Testimony of Jacob Lew

TESTIMONY OF
JACOB J. LEW
DIRECTOR
OFFICE OF MANAGEMENT AND BUDGET
BEFORE THE
SENATE COMMITTEE ON THE BUDGET

FEBRUARY 9, 2000

We must Maintain Sound Fiscal Policy in an Era of Surplus

For three years now, we - the Administration and the Congress - have faced a new challenge: maintaining a sound fiscal policy in an era of surplus. Having fought our way back from large and expanding deficits that threatened our economy, we now continue the fiscal discipline that has brought us the strongest economy in memory.

Budget surpluses and debt reduction are no longer just projections. We ran a $69 billion surplus in fiscal year 1998, and did not spend it. We ran a $124 billion surplus in 1999, and did not spend it. Eight short months from now, we will have an even larger surplus in fiscal year 2000. From 1998 through the end of 2000, we will pay off $297 billion worth of publicly held debt. It should be clear by now that we can run surpluses and pay down our public debt - if we create the right processes and policies to maintain that fiscal discipline.

We must now continue a fiscal policy that is working. Our new challenge boils down to relying on realistic assumptions and baselines, setting priorities, and making choices to maintain a balanced program. It requires addressing our existing commitments before we make new ones.

The President's budget relies on realistic assumptions and reflects balanced priorities.

Economic Performance Reflects Fiscal Policy

It is useful to begin by reviewing the state of our economy, because it shows how much is at stake. Though the private sector is the engine for economic progress, fiscal policy can encourage or discourage growth.

Our fiscal discipline has helped achieve a rapid growth of business investment, because the Federal government has stopped draining the Nation's pool of capital. This has helped to accommodate lower interest rates, and has reduced fears of inflation. Businesses have better access to capital and are better able to invest and innovate.

Under this Administration, we have enjoyed the best sustained growth of business investment since the 1960s. We have seven consecutive years of double-digit inflation-adjusted growth of business equipment investment - which is unprecedented.

Economic progress has reached almost every facet of our economic life, raising living standards for most Americans.

The economy has created 20.8 million jobs since 1993, nearly all of them in the private sector - most of them full-time and in high-paying industries.

The unemployment rate is the lowest it has been in 30 years; for African Americans and Hispanics, unemployment is lower than at any time in the quarter-century for which statistics have been kept. A record percentage of adults are employed.

Work has begun to pay more, reversing a two-decade trend of declining real wages and boosting household incomes throughout the economy. Cumulatively, since the beginning of the Clinton Administration, real wages have increased by 6.6 percent.

After two decades of decline and stagnation, Americans at the lower end of the income scale - those in the poorest 20 percent of households - have seen a rise in their real incomes. From 1993 to 1998, their incomes have risen by nearly $900 per household in 1998 dollars, a 10 percent increase. The median family's income has grown by 12 percent.

In the past seven years, 7.2 million people have left the welfare rolls, a 51 percent decline. Welfare recipients now account for the lowest percentage of the U.S. population since 1967. Meanwhile, 1.5 million people who were on welfare in 1997 are now working, and every State has met the overall work requirements mandated by the 1996 welfare reform law.

From 1993 to 1998, the number of poor people in America declined by 4.8 million, and the number of poor children by 2.1 million. The poverty rate has declined sharply from 15.1 percent to 12.7 percent, the lowest it has been in over two decades.

Crime rates are at the lowest level in over 25 years.

A record number of Americans now own their own homes, which was made possible by lower real interest rates and larger real incomes. The number of households that are homeowners increased by more than eight million since the President took office.

The President helped to set off this virtuous economic cycle with his 1993 economic plan.

We Have Made Enormous, Unprecedented Fiscal Progress

In 1998 and 1999, we had the first consecutive balanced budgets since 1957. We expect a larger surplus in 2000, and we propose a still-larger surplus in 2001. The 1999 surplus was the largest as a percentage of the economy since 1951. And the proposed 2001 surplus would be the ninth consecutive year of fiscal improvement -- the first time ever.

After 12 years of spiraling debt threatening to expand beyond control, we are now paying off the debt. By 2013, the United States will be effectively debt-free - for the first time since 1835, when Andrew Jackson was President. By the end of this year, the Treasury expects to have reduced our debt held by the public by about $300 billion from where it was three years ago. Under the President's fiscal policy, debt held by the public by the end of 2004 will decline to the lowest ratio of our GDP since 1974 - completely undoing the debt buildup of the 1980s. And by the end of 2007, the public debt will fall to its lowest share of the GDP since before the United States entered World War I.

How We Achieved this Unprecedented Economic and Fiscal Progress

When President Clinton took office seven years ago, the budget deficit was $290 billion, the largest in the Nation's history. Between 1980 and 1992, publicly held debt quadrupled, from about $700 billion to $3 trillion. It also doubled as a share of GDP, from about 25 percent to about 50 percent.

Both CBO and OMB projected that these adverse trends would accelerate without changes in fiscal policy. OMB forecast the 1998 deficit, in the absence of policy change, at $390 billion; by 2003, we expected the deficit to be $639 billion. Nothing indicated that the vicious cycle would abate.

Reversing these adverse trends required tough policy choices, which the Administration and the Congress took in 1993 and 1997.

The President's initial economic plan cut spending and increased revenues in equal amounts. From 1994 through 1998, deficit reduction more than doubled prior estimates - instead of the projected cumulative $505 billion, deficits fell by $1.2 trillion.

This Administration has controlled Federal spending well beyond the record of its predecessors.

In 1999, spending declined to its smallest share of the GDP since 1966.

As a percentage of GDP, spending in every year for which President Clinton submitted a budget has been lower than in any year of the two preceding Administrations.

