TESTIMONY OF FRANKLIN D.
RAINES
DIRECTOR
OFFICE OF MANAGEMENT AND BUDGET
BEFORE THE
JOINT ECONOMIC COMMITTEE
UNITED STATES CONGRESS
February 26, 1997
Mr. Chairman, Members of the
Committee, I am pleased to be here this morning to discuss the
President's 1998 budget and the Administration's views on the health
and direction of the
economy.
I will begin by making five basic
points about our budget. I will then discuss the budget and
the economy, focusing on the competing visions of fiscal policy that
have dominated the last two
decades -- the budget policies of the 1980s and the budget policies
that President Clinton has
pursued.
I will then be happy to take your
questions.
We have already done much of
the hard work
My first point is that, over the last
four years, we have already done much of the hard work of
achieving balance.
Before the President took office, the
deficit reached a record $290 billion in 1992 and was
headed up. In 1993, he worked with Congress to enact his economic
program of lower deficits
and more investment. Since then, the deficit has fallen by 63 percent
-- from that $290 billion to
$107 billion in 1996. We have the smallest deficit since 1981 and, as
a share of Gross Domestic
Product (GDP), the smallest since 1974.
The President's plan has exceeded all
expectations. It was designed to reduce the accumulated
deficits over five years, 1994 to 1998, by $505 billion. In just its
first three years, 1994 to 1996, it
has already reduced the deficits by $485 billion. We now project that
over the same five years,
the plan will reduce the deficits by $925 billion.
More than that, we now estimate that
the plan will reduce the deficits through 2002 by $2.5
trillion -- the difference between where our original baseline said
the deficits would be from 1994
to 2002, and where we now project them over those nine years. Our new
projections are based
on the steps we have already enacted into law. The 1998 budget calls
for a net $252 billion in
additional savings to reach balance in 2002 -- just 10 percent of the
savings that we put in place in
the 1993 plan. Having done much of the work, we surely can finish the
job.
We are enjoying the fruits of our labor
My second point is that, we are
clearly reaping the benefits of our success to date in cutting
the deficit.
We inherited an economy that, in the
previous four years, had barely grown and had created
few jobs. As I previously said, the deficit had hit record levels.
Savings and investment were
down, interest rates were up, and incomes remained stagnant, making it
harder for families to pay
their bills.
Since then, the economy has performed
well across the board. Business investment has grown
at double-digit rates. The private sector has grown faster than under
either of the previous two
Administrations, while the Federal Government component of GDP has
shrunk at an annual rate
of almost three percent.
We have over 11 million new jobs, 93
percent of them in the private sector. Wages are
beginning to rise. Inflation has remained remarkably low -- below
three percent by most
measures. Interest rates are under control. And unemployment, which
measured 5.4 percent in
January, is nearly two percentage points lower than when President
Clinton took office.
Also, partly due to a strong economy
(and partly to the Administration's policies), poverty,
welfare, and crime are down substantially all across America. For
instance, poverty has fallen
from 15.1 percent in 1993 to 13.8 percent in 1995, the last year for
which we have data. And
violent and serious crime has fallen five years in a row, marking the
longest period of decline in 25
years.
With strong growth, low interest
rates, low inflation, millions more jobs, record exports, more
savings and investment, and higher incomes, it's no wonder that such
experts as Alan Greenspan,
the chairman of the Federal Reserve, have described this economy as
the healthiest in a
generation.
Later in my oral remarks, I will
provide more details on how our budget policy has
strengthened the economy.
We are proposing a credible
budget to finish the job
My third point is that, the President
is proposing a credible budget with real savings, based on
conservative assumptions.
It wasn't too many years ago that
Presidents would routinely send to Congress budgets that
had little relation to reality. They were based on what became known
as "rosy scenarios" about
how the economy was likely to perform, with unreasonable assumptions
about growth and
interest rates. They pretended that the deficit would come down. Not
surprisingly, it never fell in
a sustainable way. Of the 12 budgets submitted by the last two
Administrations, the economy
performed worse than the forecast 10 times.
President Clinton has broken the
pattern. For four years, he has submitted budgets that were
based on reasonable assumptions about the economy and the deficit.
