationship, it is very difficult to assess in real time where
that number might be.
And so we really have no alternative but to look at, you
know, many indicators, including the one you mentioned, to try
to assess where inflation is going.
Mr. Ryan. In the past in your academic career, you seem to
be a fan of inflation targeting. We have seen other countries,
obviously much smaller economies, test inflation targeting with
some great degrees of success, it seems.
What is your current impression of inflation targeting?
Mr. Bernanke. Well, I should say that I view inflation
objectives and the like as being part of the communication tool
kit that a central bank may have to try to explain to the
markets and to the public what its approach is, what its plans
are, and how it sees the economy.
We are currently in the Federal Open Market Committee
conducting a zero-based review of our communications policies,
looking at, among them, numerical objectives for inflation, but
many other approaches as well, to try to provide more
information to the public about our plans and our approach.
So in terms of the specifics, I think I would leave that
open because our Committee has not yet decided, you know, what
approaches we want to take.
The one thing I would say is that there is certainly a
strong conviction that maintaining low and stable inflation is
not--this goes back to the first part of your question--is not
something that reduces employment and growth. To the contrary,
an economy that has low and stable inflation is going to grow
faster and have more stability than one in which inflation is
high and unstable. We learned that in the 1970s and it has
become increasingly evident in the last couple of decades.
So whether or not we have an explicit target or not, it is
very important for the Federal Reserve to maintain low and
stable inflation.
Mr. Ryan. I totally agree with that. I would just simply
encourage, and I have one quick last question.
As you continue these deliberations on your communications
toolbox, that the more explicit expectations that the market
can see, the better and more stable the market horizon and
investment horizons are for investors and for the economy. So
to the extent that you can be more explicit about that, that is
all to the good, I think.
One last final question. There is going to be a lot of talk
this year about whether or not to raise taxes. And you are
seeing a lot of speculation as to whether or not Congress is
going to affirmatively allow some tax cuts to expire, such as
the growth tax cuts, dividends, cap gains, top marginal income
tax rates, things like that.
Is there a chance that this discussion itself could have a
negative impact on the market? And we have also had surging
revenues. Would you care to comment on that as well?
And then I yield.
Mr. Bernanke. Congressman, as you know, the Federal Reserve
is nonpartisan. And I talk about many, many issues. I realize
some of them are very broad. But I do think it is important for
me, and this is something that is going to be relevant to
today's discussion, I think it is important for me not to
implicitly or explicitly endorse any spending or tax program
for or against.
So I hope you will understand if I do not make an
assessment of that.
Mr. Ryan. All right. Thank you.
Chairman Spratt. Mr. Cooper.
Mr. Cooper. Thank you, Mr. Chairman.
And thank you, Chairman Bernanke, for your excellent
testimony.
On page nine, you say, ``A comprehensive approach to
budgeting would include close attention to measures of the
long-term solvency of entitlement programs, such as the long
horizon present values of unfunded liabilities for Social
Security and Medicare.''
Last year, this Committee passed unanimously--in fact, it
was the only unanimous thing the Committee did--my amendment
that would encourage us to look not only at the unified budget
deficit but also at, for example, accrual measures of our
fiscal position so that we would have better perspective on
where we are. So this Committee has been trying to focus on a
broader set of measures.
It worries me, though, that we are in the situation of the
average American who does not know they have high blood sugar
levels, which means possible diabetes, because in this country,
there is sadly, tragically for many people, a seven-year delay
between onset of high blood sugar and then actual diagnosis of
the disease, because, as Chairman Spratt noted, there are no
symptoms. You cannot tell that you have high blood sugar.
The average American just looking at the unified budget
deficit cannot tell we have got a major problem. That is why we
need broader measures, so that we might be encouraged to take
action.
Several of us have been working on those measures, for
example, highlighting the Treasury Department's financial
report of the United States, which uses accrual accounting and
which shows that the deficit last year was not 1.9 percent of
GDP. It was closer to three or four percent of GDP.
But even that measure does not take into account some of
the most important programs that we have in this country like
Social Security and Medicare.
So in your testimony, you mentioned the unfunded
liabilities of Social Security and Medicare. Does that mean
that you count these as liabilities?
Mr. Bernanke. Let me first start by agreeing with your
basic thrust that the unified budget deficit has its value
because it says some things about the current economy, but it
is not a full measure of the fiscal obligations that are being
taken on.
As I am sure you know, the Advisory Board to the Treasury
has promoted this accrual accounting approach to the deficit,
and that gives you the bigger number you mentioned. And what
they have done there is they have included not only the current
spending, but they have, you know, taken on board the accrual
of obligations to future pensions for federal government
workers and veterans and the like, and those are legal
obligations that any private company would include as part of
its liability assessment in a given year.
The FASB is currently looking at whether to include a
measure of the accrued liabilities to Social Security and
Medicare as part of a broader measure yet of the accrual-based
deficit and there they are confronting exactly, I think, the
issue that you are talking about.
First of all, projecting those liabilities, of course, is
difficult, but that does not stop accountants usually from
trying to incorporate them.
The other question is whether or not there are legal
liabilities in the sense that, of course, Congress can and has
in the past changed benefit schedules from what had originally
been planned. And so in that sense, perhaps these are not
liabilities in the strict legal sense of the word. And that is
part of the reason why they have not been incorporated in these
accrual measures.
But I would say that there certainly is a sense that if
there is no change in policy that automatically we will be
incurring these large entitlement costs and our short-term
unified budget deficit does not in any way reflect the fact
that as we move along, we are getting older, and those
obligations, at least implicit obligations, are getting larger
and larger.
Mr. Cooper. Thank you.
In my short time remaining, it seems to me to be the
biggest single disconnect in all of American politics, the fact
that all of us on both sides of the aisle praise these programs
and promise benefits. And, yet, when you actually look at the
budget of the United States and the common deficit measure,
these entire programs are largely excluded, ignored.
So not only are these unfunded obligations or liabilities,
they are also largely uncounted obligations. And in order for
us to have a chance of delivering the benefits that we
promised, we are going to have to start counting them. That is
why I am so strong an advocate for these broader measures, so
that we have a chance to fulfill the promises that all of us
have made to our constituents.
But I thank you for your great service and your steady hand
at the fed.
Mr. Bernanke. Thank you.
Chairman Spratt. Mr. Barrett.
Mr. Barrett. Thank you, Mr. Chairman.
Chairman, thank you for being with us today. I am going to
throw three questions at you and then give you all the time to
answer them.
Number one, savings. I know other countries do this, but we
lose a lot of savings time between zero and 18 or zero, date of
birth, and when they enter the job market.
Would it not be a smart thing to do to set up some type of
personal retirement account through incentives or whatever that
would allow members, citizens to start some type of savings,
give breaks if they add to it along? Something to think about
there.
Number two, in your testimony, right at the end, you say if
early--talking about entitlement spending, by the way--if early
and meaningful action is not taken, the U.S. economy could be
seriously weakened, and you go on. Of course, I know you are
talking about Medicare and Medicaid.
Can we continue, question two, can we continue down the
road of doing a little bit here and a little bit there? Are you
talking about major course adjustments and do you not think or
do you think that we need some type of overall national road
map to say, hey, these are problems, we cannot do hit-and-miss
operations anymore, we need a national goal that all of us can
buy into and work on?
Last one, there is a direct correlation, I know you know,
between the tax burdens and economic growth. Some people seem
to think the average level is about 35 percent all government
levels.
How close are we to that level right now when we look at
state, local, federal, the whole nine yards? It is all yours.
Mr. Bernanke. Thank you.
On savings for young people, obviously it would be great to
get young people saving. There have been some proposals. Again,
I am not going to try to address very specific proposals. But
there have been proposals about giving money to children, you
know, creating an account at the time that they are born.
I think it is a problem that kids do not know enough about
saving. They do not know enough about money in general. The
Federal Reserve is very interested in financial literacy,
teaching that in the schools, trying to get kids involved in
saving and understanding that. I do not have a magic bullet
again, but I think that starting young and trying to broaden
the base.
You know, there is a certain part of our population where
these financial matters are just second nature, you know, but
many people who do not really get exposed to them and find them
difficult and mysterious and to their detriment. And to the
extent that we could help people learn about how to save, how
to budget, we are doing a great service.
On the size of the entitlements, these are very large
deficits. It is hard to find good ways to measure it. The
trustees have the present value of the infinite horizon deficit
for Medicare at about $72 trillion, to give you an idea of the
enormous amount of money that is.
That does not include the fact that we already have a
baseline level of finance in the budget for Medicare. If you
take that out, it is still about $54 trillion. So these are
enormous amounts of money.
It is important, I think, to note that the Medicare part is
probably four or five times as big as the Social Security part.
So as difficult as it has been to address Social Security,
Medicare is a bigger problem.
And I do think we are going to have to, you know, think
hard about the structure of those programs. And in the case of
Medicare, think also about the healthcare sector more generally
and the cost that it is creating.
It was implicit in my comment about looking at multiple
indicators that to the extent that Congress can look beyond the
next couple of years and perhaps have some kind of plan or some
kind of, you know, benchmarks moving forward that that might be
quite useful.
In particular, this is just going to get harder politically
because you are going to get to the point where you will be
affecting the benefits of people who are, you know, close to
retirement. If you make changes now that take place decades in
the future, you know, you will not be affecting anybody's
benefits who are either retired or close to retirement. And you
can phase them in gradually. You can give people time to plan.
So I think working well in advance is a much better way to deal
with this.
On taxes, the federal share of GDP and revenues is about 18
and a half percent. For state and local governments, it is nine
to ten percent. So we are somewhere in the 27, 28 percent range
right now.
I do not know if there is a magic number where economic
growth is affected, but it is true that on the revenue side,
that higher taxes do have disincentive effects and do have some
adverse effects on the economy. And the question, of course,
you always have to ask is whether the spending programs have
enough benefits to outweigh those costs to the economy.
Mr. Barrett. Thank you.
Thank you, Mr. Chairman.
Chairman Spratt. Mr. Allen.
Mr. Allen. Mr. Chairman, thank you for being here. I have a
quick comment and then I want to pursue this same line.
You conclude your testimony by saying decisions the
Congress will face will not be easy or simple, but the benefits
of placing the budget on a path that is both sustainable and
meets the nation's long-run needs would be substantial.
It seems to me we were once on a path, though not perfect
and not likely to grapple with all the problems of Medicare and
Medicaid, it was a lot closer to that goal than we are today.
And that was the last four years of the 1990s when we were
running surpluses and in much better fiscal condition than we
are today. And I think the policies that drove us in the 1990s
are worth looking at again.
But my question really goes back to these healthcare
issues. This is the Budget Committee. We deal with the federal
budget. But you just said that with respect to Medicare, we
need to look at healthcare more generally.
And most of the health policy experts I know would say that
the cost drivers in Medicare and Medicaid are pretty much the
cost drivers in the private commercial system as well, and that
if you look at other countries, we have essentially, you know,
one of the least cost-effective systems in the developed world.
So the question is probably, how much does it matter
whether we pay for healthcare through the public sector or the
private sector?
Imagine this. Imagine that we could take care of our small
businesses who are having trouble providing coverage, to help
Ford and GM and other large businesses that are finding it hard
to compete in the global economy, suppose we develop a simpler
healthcare system which covered more people but held down the
cost.
If more of that were paid through the public sector, would
it make--and I am not asking you to evaluate a particular
plan--but would it make any real difference, because if you had
a cheaper system with essentially more money available in the
private sector for investment but more of the healthcare sector
being taken care of through the public programs, you would wind
up with a more cost-efficient system overall but a little
larger public component.
Do you have any reason to think that would have a material
effect, positive or negative, on our global competitiveness?
Mr. Bernanke. Congressman, I have many views about the
healthcare sector, and I hope you do not expect me to give them
all----
Mr. Allen. I do not. I do not.
Mr. Bernanke [continuing]. In a minute or two. We have a
very good healthcare system. Let me just say that. And we have
the most technologically-advanced system in the world. And on
average, we get our money's worth in the sense that studies
have shown that the benefits in terms of reduced mortality from
heart attacks and so on, you know, that the cost, you know, is
justified.
Having said that, I think we could be much more efficient.
I think we could get more or less the same health benefits at
lower cost. And there are a number of issues there. There is
health IT. There is transparency. There is a whole variety of
things that we could probably do.
One of the issues that is important, I think, is that our
system promotes perhaps overuse of insurance by some people. I
mean, we have some people with no insurance and we have some
people who have first dollar insurance. And first dollar
insurance has the problem that no one cares about the cost. It
is going to generate higher cost and people are going to use
high technology solutions which may not be essentially
necessary.
So I think there are ways that we could go about making the
system more efficient, reducing costs, and rationalizing the
healthcare system overall. And I think independent of the
fiscal situation, that is just very important to do and we
should be trying to do that.
In terms of the government's role, you can point to a few
things like potentially reduced administrative costs. I would
raise the concern about a system where the middle class person
pays taxes for services received by middle class people because
by doing that, you are raising the tax burden, the overall tax
burden, and, therefore, the marginal tax rate. And that is
going to have incentive effects and efficiency effects on the
economy.
So I think in terms of the efficiency impact, I think you
are better off focusing on those with lower incomes and those
who are sick who need more help and not necessarily using taxes
to pay for the average person's healthcare.
Chairman Spratt. Mr. Garrett.
Mr. Garrett. Thank you. Thank you, Mr. Chairman and Mr.
Chairman.
Your testimony is much like testimony of other experts that
we have had before this Committee in the last month and a half,
and that is it is all ominous and discouraging. I am sure well-
intended though. Ominous in the sense of the problem that lays
before us and that is not just a short-term, but it is a long-
term one.
And in dealing with the problem, it seems very basic then
that you either have to address--some of your suggestions are
on the spending side of the equation or very simply on the
revenue side of the equation.
And so I am just going to take one little narrow approach
just for a minute here. If we look in part to the revenue side
of the equation, there are some from both sides of the aisle,
mainly I will say the other side of the aisle, that suggest
that we solve that problem by raising our taxes. And I am not
going to give you a specific tax right here.
But basic economic thought would be, correct me if I am
wrong, that if we raise taxes on one sector, for example, the
business sector, at the end of the day, businesses do not, in
essence, pay taxes. It is the consumer who ends up buying that
product that ends up actually paying that tax, whether that is
a rich consumer or poor consumer.
Is that a correct basic economic thought of how taxes get
flowed down to the bottom line?
Mr. Bernanke. Businesses are not people. Corporations are
fictional people but not real people. And somebody, either the
shareholders, the customers, the workers, or somebody, is going
to bear the ultimate burden, the ultimate incidence of taxes.
Mr. Garrett. One of the questions here was with regard to
the housing market and the huge effect that it plays. And on
the subprime market, there was a question already. And
somewhere I have here an article that talks about that. Well,
the headline in this paper was ``U.S. Mortgage Crisis Goes Into
A Meltdown.''
And they had the head of the Pacific Capital said the
sector was in an unstoppable meltdown that is, ``It is a self-
perpetuating spiral. As subprime companies tighten lending,
they create even more defaults.''
And one of the Governors of the Board, Governor Susan
Schmidt Bies, stated that although she did not see much total
large impact, she did say that there are ``hidden problems
caused by sellers pulling property off the market. The
percentage of homes where nobody is living in them is at a
record level so the potential for inventory correction is still
very high,'' she said.
With that all being said, is there an additional problem
that we could see if we took action now looking at either that
market or the overall market and said to address these
mandatory problems, Social Security, et cetera, besides just
the ones you talked about, to address that problem from a
revenue side, we are going to raise taxes at least on that
sector? Could that exacerbate the problem on the housing
sector?
Mr. Bernanke. I would have to know more about what taxes
you have in mind. If you raise taxes on housing, you would
reduce the price of housing generally speaking.
I guess I would just want to respond to your initial
comments and say that we are concerned about the subprime
mortgage sector. We are watching it very carefully. We think
there has been some bad underwriting in that sector.
We have attempted to provide some guidance to lenders about
proper procedures for underwriting and disclosing subprime
loans. And we are going to provide additional guidance, I
believe soon. So that is a significant problem. And there are
obviously some financial losses associated with it.
But as Governor Bies said and as I said earlier, so far,
there seems to be no indication that those problems are
spreading either into the broader financial markets or that
they are having significant effects on housing or housing
demand in the broader economy. But we will be watching that
obviously very carefully.
Mr. Garrett. Okay. And my last question is on that sector.
If we were to impose a tax just on the--not the middle class,
but the first time entering market in the housing market,
specifically those markets that is where the securities are
picked up through the GSEs, and that is where the market goes
into, the mortgages going into, if we were to place a tax on
that sector of the market where we are already having problems,
such as a tax on the mortgages, could that exacerbate the
problem then?
Mr. Bernanke. If there is a tax on the new home buyer or on
mortgage interest, naturally it would affect behavior.
Mr. Garrett. And, again, whether it is directly on me the
borrower going to the bank and have a tax just on me or the
overall GSE, wherever you place the tax, that eventually----
Mr. Bernanke. I see. If you are talking about the GSE
situation, I understand. I think it would depend. I think there
is an interesting and serious question about, as I mentioned
before, the incidence of a tax on a business goes to lots of
different people. It goes to shareholders. It goes to workers.
It goes to customers and so on.
And so I think one of the important questions in addressing
the issue you are talking about would be what is the incidence
of that tax. Is it mostly on the shareholders? Would it affect
the cost of mortgages? Would it affect something else? So I
think that is the question one would have to address.
Mr. Garrett. Okay. So I have 53 seconds left. I will try to
pin that down a little bit more.
At the end of the day, even if initially the burden is
placed on the shareholders, that leads to the natural
inclination of people not to want to invest so heavily in that
company or entity no matter which one it is. And eventually
that raises the cost of doing business for that particular
entity. They may have to borrow at other rates, at higher
levels.
So eventually, although the shareholders may actually pay
the cost today, that corporation ends up having to bear the
burden itself. But as you said, they do not bear burdens. They
pass it on to somebody else. So today the shareholder pays it.
But eventually if higher interest rates that they have to
charge again goes down to the ultimate user, and that is the
consumer; is that not correct?
Mr. Bernanke. Well, in the case of the GSEs, as you know,
although there is no official government guarantee behind the
GSEs, there is a perception in the market that there is such a
guarantee. And as a result, the interest rate at which GSEs
borrow is just a little bit above the Treasury rate.
I would think that until such time as there is a change in
the views of the financial market about this implicit
government guarantee that that interest that GSEs pay will
continue to be pretty close to the Treasury rate.
Mr. Garrett. Interesting. Thank you.
Chairman Spratt. Ms. Schwartz.
Ms. Schwartz. Thank you, Mr. Chairman, and appreciate the
opportunity to follow-up.
Some of my colleagues on both sides of the aisle have
talked about the concern about household debt and the
relationship to the housing market. And I think that for many
Americans, they sort of do not necessarily see the cumulative
effect of each household increasingly borrowing to meet basic
obligations. I mean, sort of meeting the pattern that the
federal government is doing the same thing. You know, we are
borrowing to meet basic obligations.