How do we know? Look at
the record. The economy has consistently performed better than the
Administration had
projected, bringing in more revenues and enabling the Government to
spend less on
unemployment compensation and other social benefits. As a result, the
deficit has fallen more
than we estimated, and by an average of $50 billion a year.
Like its predecessors in this
Administration, this budget is grounded in conservative economic
and technical assumptions. With pleasant surprises such as the recent
fourth quarter GDP figures,
we expect that, if anything, the economy will continue to outperform
our projections.
In addition, the President is
proposing significant savings -- including $137 billion by cutting
discretionary spending, $121 billion by cutting mandatory spending,
$34 billion by eliminating
unwarranted corporate tax subsidies, $16 billion in net interest
costs, and $42 billion by extending
tax provisions that have expired.
The budget savings total $350 billion
over five years, shrinking Federal spending from 22.5
percent of GDP in 1992 to an estimated 19 percent in 2002. At the
same time, the President
proposes to cut taxes by $98 billion, providing tax relief to tens of
millions of middle-income
Americans and small businesses. Thus, the budget calls for net
savings of $252 billion.
This budget does more than reach
balance in 2002. It would keep the budget basically in
balance until 2020. After that, demographic changes -- specifically,
the retirement of the baby
boom generation -- will present significant challenges in ensuring the
continued viability of Social
Security and Medicare. The President has called for bipartisan
processes to address those
challenges.
This budget invests in the
Nation's priorities
My fourth point is that, the budget
invests in the Nation's priorities.
Balancing the budget is not an end in
itself. Rather, it helps fulfill the Administration's central
economic goal -- to raise the standard of living for average
Americans. So, too, do the spending
priorities of this budget.
Let me take a moment to walk you
through the highlights:
Strengthening Health
Care. The budget preserves and improves Medicare,
extending the
solvency of the Part A Hospital Insurance Trust Fund into 2007. It
gives older Americans and
people with disabilities more choices among private health plans, and
it proposes new preventive
health care benefits to improve the health of senior citizens and
reduce the incidence of disease.
For Medicaid, the budget preserves the guarantee of high-quality
health care for millions of
children, pregnant women, people with disabilities, and the elderly.
It reforms Medicaid to give
States much more flexibility to manage their programs. It helps an
estimated 3.2 million families,
including 700,000 children, keep their health care coverage for up to
six months until their
breadwinners find new jobs. And it provides coverage for up to five
million of the 10 million
children who do not now have it.
Making Welfare Reform
Work. To help welfare recipients move from welfare to
work, the
budget proposes a Welfare-to-Work Jobs Challenge to help States and
cities create job
opportunities for the hardest-to-employ recipients; and a greatly-
enhanced and targeted Work
Opportunity Tax Credit (WOTC) to provide powerful new, private-sector
financial incentives to
create jobs for long-term welfare recipients. The budget also
proposes several steps to address
the overly deep cuts affecting single people, legal immigrants, and
children that Congress attached
to last year's welfare reform law.
Investing in Education
and Training. The budget expands the President's
investments in
Head Start, in Goals 2000, in the Technology Literacy Challenge Fund,
in Pell Grants, and in
other key education programs. It also proposes a $1,500-a-year HOPE
scholarship tax credit to
make two years of college universal; a tax deduction of up to $10,000
to help middle-income
families pay for postsecondary education and training; the America
Reads Challenge to help
ensure that all children can read well and independently by the end of
third grade; and a new
school construction fund to leverage new construction or renovation
projects.
Protecting the
Environment. The budget increases funding for the
Environmental Protection
Agency's (EPA) operating fund and funds the Kalamazoo Initiative, a
new national commitment
to protect communities from toxic pollution by the year 2000. It
funds start-up activities at the
Grand Staircase-Escalante National Monument; increases funds for the
National Park System to
help improve park facilities and further protect our natural and
cultural treasures; and re-proposes
the President's "Everglades Restoration Fund" to provide a steady
source of funds mainly for land
acquisition to maintain the South Florida Ecosystem.
Promoting Science and
Technology (S&T). The budget maintains the
President's
commitment to biomedical and behavioral research, which promotes the
health and well-being of
all Americans. For the National Institutes of Health, in particular,
the budget includes increases
for HIV/AIDS-related research; research into breast cancer and other
health concerns of women;
minority health initiatives; high performance computing; prevention
research; spinal cord injury;
and developmental and reproductive biology.