What is happening, and I wanted you to comment? You talked
a bit about both risky behavior and maybe some of the subprime
market. But even more middle class folks are now using the one
big asset they have, maybe the only real long-term asset they
have, their home, to borrow against in order to continue
spending.
Now, some of them may be outside of their control a little
bit in terms of meeting basic obligations, healthcare costs,
obviously other kinds of costs that they have.
But could you speak really a little bit more specifically
about how you see either the risky behavior on the part of
lenders or maybe the risky behavior on the part of borrowers,
and this is really every-day Americans who are trying to meet
their obligations, who have stopped saving and are not only
using all their dollars that they have to meet obligations, but
are now refinancing their homes, they are consolidating credit
card debt and other kinds of debt, maybe even educational debt,
to borrow against, as I say, that one asset, which is seeing an
increase?
Now, of course, the bubble is over in housing. We may not
actually see the house even be worth it in the future. So they
are borrowing against their only asset.
And to what point does that put that family at greater risk
long term in not planning for a downturn personally, but also
the effect it has more broadly on the economy not being able to
access that capital that used to be put into savings
potentially, either for themselves or so it would be available
in the marketplace?
Mr. Bernanke. Congresswoman, that is a very interesting
question. With respect to an individual family, it would depend
a lot on their individual financial circumstances. There are
people who have owned their homes for a long time and they have
quite a bit of equity in the home. And in that case, it
probably makes sense to consolidate debt and to pay for college
and so on from home equity. It is an important part of wealth.
There are others who have very little equity share and they
are putting themselves in a situation where they are not able
to refinance and they could end up losing their home. So it
depends very much on the individual circumstance.
I think, you know, it is good that markets have become more
sophisticated and more flexible so that people do have the
flexibility to use money from their home under, you know,
appropriate circumstances. But it does probably contribute to a
lower saving rate, at least over short periods of time.
The increases in people's wealth associated with higher
house prices or higher stock prices are not counted as part of
the national saving rate or individual household saving. So
when you do have a run-up in house prices, for example, and
people let their houses do their saving for them, then that is
one reason why the current saving out of current income is low,
and that has the consequence that we talked about before, that
we have to then borrow for new investment. We have to borrow
from abroad or pay higher interest rates.
So my expectation, I mean, one effect potentially of the
flattening out of prices in the housing market may be if people
are therefore less able to use extracted equity, they may
actually begin to save more out of current income. And that is
one reason to think that saving out of current income may rise
a bit over the next couple of years.
Ms. Schwartz. Is there more that we could do, either we,
you or we could do in helping to have most Americans understand
that in a way?
Now, some of what you are suggesting might just be market-
driven people understand they cannot borrow against their
house, but we are doing the same thing. We are sort of by
example, federal government is borrowing to meet obligations.
We are suggesting and there is a lot of market out there
that is suggesting consolidate your debt. Again, that may be a
good thing. But over time, individual families are not
protecting themselves and there will be a consequence to them.
And could you be more specific in the few seconds left
about what else we could be doing either by example or to
educate the American family about how that may not be the best
even if the market is telling them they can do it?
Mr. Bernanke. Well, there is one important difference
between the hypothetical family than the U.S. government. The
hypothetical family is borrowing against an actual asset that
they have. I mean, household wealth is still rising on net, net
of debt. So it is not that the households are drawing down
their debt in that sense.
Ms. Schwartz. But it is a point well taken. The government
is actually borrowing against----
Mr. Bernanke. We are borrowing against future taxes
essentially.
Ms. Schwartz. And we are borrowing mostly from foreign
governments at this point.
Mr. Bernanke. Well, not directly, but indirectly, yes. On
the individual family, I am again a strong advocate
particularly for lower-income families, helping them through
counseling, training, financial literacy, and so on, to
understand better, you know, the complexities of finance,
personal finance, so that they can live better lives in terms
of saving and acquiring assets.
Ms. Schwartz. And then we should learn by example from
them.
Mr. Bernanke. Yes, ma'am.
Ms. Schwartz. Thank you.
Chairman Spratt. Mr. Hensarling.
Mr. Hensarling. Thank you, Mr. Chairman. And thank you for
holding this hearing which I believe is probably one of the
most important hearings we may have this year.
Chairman Bernanke, welcome. It is good to see you again.
If I could have chart number two pulled up please.
Mr. Hensarling. Chairman, on page two of your testimony,
you used the phrase that we are experiencing what seems likely
to be the calm before the storm. You allude to the growth in
the three major entitlement programs and relate that to a
percentage of GDP.
As I understand it, you were referring to CBO analysis and
in that analysis, I believe you show that in 2006, Social
Security, Medicare, and Medicaid totaled about 40 percent of
federal expenditures or eight and a half percent of GDP, soon
to increase to ten and three-quarters of GDP by 2017.
And eye-balling spending under CBO analysis over the long
term, it appears that the budget will grow from roughly 20
percent of GDP if we do not reform current spending trends to
roughly 30 percent by 2037 and approaching 40 percent, almost
double, in about 40 years. I do not know if that is one or two
generations.
My first question is, and I believe your numbers are based
on CBO analysis, to the extent that you have looked at other
analyses from OMB, from GAO, from Treasury, everybody who is in
charge in the federal government of looking at long-term
spending trends, is this an accurate analysis? Is there any
significant disagreement of thought on these long-term spending
trends?
Mr. Bernanke. There is always some uncertainty because of
just the difficulties of projecting far into the future. We are
quite confident about the demographics. We know how that is
going.
One issue which creates some uncertainty is how quickly
medical costs are going to rise. The standard assumption, which
is in the CBO analysis that I presented and is also in the
Medicare Trustee's analysis, is that costs per beneficiary are
going to grow at one percent faster than incomes, which
creates, you know, higher and higher cost and is a big part of
this.
Now, you could think of that as being pessimistic or
optimistic. It is actually optimistic in the sense that
historically, the last 25 years, the so-called excess cost
growth has been about two and a half percent, much higher. So
we are going to have to get some efficiencies in terms of our
medical sector just to get down to that one percent cost
growth.
Mr. Hensarling. Using the CBO analysis on page five of your
testimony, you have a footnote here. Assuming that we were
agreed that we wish to balance the budget and it had to be done
in one fell swoop, you allude to an analysis that if we took
half the burden from tax increases and half from spending
reductions that we would be looking at an 80 percent decrease,
I believe, in discretionary spending relative to the baseline
and an increase in nonpayroll taxes of 35 percent.
So would that seem to suggest that if we follow that model
in one generation----
Mr. Bernanke. He actually did it.
Mr. Hensarling [continuing]. For all intents and purposes,
we would have to increase taxes, nonpayroll taxes 35 percent
just to have a federal government that consists of little
besides Medicare, Medicaid, and Social Security? There may be
no border patrol. There may be no U.S. Marines. There may be no
Department of Education.
Mr. Bernanke. Congressman, if I may, the simple arithmetic,
in 2030, according to projections, the entitlement programs by
themselves will be about 15 percent of GDP and interest on the
national debt will be about four percent of GDP. So you add
those things together, you are already above the 18 and a half
percent of GDP which we are currently receiving in revenues.
So if you wanted to balance the budget in that case without
either changing entitlements or raising taxes, as you point
out, you would have to eliminate the Defense Department and
everything else that the government does.
Mr. Hensarling. My time is about to run out. I would like
to try to slip in one more question. Alluding to this chart up
here, the debate in Congress today tends to be between that
blue line and red line debating the wisdom of previous tax
relief over the last few years.
Again, this is a CBO analysis. But to some extent, does
that tend to suggest that we are debating how to mop up six
inches of water in the stateroom of the Captain of the Titanic
when we should be focused upon the gaping hole in the hull of
the ship?
Mr. Bernanke. I do not want to downplay the importance of
near-term decisions that you are going to make both in terms of
spending decisions and how to structure the tax code, how high
taxes should be. Those are important decisions that are going
to affect how our economy performs. And they are going to
affect the near-term deficits as well.
But I think what that picture tells you is that, you know,
you should probably think hard about going to the heart of the
problem, and the heart of the problem is are the entitlement
programs and those--you are not going to solve this problem by
small budget cuts or small tax changes. You do have to think
about these large obligations and, you know, how you want to
deal with them.
Mr. Hensarling. Thank you.
Chairman Spratt. Ms. Kaptur.
Ms. Kaptur. Thank you, Mr. Chairman, very much.
Welcome, Chairman Dr. Bernanke. Glad to have you here.
Mr. Bernanke. Thank you.
Ms. Kaptur. The first two items I want to mention would
just be a reporting back from your staff to the Committee. I
would like your staff to provide a complete list to us of which
Wall Street firms are earning fees off the sale of the array of
U.S. debt securities, to provide a list of which firms from
2000 to the present, and the amount that each has been paid
annually by U.S. taxpayers for conducting those transactions.
That is the first request.
Number two, based on your testimony, in order to help to
create a savings consciousness in our country, particularly
among the young, I would invite your cooperation and
suggestions on how to create and promote a public debt postal
savings stamp program to sell the debt to our own citizens,
including our youth in small denominations, as the Japanese
have done through their postal savings stamp system and
Franklin Roosevelt created in this country during the 1930s. I
would value your suggestions there.
I wanted to make a comment and then ask two questions. The
basic theme that runs through my comment is that our capital
markets have to be held accountable in solving some of the
problems that we face in this nation and that our economy is in
unchartered waters.
As you say, we have very high debt levels. Our public debt,
according to your testimony, amounts to 37 percent of one
year's GDP. And if you add to that the fact that the trade
deficit knocks off an additional point off that GDP, that is
well over half of the growth that does not benefit economic
investment in this country.
Our middle class is shrinking. I used to say that these
conditions were resulting in the middle class running hard to
stay in place. I now say the middle class is running harder but
falling behind as reflected in their rising debt levels and net
negative savings.
Factory workers in my district are working six days a week,
ten hours a day, week after week, month after month, and we
still see the hemorrhage of jobs. They are being told the
reason for their predicament is that they are in a knowledge
economy and they are falling behind because they are not smart
enough or that the problem in your testimony is, well, the fact
is we got too many people getting older. I beg to disagree.
I think what is happening is that capital investors have
figured out how to make egregious profits by outsourcing jobs
to very undemocratic places and then reimporting those goods
here because our trade policy is snuffing out jobs and we have
a tax policy that rewards it.
And we do not have a redistributed income policy that helps
our people to keep up in view of what is going on. ExxonMobile,
I guess, is my key example of where we are out of whack, out of
sync.
So my two questions are, what do you think might happen to
the market for U.S. debt securities if a foreign buyer like
China or Japan were to sell off a significant portion of their
holdings of U.S. debt securities?
And, number two, nearly 95 percent of recent issues of U.S.
debt instruments have been purchased by foreign buyers. Why are
they the purchasers rather than American investors?
Mr. Bernanke. Well, on the first question, I should first
point out that it is not in the interest of China or Japan to
dump treasuries on the market. They themselves would suffer
capital losses from doing that.
I do think if there were--and I should be very clear, I
have no information or expectation this is going to happen--but
if there were significant sales by foreign central banks, for
example, that there would be some short-run effect on the
market in terms of the currency and interest rates probably.
I think the longer-term effect would be somewhat less
because the market would adjust. It is a liquid market. And the
holdings of, say, China of U.S. debt securities, including both
public and nonpublic, is only about five percent of the total
credit market outstanding.
So obviously we are watching that very carefully. I do not
see that as a major threat to our financial system or our
economy.
I am sorry. The second question was?
Ms. Kaptur. The second question is nearly 95 percent of
recent issues of U.S. debt instruments have been purchased by
foreign buyers. Why are they the purchasers rather than
American investors?
Mr. Bernanke. Well, a couple of reasons. One, as we talked
about before, is that Americans are not saving that much, and
you have to save in order to buy assets. And so that is part of
the problem.
The other is interestingly that Americans seem to have a
stronger preference for equities and riskier investments than
particularly foreign central banks. So at the time foreigners
have been acquiring fixed income instruments like Treasury debt
or GSE debt, a lot of American investors have been purchasing
either domestic or foreign equity which pays a higher return,
but is also riskier.
So there is a bit of diversification going on in both
directions for investors. But, again, the low rate of saving is
also a contributor to that.
Ms. Kaptur. Doctor, could I just ask you on the first two
requests I had for data on providing a list of those brokerage
firms, can you provide that to the record?
Mr. Bernanke. I am not certain that we can, but we will do
our best.
[The information requested follows:]
Board of Governors of the Federal Reserve System,
Washington, DC, March 30, 2007.
Hon. Marcy Kaptur,
House of Representatives, Washington, DC.
Dear Congresswoman: I am responding to a question that you posed
during my testimony before the House Budget Committee on February 28.
You asked for information regarding the fees paid to Wall Street firms
for underwriting Treasury debt.
On further consideration following the hearing, it seemed to me
that your question could be based on a misunderstanding of the
Treasury's approach to issuing debt. Treasury debt is not issued
through a process in which the underwriting firms earn specified fees
for assisting with Treasury's debt placement. Rather, the Treasury
issues marketable debt through a public auction process in which the
highest bidders are awarded the securities being issued. (Some small
investors also bid to receive securities at the interest rate set by
the auction.) Such auctions are open not only to the twenty-one primary
dealers firm but to all potential buyers, including other dealers,
banks and other depository institutions, insurance companies, pension
funds, mutual and hedge funds, and foreign investors. These auctions,
like virtually all aspects of the Treasury securities markets, are
highly competitive and transparent. The auction process helps ensure
that the Treasury issues debt at the lowest possible cost to the
taxpayer over time.
I hope this information is helpful. Please let me know if I can be
of further assistance.
Sincerely,
Ben S. Bernanke,
Chairman.
Ms. Kaptur. And the fees that are being paid. Who would
have that if the Federal Reserve----
Mr. Bernanke. We deal directly with so-called primary
dealers who are brokers who deal in the Treasury securities and
will have some information. We collect some information about
their operations and their income and so on. And we will check
to see what we have and we will be in touch with your staff.
Ms. Kaptur. Thank you.
I mean, you would expect to see Cantor Fitzgerald on that
list; would you not? You would expect to see Goldman Sachs on
that list; would you not?
Mr. Bernanke. Yes.
Ms. Kaptur. All right. We would be very interested in the
fees.
And then secondly, on the question on the postal saving
stamp program, could you perhaps provide a framework in which
to suggest how that might be reinstituted in this country?
Mr. Bernanke. Well, I am eager, as I said before, to try
and promote saving behavior among young people, and there are
many ways to do that. Making saving more accessible, making
acquisition of assets more accessible would be one step in that
direction. And, you know, I think it is worth looking at.
Ms. Kaptur. Thank you.
Thank you, Mr. Chairman.
Chairman Spratt. Mr. Campbell.
Mr. Campbell. Thank you, Mr. Chairman.
Thank you, Dr. Bernanke.
I have a couple of economic questions, then one relative to
the savings. First on the economic question, as you stated,
spending currently is 20.3 percent of GDP which is roughly
equivalent to the average since 1960.
If as part of curing this long-term problem that government
spending as a percent of GDP went up, what impact would that
have on economic growth?
Mr. Bernanke. If government spending as a share of GDP went
up primarily in order to finance transfer payments, that is
entitlement programs, and taxes would have to go up a
comparable amount in order to have long-term budget balance,
then depending on the nature of the taxes, presumably it would
tend to create a dead-weight burden. It would tend to slow
economic growth.
Mr. Campbell. You have eloquently pointed out the problem
of our snowball of accumulating spending and debt. If, big if,
political if, we were to arrest that and basically balance the
budget going forward, does carrying the existing national debt
that we have, if we were to carry that over time, how big a
drag is that on the economy and how big a problem is that, if
we were not adding to it?
Mr. Bernanke. If we were not adding to it, I think it would
be a good stable situation. The 37 percent ratio of debt
outstanding to GDP is actually lower than most other countries.
Japan has a ratio of over 100 percent, for example.
So if we were staying at this point, it would be fine. The
problem is that prospectively with the entitlements coming down
the road, we are looking to go well over 100 percent in the
next 25 years.
Mr. Campbell. Right. But carrying that forward is not the
great economic disaster if it is does not continue?
Mr. Bernanke. No. No. I would say that the current level of
debt, if there were no entitlement problem, which is an
enormous if, would be not necessarily a problem. But it is the
prospective increases that are a concern.
Mr. Campbell. So putting those two questions together, if
we were able to balance the budget, arrest the increase in
debt, and keep the government spending and revenues at roughly
the same kind of level that they are at today and have been
historically, that would be a pretty good economic situation in
terms of the government's contribution?
Mr. Bernanke. Given what we are seeing in terms of the
potential liabilities for entitlements, it would be an enormous
improvement over the current situation.
Mr. Campbell. The last question I have is relative to the
savings and net worth. Now, I am from California. And as you
mentioned, net worths are rising. Savings have not been.
It seems to me that people are consciously making the
decision to put their net worth increase in places other than
traditional savings as measured by the Fed or whomever, whether
that be in the value of their house, equity in their house, or
some other nonfinancial asset or whether that be in some
retirement thing or stocks or some other financial asset.
And I would suggest that people are making those decisions
because they believe that financially it is smarter to put
their net worth in those sorts of assets rather than in
traditional savings.
So my question to you is, why is the savings rate a problem
if you agree, and maybe you do not, that that increase in net
worth is not going into savings because people are making a
rational economic decision which improves their financial
stability or certainly they believe improves their net worth
over time?
Mr. Bernanke. To a large extent, it is a rational decision.
If your stocks and your home value are going up a lot, then
there is less need from your personal family perspective to
save out of your current income.
I would just add parenthetically that what some people do
is take money out of their home, for example, in order to
invest it in other assets so as to diversify to some extent
their overall portfolio.
From the national perspective, though, the problem is that
increases in the value of homes, for example, do not constitute
funds that are available to make new investments, for example,
in capital equipment and so on.
And so in order to maintain our investment rate which
includes construction of new homes as well as business capital
investment, we have been forced to go abroad to the tune of
about six, seven percent of GDP to finance that out of current
flows of savings.
So from the individual family perspective, it is not
irrational. I would----
Mr. Campbell. Well, if I can then insert my last question
before my time runs out, then are we not seeing here a
disconnect between an individual family perspective making
something that is perhaps best for them but may not be best
from a national perspective and, if so, what could we do to
align those two?
Mr. Bernanke. Well, I would note first of all that the
family with lots of equity that is making rational financial
decisions, that is one group of people. That is not everybody.
There are obviously some people who would be well served to
increase their saving, increase their assets, be better off
financially.
And the second comment I would make is that, apropos to the
subject of this hearing, that a big negative influence on the
national saving rate is budget deficits at the federal, state,
and local level. And one very direct way to begin to increase
national saving and in particular to create more resources
available for current investment, current home construction is
for the budget deficits to be reduced or for surpluses to
increase.
Mr. Campbell. Thank you, Dr. Bernanke.
And thank you, Mr. Chairman.
Mr. Becerra.
Mr. Doggett.
Mr. Doggett. Thank you. Thank you for being with us.