Enforcing the Law.
The budget puts 17,000 more police on the street,
continuing the
progress toward the President's goal of 100,000 by the year 2000. To
fight drug abuse, it
increases funds for the Drug Courts initiative, for drug testing, for
the Safe and Drug-Free
Schools and Communities program, for interdiction efforts along the
Southern border, and for
disrupting the drug industry and its leadership overseas. To
strengthen efforts to control illegal
immigration, it increases the number of Border Patrol agents,
continues Port Courts to expedite
removals, and expands efforts to verify employment eligibility of
newly hired non-citizens.
Providing Tax Relief.
The budget provides a $500 tax credit for dependent
children under
13; expanded individual retirement accounts, and the HOPE scholarship
tax credit and tax
deduction for postsecondary education and training that I just
mentioned. It also exempts 99
percent of all home sales from capital gains taxes by excluding up to
$500,000 in gains for
married taxpayers. At the same time, the budget cuts unwarranted
corporate tax subsidies, closes
tax loopholes, improves tax compliance, and extends various excise and
other taxes that were
allowed to expire.
Projecting American
Leadership. The budget continues support for democratic
reform and
free markets in Russia and the New Independent States (NIS) of the
former Soviet Union, ensures
that the United States continues to play a vital role in crafting a
lasting Middle East peace, and
proposes a mechanism to liquidate our arrears to the United Nations
and its affiliated
organizations -- presuming these organizations undertake the
management, budget, and
assessment changes that we and others have urged. The budget
continues the President's policy
of sustaining and modernizing the world's strongest and most ready
military force, capable of
prevailing with our regional allies in two nearly simultaneous
regional conflicts. It continues our
commitment to maintaining high levels of training and readiness for
that force and to equipping it
with technology second to none.
We need bipartisan
cooperation to achieve a five-year agreement
And my fifth and final point is that,
we need bipartisan cooperation to achieve a five-year
balanced budget plan.
We obviously think that the
President's budget is the best plan for reaching balance by 2002.
And, we think his budget is the right starting point for our
discussions. But we understand that
the executive and legislative branches share responsibility for
enacting a budget.
The time to balance the budget is
now. Our economy is strong, so it can absorb the spending
cuts that we would have to put in place. And the political stars seem
to be lining up in the right
orbit. Everyone learned the lesson of the last two years -- that
conflict over the budget is not a
path to success. Both the President and Congress have voiced their
commitment to reach an
agreement this year.
So I am cautiously optimistic. But I
am realistic as well. Mr. Chairman, as you know, we
have been down this road before. You know that agreements that seemed
inevitable have eluded
our grasp. If we are to avoid that fate, we have to work together, in
good faith. I want to assure
you this afternoon that, from the President on down, this
Administration is prepared to do that.* *
*
Mr. Chairman, I would now like to
shift gears a bit. I will discuss President Clinton's fiscal
policy, compare it to the fiscal policy that dominated the 1980s, and
highlight the achievements of
each.
The 1980s-era fiscal policy held that
tax cuts would generate greater saving, investment, and
work effort, strengthening the economy and leading to more growth.
The deficit, then, would
take care of itself.
President Clinton's policy held that
reducing the deficit would strengthen the economy, leading
to more saving, investment, and work effort. His program was designed
to reverse the
unsustainable rise in our deficit and debt that began in the 1980s,
end uncertainty in the financial
and investment markets, and show the world that this Nation had the
will to address its problems.
Now that we have tried the two
policies, we can compare the results. And, as the record
shows, President Clinton's policy worked. In fact, the program
accomplished more of the explicit
goals of the 1980s-era fiscal policy -- more saving and investment,
higher growth, and lower
deficits -- than that policy itself.
Saving.
Economists agree that capital formation, a major goal of the 1980s-era
budget policy,
requires more saving -- putting aside some of what we produce to
invest in the capital needed to
raise future production. Advocates of the tax cuts of the early 1980s
argued that when people
paid less in taxes, they would save more.