In your recent address in Omaha, you endorsed boosting
national investment in education and training and cited
specifically the work of the Federal Reserve Bank of
Minneapolis and its findings of the higher returns from pre-
kindergarten programs and other early childhood efforts and how
that can help us achieve lower rates of social problems like
teenage pregnancy and welfare dependency.
Why do you recommend investing in pre-k and does it appear
to be one of the public policies with the best return?
Mr. Bernanke. Well, I was referring to some very active
research that has been done at the Federal Reserve Bank of
Minneapolis and some policy work that is being done in
Minnesota as well. And I was citing the research by Jim
Heckman, who is a Nobel Prize winner, and others that this is a
high return activity from a social perspective and from an
individual perspective as well.
So I do think it is definitely a direction that might well
we pay attention from the Congress.
Mr. Doggett. Thank you.
I am trying to balance this hearing and one that is
happening at the same time in Ways and Means concerning climate
change. And as you are well aware, an increasing number of
responsible businesses are urging that we address the troubling
increase in global temperatures, and fewer and fewer fit within
that shrinking breed of climate change deniers.
Do you believe that the dynamic economy that you have
described can absorb the cost of reasonable measures to address
global warming and perhaps even expand clean energy and energy
efficiency as a growth industry for our country?
Mr. Bernanke. Well, let me say first obviously that I am
not a scientist and I do not have an independent opinion about
the magnitude of the problem, and I think very importantly I do
not have an independent opinion about how severe or how large
the effort would have to be if we were try to reduce emissions
to levels of 20 years ago. I would imagine it would be a fairly
significant cost associated with doing that.
So I hope that the scientists and the economists will get
together and try and think together about, first of all, you
know, how much effort is needed, how fast in terms of what
makes sense for both the climate and for the economy.
And secondly, I think very importantly that, to the extent
we agree, that we need to do something that we try to do it in
ways that will minimize the impact on the economy. One way to
do that, which is consistent with what you were saying, is
government support for basic technology. I think that there are
incentives for firms to develop applied technology. But at the
basic research level, the government can provide some help,
some resources.
And secondly, if, and, again, I am making no judgments
about whether this should be done or not, if Congress were to
decide to go forward with some kind of program, trying to use
some mechanism like a cap and trade or market-based system that
equalizes the cost of any given amount of carbon reduction
across firms, across industries could allow a given amount of
carbon reduction at lower cost. And obviously we should always
be looking for ways to reduce the cost of achieving any
particular environmental objective.
Mr. Doggett. So a reasonable cap and trade system that
tries to rely on the marketplace to address these issues is one
approach that you think we should consider?
Mr. Bernanke. I think relative, for example, to an approach
that prescribes how much each particular company, each industry
has to do that this would provide, again if Congress decides to
go in this direction, it would allow a given amount of emission
reduction to take place at lower overall cost to the economy.
Mr. Doggett. One last one. Some of the questions I have
heard here this morning seem to suggest that we do not need to
worry about revenues or tax shelters or tax savings or whether
corporations are paying their fair share, that all we need to
be concerned about is that grandma's Social Security check is
too big.
And without minimizing our need to focus on entitlements
and 2030, you are certainly not saying that as we look over the
next few years of the budget we are developing that we do not
need to consider both the revenue side as well as the
expenditure side?
Mr. Bernanke. No. It is the Congress' responsibility to
look at all the options, and I am not going to take one side or
the other, but I think that you should definitely consider all
options and try to balance the costs and benefits of both sets
of approaches.
Mr. Doggett. Thank you for your testimony and your
important service.
Chairman Spratt. Mr. Smith from Nebraska.
Mr. Tiberi.
Mr. Tiberi. Thank you, Mr. Chairman.
Chairman, can you tell us a little bit about your thoughts
on, when we have seen the economic growth over the past several
years higher than most economists have projected, when you look
at that, what are your thoughts in terms of behavior? And you
have talked about behavior with respect to our tax policy. What
are your thoughts on how the cut in the capital gains tax and
dividends have impacted that growth?
Mr. Bernanke. It is frankly hard to assess the effects of
one specific tax over a short period of time. From a longer-
term perspective and looking strictly at the efficiency side of
it, public finance economists generally, I would say, support
keeping taxes on capital low because of the implications for
saving and investments and other effects that might have.
But as always, you know, the Congress has to balance that
against the revenue and progressivity aspects of the tax code
as well.
Mr. Tiberi. But a general belief would be that keeping
taxes on capital gains and dividends would encourage more
savings and investment.
Mr. Bernanke. That would be, I think, the view of most
public finance economists, yes.
Mr. Tiberi. Thank you.
Again, thinking about economic growth, we have seen
probably or I have seen, let me say, over the last year a bit
of a backlash with respect to America's trade policy, with
statements made by some that America's trade policy,
international trade policy has been negative to economic growth
in America.
Can you share your thoughts on how international trade
impacts our economic growth?
Mr. Bernanke. I think that trade is very positive for
growth. If you look around the world, countries that are open
and actively trading show higher growth rates than those that
are less open. So I think that for the economy as a whole,
trade provides very substantial benefits.
Like new technologies, it also creates a certain amount of
disruption and that is the kind of concern that would be useful
to address in order to preserve the political support for open
trade and capital flows, which I do believe are very beneficial
to our economy both in the short run and the long run.
Mr. Tiberi. So in the long run, and I do not want to put
words in your mouth, you believe that a trade policy which
encourages fair trade between the United States and other
countries abroad can be helpful to a broadening middle class?
Mr. Bernanke. I do believe that it will provide broad
benefits for the economy. Again, one of the problems here is
that, like many things, that the benefits of trade are
sometimes widely spread and, therefore, not quite so evident as
the obvious costs of a shutdown of a mill or a factory.
And so we have to weigh those costs and benefits and in
particular to again provide political support for continued
integration with the world economy, continued openness. I do
think we have to, you know, not ignore the dislocations that
take place in particular communities, particular industries.
Mr. Tiberi. One final question, Mr. Chairman. Following up
on Mr. Campbell's point about the savings rate, it appears to
me that a family that rather than puts money in a savings
account but quickly pays off their 30-year mortgage and has
equity in a home, the current formula is not showing that
positive benefit from that family's perspective of paying off a
home. Yet, if they had not paid off the home and put that money
in a savings account, it would have shown a different picture.
What can we do to paint a more accurate picture of
America's savings?
Mr. Bernanke. Well, actually, the increase in the value of
the home due to a rising real estate market, for example, would
show up in the Federal Reserve's measures of household wealth.
So we do capture it in wealth measures as opposed to savings
measures.
The example you gave of paying down the mortgage, if I put
something aside from my paycheck in order to pay down the
mortgage, that, in fact, gets captured as saving because that
is part of current income which is not being consumed. It is
being used to pay down debt. That would be part of saving.
Mr. Tiberi. Thank you.
Thank you, Mr. Chairman.
Chairman Spratt. Ms. Hooley.
Ms. Hooley. Thank you, Mr. Chair, for being here today.
I just want to follow-up on a couple of questions. One was
we were talking about capital gains tax cuts, whether that is
increased savings or not.
Do we have any proof that that is increased savings? Do we
know that that has had an impact on savings?
Mr. Bernanke. Well, as I said, it is difficult to assess
the effects of one small part of the tax package over a short
period of time. Economists have looked at this and their
concern is that when you tax capital income at a too high a
rate that that will have effects over a long period of time
because they really distort the decision about how much to
consume today and how much to save, say, for retirement.
So there is sort of a theoretical case for this. But,
frankly, you know, for a specific tax cut over a short period
of time, it is hard to make an absolutely convincing empirical
case.
Ms. Hooley. You said in a recent speech that the income of
the top 90th percentile has grown over the last 27 years by 34
percent whereas if you are at the 10th percentile, it has grown
four percent.
How do we close that gap?
Mr. Bernanke. I think there are a few things that could be
done, but I think by far the most important is to create a
broader base of skills and knowledge and education.
There was earlier discussion about manufacturing. So it is
true that as manufacturing industries have become much more
productive that the number of assembly line workers has
dropped. So that type of reasonably well-paying job for
relatively low educated people is no longer available.
At the same time, though, the demand for high skilled
workers in manufacturing who have not necessarily college
degrees but who know how to operate complex equipment and so on
has been soaring. In fact, manufacturers cannot find enough
people with the kinds of skills they need.
So, again, I am not an education expert and I am afraid I
cannot give you a long list of detailed recommendations, but I
think broadly speaking what the issue is is helping those who
have been left behind to acquire the skills they need to earn
good wages in what is becoming a more and more technologically
sophisticated economy.
Ms. Hooley. Well, as I see our economy changing, I see the
need for more training and retraining of our workers as time
goes on. And, yet, I look at the budget that was given to us
and it has billion dollar cuts in employment and training
programs. And I think that is where we make a mistake when we
do not put money into that retraining program. I think our
economy is better off when we do that.
Would you agree with that?
Mr. Bernanke. One of the tough challenges with both
education and training programs is being effective and doing a
good job. And so if the budget involves a reallocation from
some types of training activities to others, for example, I
think it would be very important not just to look at the total
dollar number but to see are we using programs that are known
to work and that are effective because the total dollar input
is not as important as what is the output on the other side in
terms of skills acquired.
Ms. Hooley. I am going to ask you a question that has not
been asked, and that was if you were in a class of fifth
graders, how would you explain to them the consequences of our
national debt and deficit and how that is going to impact their
lives, and what happens when they do not have a savings? So
what would you say to that fifth grade class?
Mr. Bernanke. I would say that our economy needs machines
and new factories and new buildings and so on in order for us
to have a strong and growing economy. If the government does
not cover all those expenses, it has to take out the money that
would otherwise be used to build those machines, those
factories, those office buildings, all those things that make
the economy strong, and give them the opportunities when they
grow up to have well-paying, productive jobs. That probably
would not work for a fifth grader, but that is about as close
as I can get.
Ms. Hooley. That is okay. Thank you for your time.
Chairman Spratt. Mr. Alexander.
Mr. Alexander. Thank you, sir.
Mr. Chairman, good morning still.
One of the ladies earlier said something about a stamp
program under the Roosevelt's Administration to help stimulate
growth. But is it not true that President Roosevelt used some
of the Social Security funds to finance the new deal?
Mr. Bernanke. Well, Social Security was tiny. It was just
beginning essentially in the 1930s.
Mr. Alexander. Well, it was tiny, but the pay-outs were
tiny, but----
Mr. Bernanke. Well, it is true that the Social Security has
always been primarily a pay-as-you-go system which means that
the payroll taxes that are collected have not been invested in
real capital. They have either gone into holding government
debt or otherwise been used on benefits.
Mr. Alexander. Okay. When we are talking about the
entitlement programs, a lot more money coming out of those
programs today than it has been in the past and, of course, a
lot more money going into those programs.
But on a percentage basis, how much difference is it today
percentage going in and percentage coming out than it was 20
years ago?
Mr. Bernanke. I might not have your question exactly right.
In terms of the flow of in and out, currently, as you know, the
Social Security system is running a surplus, even forgetting
about interest on the trust fund. The total benefits being paid
are about four and a quarter percent of GDP and the total
payroll taxes being collected are about five percent of GDP.
So that is three-quarters of a percent GDP contribution to
the unified budget deficit not counting the interest being
earned on the trust fund. So the Social Security fund is still
in surplus now and is reducing the unified budget deficit.
Mr. Alexander. Okay. Going back a long way, I think 1965 is
when President Johnson signed Medicare into law.
Mr. Bernanke. Right.
Mr. Alexander. At that time, I could have bought absolutely
the best car on the lot for $4,000. And today we have a system
that is spending that much or more for medical devices,
motorized wheelchairs or whatever, and I am not arguing that
there is not a need for it, but I am just leading up to a
question.
The amount of money that is being spent withdrawing from
those entitlement programs now, how much of it is a decision by
bureaucrats versus Congress? I mean, I do not know if it was a
congressional act that said, okay, we will now start buying
fancier wheelchairs for people that need it.
Mr. Bernanke. Well, going back to history, there has been a
big increase in the size of the entitlements even up to now.
The total entitlement spending in the mid 1960s was about three
percent of GDP and now it is greater than eight, eight to nine
percent of GDP. So there has been a big increase.
The Congress is ultimately responsible, of course, for the
spending plans. In some cases, they are put on somewhat
automatic pilot, which is why they are called mandatory
programs.
For example, the formula for calculating initial and
subsequent Social Security benefits is in the law and then
whatever wages and prices do, that determines how much the
benefits actually are.
And similarly some of the medical expenditure is not
directly controlled. It is set by the rules that Congress has
created for defining those benefits. So there is an annual
appropriation for the total spending on entitlements.
Mr. Alexander. In other words, you are saying oftentimes
the spending is not necessarily something advocated by
Congress, it is just something that Congress did not stop when
they had an opportunity to?
Mr. Bernanke. Well, Congress created the structure and the
rules and that is the consequence of those rules.
Mr. Alexander. Thank you.
Chairman Spratt. Thank you, sir.
Mr. Berry is not here.
Mr. Moore.
Mr. Moore. Thank you, Mr. Chairman.
Chairman Bernanke, thank you for being here today and for
your service to our country.
I printed off just before I came over here from the U.S.
Treasury web site a document that shows major foreign holders
of Treasury securities of our country, and it shows Japan as of
December 2006 held $644 billion; China, mainland China, $349
billion; United Kingdom, $239 billion; and even Mexico had $34
billion in holdings for a total--I did not read off all the
countries--but for a total, according to this document, of
$2,223,000,000,000. Does that sound correct, sir?
Mr. Bernanke. I think that is the total of international
reserves. There might be more in private hands.
Mr. Moore. Okay. But I am talking about----
Mr. Bernanke. That sounds about right.
Mr. Moore. Okay. And I heard your answer to Ms. Kaptur's
question about what if these countries that hold our debt
decided they did not want to hold it anymore for whatever
reason, because of our deficits, because of our trade deficits
or budget deficits or trade deficits, and decided they wanted
to not hold these anymore.
And I heard you say I do not think that will happen, and I
hope you are right. But sometimes we are not right. Sometimes
we are wrong.
And if these foreign countries decided for whatever reason
they did not want to hold our debt in the future, what would be
the impact? What would you expect to be the impact in this
country?
Mr. Bernanke. Well, it would be disruptive in the debt
markets in the short run. It would cause, for example, an
increase in interest rates.
As I said before, I think in the longer term, the effects
would be somewhat less because besides the Treasury debt, there
is many other forms of corporate and GSE and other debt that is
available as part of this broad fixed interest market.
I think it should be noted that the Federal Reserve could
be of assistance in that situation. If interest rates went up
and slowed U.S. economic growth, for example, the Federal
Reserve could respond by using monetary policy and that would
have some benefits.
I want to make a distinction that the foreign central banks
acquire U.S. assets because we do have very deep and liquid,
safe financial markets and they find it in their own benefit to
do so, not because they are doing us any kind of favor.
Mr. Moore. I understand.
Mr. Bernanke. And as I said, I think that they will be
willing to hold that for some time. In the scenarios I have
described, though, where 20, 25 years from now the debt and the
deficits are so big as to create a tremendous burden, then the
willingness of foreigners or even our domestic citizens at that
point to hold government debt at reasonable interest rates
would certainly be much affected.
Mr. Moore. I understand. I just wanted to point out,
though, that sometimes we are incorrect in our assessments and
the Administration, in fact, projected that between 2001 and
2004, there would be a $1.28 trillion surplus which, in fact,
turned out to be an $850 billion deficit.
So sometimes with the best intentions in the world and
trying to be completely straight, we just are in error in our
assessment; is that not correct?
Mr. Bernanke. Yes, sir.
Mr. Moore. Another question then, and I have got just a
minute and a half left. What would you think, Chairman
Bernanke, about--well, you said that the Social Security fund
is still in surplus now, correct?
Mr. Bernanke. The current flow of payroll taxes collected
is still higher than the benefits being paid out.
Mr. Moore. Right. What would you think about establishing a
true Social Security Trust Fund, one that could not be used for
any purpose except what it was intended for and that is to pay
Social Security benefits?
Mr. Bernanke. So currently we are shooting for a budget
balance that includes the Social Security system.
Mr. Moore. Yes, sir.
Mr. Bernanke. If we were able to shoot for a budget balance
that did not include the Social Security system and, therefore,
was essentially buying down Treasury debt with that surplus,
then clearly that would be putting our long-term fiscal
situation on a stronger footing.
Mr. Moore. We talk about a Social Security Trust Fund. In
fact, in the real sense, the legal sense of the word, there is
not one because we spend Social Security money for a lot of
other things, some good things and some things people might
have questions about, is that not correct, even though we still
do have as a government the liability and the obligation to
make good on the Social Security money that was supposed to be
in that fund; is that not correct?
Mr. Bernanke. Well, the $2 trillion Social Security Trust
Fund is an asset of the Social Security system and affects the
benefits profile, for example, going forward. But the $2
trillion Social Security Trust Fund is not an asset of the
government as a whole because every dollar that is owed Social
Security is a dollar that the government has to raise. So it is
correct that from the government's perspective or from
society's perspective, it does not reflect any real assets like
capital or equipment.
Mr. Moore. Thank you, sir.
Chairman Spratt. Mr. McHenry.
Mr. McHenry. Thank you, Mr. Chairman.
Great to be with two of my neighbors to the south, Chairman
Spratt from South Carolina and Chairman Bernanke from South
Carolina. It is a pleasure to be with you all.
I wanted to follow-up on Mr. Tiberi's question about
unlocking the potential of capital and the free movement of
capital by reducing capital gains tax rates.
At the time we reduced the capital gains tax rate for
individuals, we did not reduce the corporate capital gains tax
rate, which now stands at 35 percent.
In terms of unlocking the potential of capital to move
freely and to see its highest and best use, would it be
appropriate to look at that, reducing the corporate capital
gains tax rate?
Mr. Bernanke. Well, specifically one of the advantages of,
again from specifically an efficiency perspective, of keeping
the dividend tax rate low is that it allows firms to pay out
dividends without tax penalty and that money then gets
recirculated in the capital markets and may find better uses
than if it is in some sense trapped in the corporation. So that
is one of the benefits from an efficiency perspective of low
dividend tax rates.
Mr. McHenry. But in terms of corporate capital gains.
Mr. Bernanke. Corporate capital gains are a part of the
return to savings, return to investment. And for some of the
reasons I gave earlier, economists tend to argue that moving
towards taxing consumption and leaving saving to accumulate,
not distorting saving decisions through taxes on saving
behavior, leads to higher income in the longer run.
Mr. McHenry. All right. Chairman, you also spoke about
whatever the size the government is chosen to be, tax rates
must ultimately be set at a level sufficient to achieve an
appropriate balance of spending and revenues in the long run.
I know you have spoken about this before. But in terms of
entitlement reform, at what point does our inaction as a
Congress have a negative effect on the economy, meaning our
inaction to achieve entitlement reform? At what point does that
actually become a drag? Is that 2008?