The reasoning had a logical flaw,
however; government, as well as households, can add to, or
subtract from, the savings pool. If tax cuts raised the Federal
budget deficit dollar for dollar, thus
reducing the Nation's saving, then taxpayers would have to save every
penny of their tax cuts just
to hold national saving constant.
In contrast, the President proposed
to increase national saving by decreasing Federal dis-
savings -- that is, by reducing the budget deficit that was
subtracting funds from the savings pool.
His 1993 program relied on both spending cuts as well as tax
increases, the latter geared largely
to the most well-off Americans.
The result is clear, as seen in the
chart on national saving. Net national saving averaged 9.3
percent of GDP from 1960 through 1980. It fell to 5.4 percent from
1981 to 1984, mainly
because Federal saving fell from -0.8 percent of GDP in the 1960-to-
1980 period to -3.7 percent
in the 1981-to-1984 period.
Rather than rising, private saving
actually fell after the 1981 tax cuts -- from 8.1 percent of
GDP from 1960-to-1980, to 7.3 percent from 1981-to-1984. Americans
chose to consume,
rather than save. From 1984 to 1992, national saving continued to
fall. By 1992, net national
saving was only 2.4 percent of GDP; private saving was only 5.5
percent, and Federal dissaving
was -4.5 percent.
National saving has risen in the last
four years (though it has not yet regained its pre- 1980s
form). From 1992 to the third quarter of 1996, net national saving
rose from 2.4 percent of GDP
to 5.4 percent. Federal dissaving fell from -4.5 percent to -1.8
percent, accounting for most of
the improvement. And, although high-income taxpayers faced an
increase in their marginal tax
rate, private saving also rose a bit -- from 5.5 percent of GDP in
1992 to 5.9 percent in the first
three quarters of 1996 -- surely aided by the big increase in
corporate profits under this
Administration.
With greater saving, we have greater
potential capital formation, greater future productive
capacity and productivity, and faster potential economic growth. In
this important respect, the
President was clearly successful.
Investment.
The second essential for capital formation is strong business
investment.
Economists generally agree that a larger and newer capital stock will
raise our productivity and
our productive capacity in the coming years, boosting prosperity and
growth. The tax policies of
the 1980s were designed to increase business investment; tax
incentives for business, such as more
generous depreciation allowances and an investment tax credit, were
expected to induce greater
investment spending.
The Clinton philosophy was very
different; while the President proposed more investment
expensing allowances for small business, he relied mostly on a lower
deficit and, thus, lower
Federal credit demands and lower interest rates.
Again, the record is clear. The
1980s witnessed a typical fall in investment with the 1981- 82
recession, and then a typical recovery of investment. But historical
patterns changed little. By the
end of 1992, the ratio of our equipment investment to our GDP was
little more than when the
1980s began. As a share of real GDP, real equipment spending rose
from 5.7 percent in 1977-to-
1980 to 5.9 percent in 1981-to-1984, and then to 6.3 percent in 1985-
to-1988. But by the last
year of the previous Administration, real spending on producers
durables was still only 6.2
percent of real GDP.
The Clinton years, though, have
broken the mold. Real business investment in equipment has
grown 2-1/2 times faster than in 1981-to-1988, and five times faster
than in 1989-to-1992. Real
equipment spending has risen from 6.2 percent of GDP in 1992 to 8.4
percent in 1996 -- a record
level for this measure of investment spending. The four-year increase
in investment spending of
over 2 percentage points of GDP is the largest rise in equipment
investment in the post-World
War II period, and it will pay dividends in the form of greater future
productive capacity,
productivity, and prosperity.
Work.
Another fundamental of economic growth is work effort; labor must
complement the
greater capital that results from saving and investment in order to
produce growth. Over much of
our recent economic history, labor force participation has followed a
steadily rising path,
apparently impervious to policy. Much of the change has come from
increased participation by
married women, and experts have anticipated that, at some point, that
trend would have to reach
its limit.
Starting in the mid-1960s, labor
force participation in the United States began to rise sharply,
mainly due to the rising participation rate of women. The average
annual rise in the labor force
participation rate over this period was 0.3 percentage point, and the
cumulative increase sent
labor force participation from 58.6 percent of the working age
population in January 1965 to 63.8
percent in August 1981. At that point, the large tax cut was designed
to increase the after- tax
reward to work effort, thus increasing the supply of labor.