Mr. Bernanke. I do not think there is a magic point. But
the further this goes without any action, the bigger the
current deficits are going to get which is going to draw
capital out of more productive uses like capital investment or,
alternatively, increase our obligations to foreigners. And,
moreover, the further along we get, the harder and more painful
it is going to be to try and adjust the budget in order to stop
the accumulation of debt.
So it is really a two-sided aspect which is that it is true
that we are not feeling a lot of pain at the moment from
deficits, which makes it harder, I understand, politically to
take action, because the benefits and costs of this are further
down the road.
On the other hand, as I said, by acting now, we can at
lower cost and with greater notice, we can make changes to
programs that will take effect ten, fifteen, twenty, twenty-
five years from now. And in that respect, we can do what we
need to do or you can do what you need to do without immediate
impact or without affecting those people who are already
retired, who are near retirement, and who would perhaps
justifiably feel that they were not getting what they had been
promised if you were to affect their benefits.
Mr. McHenry. I know there are a number of discussions going
on in the Congress right now about entitlement reform and, in
essence, creating a commission to look at all the entitlement
programs, all the mandatory spending programs, to look at ways
to reform them.
And I wanted to ask you if you would be willing to comment
on those ideas for maybe a BRAC like, BRAC style commission to
review policy prescriptions and have that sent back to the
Congress for a simple up or down vote.
Mr. Bernanke. I am reluctant to endorse or comment on
specific budgetary measures or similar measures as you
describe. However, I do think that trying to focus Congress on
the longer term and emphasizing the urgency of beginning to
take action is highly desirable and whatever methods achieve
that objective would be very good to undertake.
Mr. McHenry. Thank you, Chairman.
Chairman Spratt. Mr. Berry.
Mr. Berry. Thank you, Mr. Chairman.
Thank you, Mr. Chairman, for being here.
The United States Congress almost all the time is in this
debate about taxes and tax cuts are good and tax increases are
bad and so on and so forth. And I think we all agree that the
lower the taxes can be, the better it is.
Now, you have already said here today, I believe, that they
need to be the same. Whatever your revenues are, they need to
be the same as your expenditures.
Does the impact of a tax cut change if you make that policy
change and it results in tax reductions, but to offset the loss
of revenue, you borrow the money?
Mr. Bernanke. Because taxes and spending have to be
commensurate in the long run, if you cut taxes and lose revenue
through that tax cut and you do not make any adjustments on the
spending side, then that tax cut will essentially have to be
temporary. It will eventually have to come back up in order to
finance the spending.
So in order to get the incentive benefits of a tax cut, you
also have to look on the spending side and be willing to make
equal cuts in spending.
Mr. Berry. We have heard from any number of people that
sometimes these tax cuts do result in an improved economy and
sometimes they do not. Would you agree with that?
Mr. Bernanke. Not all tax cuts are created equal. Some are
more effective than others. And, again, tax cuts that are
accompanied by spending restraint would be more effective than
those which are not.
Mr. Berry. And we have also heard over and over again, and
I think it is obviously true, that Medicare and Social Security
as they are structured today are unsustainable, that we have
got a train wreck waiting to happen out there. It is not going
to happen tomorrow, but it is a very serious matter to this
country.
Would this nation be better off without those programs?
Mr. Bernanke. I do not think anyone is seriously advocating
eliminating those programs. I think the question is trying to
look at how they work and make some judgments about are there
ways that the cost can be reduced and, if not, and let me just
say, if not, then making the tough decisions to raise taxes on
the other side.
I mean, the main decision which Congress has to make is how
big is the government going to be. And all I am saying is the
laws of arithmetic have to apply. If you just decide to have a
larger government, which is not illegitimate, you could well
believe that the social services and the other benefits of
government spending are worth it, then that is fine, but you
just have to be willing to accept the higher taxes and the
implications that might have for economic growth.
Mr. Berry. But right now we are really not facing up to
that and we are just kind of whistling past the graveyard.
Mr. Bernanke. Yes, sir.
Mr. Berry. And hoping that the tooth fairy comes and bails
us out of this deal. Is that a correct assessment? I know that
is mine, not yours, and I would not expect you to assign
yourself to what I just said.
Mr. Bernanke. I do not know about the metaphors there, Mr.
Congressman, but I do think that Congress does, and I realize,
as I said several times, this is not an easy task by any means,
but Congress does need to begin to address these long-run
fiscal imbalances.
Mr. Berry. Thank you, sir.
Thank you, Mr. Chairman.
Chairman Spratt. Mr. Andrews.
Mr. Andrews. Thank you, Mr. Chairman.
And thank you, Mr. Chairman, for your very edifying
testimony. I wish every member would read it. I think it is
very, very edifying.
You describe our budgetary situation as the calm before the
storm and I think you very correctly identified the storm as
being severe consequences for the economy if capital pools are
drained, if the price of capital rises, if we continue a policy
of borrowing our way to an illusionary prosperity.
One of the matrix that you discuss as a way of measuring
our progress toward avoiding that storm or preparing for that
storm is the idea of the measurement of the long-term solvency
of entitlement programs, such as the long horizon present
values of unfunded liabilities for Social Security and
Medicare.
Do you think that there are benchmarks that the markets are
going to express and manifest as to which benchmarks we have to
hit on that issue? I will ask you the question another way.
My understanding is we are adding each year to the present
value of those unfunded liabilities by failing to take action
on entitlement reform, and we are also adding to it by failing
to put away Social Security surpluses which could be saved for
those forthcoming problems.
Do you think that the market will manifest a benchmark
where if the unfunded liability grows too large and the time
before the storm starts grows too short that the markets will
begin to punish us with higher long-term interest rates and, if
so, what would you think those benchmarks are both in terms of
size of the unfunded liability and distance from the storm?
Mr. Bernanke. I think it would be hard to give you exact
numbers. Thus far, the Treasury market has very willingly
financed the government. Real interest rates are low. They have
not come up much.
I would think that concerns would begin to mount if the
government got to the point where it was coming closer to one
of these snowball situations where the accumulation of interest
on the debt was adding to the deficit which was adding to the
debt.
If that looked to be something that was inevitable and that
it was becoming increasingly unlikely that the Congress was
going to be able to address that, and, again, the closer you
get to that, the harder it is, then I think capital markets
would become concerned about it.
Mr. Andrews. We, as you know, deal in five-year budget
windows in the resolutions that the Committee addresses.
Could you give us a perspective as to what the markets
would regard as a successful five-year project that would
either reduce the unfunded liabilities or at least let their
rate of growth slow? Is there a target we should be shooting at
in the five-year window?
Mr. Bernanke. Well, as I indicated, you need multiple
indicators, and I am not sure that the five-year window
sufficiently captures the long-run imbalances. So it would be
interesting to look at projections as we saw on the screen a
while ago of the imbalance at ten, fifteen, twenty years down
the road and steps that move in the direction of ensuring that
those imbalances are being closed. And I think just moving in
the right direction is important.
Mr. Andrews. Assuming that we were able to enact a budget
resolution that during the five-year window stop the process of
using the Social Security surplus and began to bank it or save
it toward reducing this future unfunded liability by making it
funded, would you regard that as a positive development?
Mr. Bernanke. I think it would be extraordinarily difficult
to move that far on budget surplus in a few years, within five
years and----
Mr. Andrews. But if it were, would it be a positive
development?
Mr. Bernanke. Well, the Federal Reserve would have to
offset the short-term spending effects of that with lower
interest rates. But that would be----
Mr. Andrews. So you promised us lower interest rates if we
do that? Is that what I just heard?
Mr. Bernanke. If you do that, we will do our best. But what
we would do is we would respond in such a way as to try and
keep the economy at full employment.
Mr. Andrews. I understand.
Mr. Bernanke. But I think if you can demonstrate a plan
that seems plausible and make a down payment on it, if I may
say so, that would be certainly the right direction. It would
be reassuring.
Mr. Andrews. I think one of the imperative projects of this
Committee is to define plausibility, and we need your input on
that and those of other leaders.
And I thank you very much for your testimony and for
answering my questions.
Mr. Bernanke. Thank you.
Mr. Andrews. Thank you, Mr. Chairman.
Chairman Spratt. Mr. Etheridge.
Mr. Etheridge. Thank you, Mr. Chairman.
Chairman, thank you for being here this morning and thank
you for your time. This is an important issue and you have got
a tough job. We appreciate the job you do.
Let me ask you a question. You touched on this in different
ways and all of us sort of struggle with our own family incomes
and what our debt ratio is to our assets, et cetera. But my
question is, do deficits matter at the federal level?
Mr. Bernanke. Yes, they matter because they are part of the
process by which debt builds up, and that debt burden is going
to affect our children and grandchildren in two different ways.
First of all, it is going to be actually a debt that they
have to do something about paying off, number one. But, number
two, it is going to drain capital from the construction of new
machines, new factories, and the like, or increase our debt to
foreigners so that when that time comes to pay off that
interest, they are going to have a less vibrant economy, you
know, to earn income from in order to do it.
So debt does matter because it is the process of
accumulation of debt which creates the burden for the next
generation.
Mr. Etheridge. Thank you. I happen to agree. I just asked
that question because Vice President Cheney has stated that
deficits do not matter. And it is obvious they do not with some
of the spending, but let me move to another question.
You were quoted earlier saying, and you touched on this a
little earlier today, and you had said earlier this month
really that policies that focus on education, job training, and
skills and that facilitate job search and job mobility seem to
me to be promising means by moving toward that goal, talking
about expanding the economy, et cetera, making it bigger,
making the pie much larger.
I assume you still stand by that statement.
Mr. Bernanke. Yes, sir.
Mr. Etheridge. Thank you.
I ask that question because, just so you will know, in my
previous life, I was in business. Prior to that, I was State
Superintendent of Schools for a few years. And I happen to
believe that if you are going to make the pie larger as we look
out with all the challenges or projections, we can change those
projections by changing output, educational levels and
productivity of workers and the value added of each worker to
that, because you have been saying that.
Mr. Bernanke. It will add to growth and it will also create
more opportunities for people across the income spectrum.
Mr. Etheridge. Change those dynamics. And I look at the
budget that we are dealing with that the Administration sent
over, and there are a whole lot of gaps as relates to job
training and education and those investments that I think are
long-term investments as we look at the out years.
And I would be interested again in your comments and any
thoughts you could help us with as we are dealing with that
because it seems to me that if you really want to change the
dynamics, it is an investment versus and expenditure, and you
invest in the future and you spend for today.
And I think your comments have indicated previously that if
you invest in education today and monitor it and measure it,
that will give you a reward down the road if you do it right.
Mr. Bernanke. If you do it right. I mean, the only caveat I
would add is that the total budget line is not the only
indicator of the commitment or the effort. It also has to be in
programs that have shown to produce a good result.
Mr. Etheridge. Well, let me just give you a couple examples
before we get to your comments because I think it is important.
If we go back to World War II, the GI Bill was an
investment. And men and women who were coming home and we know
the results of that.
In the 1960s with the Sputnik, we got frightened. We put
the ``National Defense Act'' in place, and the results of that
was an infusion of capital that excited young men and women
about a goal of going to the moon and it turned into a
tremendous economic boom for this country. And we led the world
in a host of ways.
We really need, I think, that kind of vision once again for
our young people to challenge them academically to generate the
kind of growth in opportunities we need.
And I think budgets are more than just numbers and figures.
I think they are moral documents that speak to our visions, our
hope for the future.
Mr. Bernanke. I agree that a strong commitment to helping
young people realize their potential is extremely important.
There are many ways to address that. People disagree about the
right way to do it. And I urge Congress to have a healthy
debate about how best to foster learning, education, and skills
among our whole population.
Mr. Etheridge. Thank you. And thank you for your time.
Thank you, Mr. Chairman.
Chairman Spratt. Mr. Chairman, if you will indulge, Mr.
Cooper has a question he would like to ask also, if you have
the time. Thank you very much.
Mr. Cooper.
Mr. Cooper. Thank you again for your testimony.
You say toward the close of your testimony that if early
and meaningful action is not taken implied by Congress, U.S.
economy could be seriously weakened and future generations
bearing must of the cost.
Our problem here is lighting a fire under some of our
colleagues to get the tough decisions made. So one of the
pieces of data that I have been using came from last summer's
``Wall Street Journal.'' It was on page C6. It was from
Standard & Poors, a leading credit rating agency.
And they projected, they did not predict, but they
projected that the U.S. Treasury bond itself would lose its
triple A credit rating if current trends continued by the year
2012.
Then they went on to project that by the year 2025, the
U.S. Treasury bond would achieve junk bond status below
investment grade. And that has been one of the more tangible
warning signs because most folks kind of heard of S&P and
think, well, gosh, that is not Democratic, that is not
Republican, that is credit markets. And everyone has a sense
that U.S. Treasury bond is the most important, most liquid
instrument in the world.
So the prospect that we are literally destroying America's
credit today by our inaction has helped light a few small
fires, but still not enough to get folks going. So I
appreciated your response to Rob Andrews' questions.
We, if we were to follow the President's budget, would be
using $1.3 trillion worth of alleged Social Security surpluses
to mask the true size of the deficit, because when the
President brags that he is going to achieve a surplus in year
five that he does not tell you that he would be doing that by
borrowing that year about 230 or 40 billion dollars from Social
Security.
So that really, if you look at all of our programs,
including Social Security, we are still going to have a deficit
in year five.
So how do we get a greater sense of urgency here? You are
doing all that you can, but what can we be doing to get this
problem solved early as you suggest?
Mr. Bernanke. I think you need to consult with your
colleagues and try to think about a plan. I think one of the--
and, again, I am reluctant to get into congressional process of
which I am certainly not an expert--but a good bit of the
budgetary planning is about the relatively short run, and the
question is whether Congress can define some matrix or
benchmarks for progress on the long-term imbalance issue. If
that were possible and if there were some will in Congress to
try to meet those benchmarks, that would be a step in the right
direction.
You are right. That is somewhat difficult because so far,
the effects of the deficits are not evident to the average
American. I mean, the average American does not know about the
current account deficit and those sorts of things.
But, again, I think it is also an opportunity because we
have enough lead time that we can make changes in programs that
will not take effect until people who are now in their thirties
and forties are approaching retirement and give them plenty of
time to plan and adjust to those changes.
Mr. Cooper. I thank you, Mr. Chairman.
Chairman Spratt. Mr. Becerra.
Mr. Becerra. Thank you, Mr. Chairman.
Mr. Chairman, thank you for being patient and wading
through the different questions that we have all asked you.
I want to go back to something that I know you have talked
about quite a bit today and in other days and that is how
deficits do matter.
And I think to underscore that, it is important to point
out that this year, we are paying something close to the size
of the identified deficit of $240 billion simply in interest
payments on the national debt, which means we are getting
nothing out of those $240 billion or so in payments on money we
owe.
But I wanted to highlight and talk to you a little bit
about what I think is not being explored well by all of us in
government, certainly to the detriment of the American people,
and that is the fact that while the President identifies our
budget deficit for 2007 as being $244 billion, if it were not
for the fact that we are using all the monies that we are
collecting in the Social Security Trust Fund, all the extra
dollars that are not being spent today for benefits to the
Social Security recipients, the actual size of the deficit
would be closer to $435 billion because there is about $190
billion in excess money that you today, I today, and every
American who got up today to go to work is paying in the FICA
tax for our Social Security and Medicare contributions.
I think it is unfortunate, and I think the Chairman tried
to focus on this as well, that the American people do not quite
understand what is going on and do not quite grasp why deficits
do matter and what the consequences could be, not so much to us
today, but to our children in the future.
And I am wondering if you can just comment a bit. This year
in 2007, there are about $190 billion in surplus dollars in
Social Security that you and I and everyone in America who
works is contributing to the system with the expectation that
it will be around when we retire. Next year, that amount rises
to over $200 billion in surplus money. In 2009, it is about
$218 billion estimated. In 2010, $230 billion. In 2011, $246
billion. In 2012, $255 billion in surplus monies in Social
Security.
Each one of those amounts of surplus in each of those
years, the President has in his budget that he has presented to
us consumed every single cent of those monies, over a trillion
dollars, in something other than Social Security. And you have
mentioned how we need to have some fiscal discipline, how we
have to get these deficits down. Is it wise for us--here is the
question--is it wise for us knowing that we will have this
liability, whether it is legal or otherwise, to the American
people who today are contributing in FICA taxes for the Social
Security benefits in the future, is it wise for us to not do
more to explain to the American people that the size of the
deficits are not 244 billion as the President identifies in his
budget, but really $434 billion because we are masking the size
of the deficit by using Social Security monies that ultimately,
I think you and I would agree, we must commit to spend on
Social Security in the future?
Mr. Bernanke. Well, first, the unified budget deficit
concept, which is what you are talking about, has been in use
for a while. It is not a brand new thing. But you are right. It
does have the property that essentially the surplus from each
year is payroll taxes being used for other purposes.
I do not know how effective it would be, but I think
probably some Americans do think that Social Security is like a
401k plan and that their contributions are being invested in
real assets, which is, of course, not the case except in the
very narrow sense that the trust fund has these IOUs in it. So
I do think that would be something worth pointing out.
And I guess I could go even further and just note, as we
had discussed earlier, that beyond the on budget deficit, which
is what you are talking about, there is also the accrual
deficit which adds to that the accrued obligations to, say,
federal employee pensions and the like. And beyond that, it is
the money that we are essentially owing each year as we get
closer and closer to the demographic crunch.
So there are multiple measures of this. And I agree that
the unified budget deficit is in some sense the least revealing
in terms of long-term obligations.
Mr. Becerra. And, Mr. Chairman, I would guarantee you that
most Americans would say to you so you are using those monies
that we are contributing extra to Social Security to help us
take care of our troops, to make sure they are well armed, or
to make sure that Katrina victims are being addressed or taken
care of in New Orleans. I think they would say fine, that is a
good investment.
But I wonder if most Americans would say that helping pay
for the President's tax cuts which have benefitted very few of
the majority of Americans who got up to work today because most
of those tax cuts are directed towards folks who are probably
in your income bracket and my income bracket and the upper
echelons of our wealth, if the American public would say, well,
that is really where I want to see my $190 billion in surplus
Social Security funds going, recognizing that today we have got
a budget deficit that is bigger than the whole $190 billion
that Social Security is contributing to this budget.
And I think if we did a better job, all of us, in our
respective roles of educating the public on the money that is
out there, I think they would guide us in some good decisions
and these long-term decisions that we have to make to try to
corral these deficits that are growing very large and the
entitlement spending that we have to at some point address as
well.
So I thank you for being patient and being here and look
forward to seeing you again at some point in the future.
Thank you, Mr. Chairman. I yield back.
Chairman Spratt. Thank you, Mr. Becerra.
Mr. Chairman, you have been forthcoming as well as
forebearing and we appreciate the efforts you have made to help
eliminate the problems that line our path. They are daunting
challenges, but they definitely need to be addressed. And you
have helped issue a sobering call to action.
Thank you very much for your testimony today. We very much
appreciate it.
Mr. Bernanke. Thank you, Mr. Chairman.
[Whereupon, at 12:25 p.m., the Committee was adjourned.]
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