Labor force participation continued
to rise after the 1981 tax cut -- but no faster than during
the previous 15 years. From 1981 to the end of 1988, the increase
averaged the same 0.3
percentage point a year. From 1989 to 1992, labor force participation
dropped even though
marginal tax rates remained low for most workers, probably due to the
recession and the poor
prospects for finding a job.
But, under this Administration, the
stall has ended. As the chart shows, labor force
participation has resumed its increase in the last four years, and the
ratio of employment to the
adult population has reached a record level. In other words, the
President's policies of the last
four years have worked even better to achieve the goals advocated by
those who pursued the
policies of the 1980s.
In the last four years, employment
has grown by over 11.5 million jobs -- over 93 percent of
them in the private sector. The Council of Economic Advisers recently
reported that two- thirds
of them are in employment and occupation categories that pay greater
than the average wage.
Growth.
Higher economic growth was the ultimate goal of the 1980s-era
policies, but
private-sector growth in Clinton years has exceeded growth in the
1980s. And growth under this
Administration has followed the fundamentals of saving, investment,
and work effort. More
saving has led to more investment, concentrated in high-productivity
private business equipment.
This increased investment has facilitated the higher employment levels
I just mentioned.
As the chart shows, private-sector
GDP -- the portion originating outside of government -- has
grown more rapidly under this Administration than under either of its
predecessors. The Federal
Government component of GDP has actually shrunk at an annual rate of
2.6 percent; Federal
employment has shrunk by 263,500 full-time equivalent positions, or 12
percent, since this
Administration took office. Also noteworthy, business investment in
equipment has been the
leading growth sector in the economy by a wide margin under this
Administration.
Other economic
indicators. Several noted, non-partisan economic experts
have observed that
this economy is the best of any in decades. Their comments reflect
both the phenomena that I
have discussed above, as well as other phenomena. Generally speaking,
the major economic
indicators today suggest that this expansion is extraordinarily solid,
and can continue for some
time.
As a corollary to higher national
saving, interest rates remain low. What has been remarkable
about the economy under this Administration is the combination of high
employment and low
interest rates, as the next chart highlights. At times in the 1980s,
the unemployment rate has been
as low as under this Administration; at other times, interest rates
have been as low. This
Administration is unique for having low interest rates and low
unemployment at the same time. In
fact, the last time unemployment was as low as now, the 30-year
Treasury bond rate was about
1.5 percentage points higher.
Another indicator of long-term
macroeconomic health is the modest rate of inflation. Since
the start of this Administration, and despite low unemployment and
solid growth, the core rate of
inflation has fallen to its lowest rate since the mid-1960s. The
following chart shows this trend.
Because of this low and stable inflation, many economic forecasters
believe that our steady, solid
growth can continue into the foreseeable future.
Thus, our economy is remarkably
sound. Though we have not abolished the business cycle, no
problem on the horizon threatens the current expansion. The
President's fiscal policies would
build on these accomplishments -- with continued deficit reduction to
further facilitate business
investment.
The deficit.
With low interest rates and a strong economy, the budget deficit
fell swiftly and
more than we forecast. As I have said, the deficit now is at its
lowest level since 1981 and, as a
share of GDP, its lowest since 1974. Four straight years of lower
deficits have brought debt
service costs under control. The ratio of our debt to our GDP, which
virtually doubled in the
previous 12 years, has begun to decline. We have put the worst of the
fiscal excesses of the
1980s behind us.
Some would argue that the President's
program did not reduce the deficit; the economy did.
To be sure, our brighter fiscal outlook is largely a product of the
economy. But a key lesson of
the last 16 years is that the economy cannot do its work when the
Federal Government erects a
barrier of fiscal uncertainty. The economy can work even better than
we might have thought
when the Federal Government gets its fiscal house in order.
The last four years have shown what a
responsible fiscal policy can do for our economy. And
our progress to date gives us a second chance to reach agreement now
on a plan to finally balance
the budget. Such an agreement would enable us to reap the rewards of
further economic
progress.
* * *
Mr. Chairman, that concludes my
remarks. I would be happy to take any questions that you
have.