In 2001, our policy would further reduce spending to 18.3 percent of GDP. And thanks to the strong economy, receipts have grown beyond expectations, even though income tax rates on typical households are the lowest since the 1970s.

A typical family of four with the median family income will pay a lower share of its income in income and payroll taxes this year than at any other time in a quarter century. Its income tax payment considered alone will be the lowest share of income since 1966.

A family with income at one-half of the median level will pay the lowest share of its income in income and payroll taxes since 1965. It will receive money back from the Federal government because of the earned income tax credit.

Even a family at twice the median income level will pay less in income tax as a percentage of income than at any time since 1973.

The historic bipartisan Balanced Budget Agreement of 1997 has reinforced expectations of Federal fiscal responsibility. This has had a positive impact on interest rates and has helped spur economic growth.

In the last seven years, we have enjoyed extraordinary economic performance in part due to sound fiscal policy. To continue our strong economic performance, we must continue along the path of fiscal discipline and prudent investments.

We Need a Realistic Baseline, with Adequate Resources for a Strong Defense and Critical Investments in the Future

Since 1993, discretionary spending has declined in inflation-adjusted dollars. The Federal government must continue to accomplish the missions assigned to it in a growing economy with a growing population. We often take for granted the need to maintain critical functions like air safety, law enforcement, the administration of Social Security and Medicare, and national security -- both defense and diplomacy. We need realistic budget projections to provide funding for these essential functions that the Nation has a right to expect its government to perform well.

Realistic projections also needed to accommodate investments in education, families, protecting the environment, research and development and national security -- all necessary to assure a better future. CBO served the policy process well this year by illustrating three potential discretionary baselines -- only one of which I believe is realistic.

A discretionary budget baseline that would retain the 1997 spending caps is not realistic. Congress appropriated above those caps by tens of billions of dollars in both 1999 and 2000. To bring spending down to the caps in 2001 would require an unachievable one-year reduction from 2000 program levels of almost $70 billion of budget authority - 11 percent.

Likewise, a discretionary budget freeze over ten years is unrealistic. The Congress increased discretionary budget authority by 7.0 percent in 1999, and 3.5 percent in 2000. A nominal freeze in 2001 would require a budget authority reduction from 2000 program levels of 3 percent. Extending such a freeze for ten years would require program level cuts of 23 percent by 2010 - assuming that defense would be frozen along with non-defense. Such reductions should not, and I believe would not happen.

If defense spending increases within the overall freeze, the implications for all other spending would be even more severe. Within an overall freeze, appropriating the President's 2001 defense request would turn a hard freeze into a 9 percent cut from 2000 levels for all non-defense programs. Any addition to the President's defense request would make the effect on non-defense programs even worse. This is just not realistic.

In contrast, a baseline that maintains the program levels enacted by the Congress last year would provide a sound basis to plan for the future. It would allow for continued investments in key program areas and for the maintenance of vital government functions.

A budget based on unrealistic assumptions is unlikely to stop necessary spending. What ultimately would suffer are fiscal discipline and the commitment to protect the Social Security surplus. If the surplus is exaggerated to make room for either tax cuts or spending increases, when discretionary spending cuts do not materialize, the non-Social Security surplus disappears. This means that both fiscal discipline and the Social Security surplus would be jeopardized. Moreover, any perception that fiscal discipline in Washington is on the decline would undermine our unprecedented economic progress.

Our projection of the non-Social Security surplus of $746 billion over ten years provides substantial resources for a balanced program, in the context of realistic assumptions. The President's budget continues the fiscal discipline that since 1993 has fostered this era of prosperity and surplus. It uses conservative economic assumptions and a realistic baseline for discretionary spending. To stay on our successful budget track, we urge the Congress to consider this approach, and the President's specific policy choices as well.

The President's Budget Framework Relies on a Balanced Approach

The President's budget relies on a balanced approach, which maintains fiscal discipline, eliminates the national debt, extends the solvency of Social Security and Medicare, provides a tax cut and funds essential investments for our future.

The President's budget projects a total surplus of $2.9 trillion over the next ten years. Of that, $2.2 trillion is the surplus from Social Security, which is put in a Social Security solvency lock box and used to retire the Nation's publicly held debt. Beginning in 2011, interest savings because of the Social Security surplus will be transferred from the on-budget surplus to the trust fund, to extend Social Security solvency to 2054. These interest savings are substantial. In 1993, we projected that in 2010 interest would consume 23 cents out of every Federal dollar. Today we project that only three cents out of every dollar will go to interest. These savings permit the extension of Social Security solvency.

The remaining on-budget surplus is $746 billion.

Overall, $432 billion is allocated to Medicare: (1) $299 billion is contributed to the Medicare trust fund to extend its solvency for ten years, to 2025; (2) $98 million is used for Medicare prescription drug policy along with several other health initiatives (including allowing uninsured older workers to buy into Medicare); and (3) $35 billion is reserved to augment the President's proposal for prescription drug coverage under Medicare, to provide for catastrophic costs to the elderly. Pending enactment of that policy, this sum, too, retires debt. (This debt reduction, combined with the Social Security surplus, allows the President to make the Nation effectively debt-free by 2013.)

Another $91 billion of the surplus is allocated to the President's initiative to expand health-care coverage under the existing State Children's Health Insurance Program (SCHIP) and extend coverage to the uninsured parents of those children.

The President's proposed tax cuts - to help low-income working families with children, to reduce the marriage penalty and the burden of the Alternative Minimum Tax (AMT), to encourage saving for retirement, to make higher education more affordable, to aid in school construction and renovation, to help those with long-term health care needs and to extend health insurance coverage, to promote philanthropy, and encourage energy efficiency and protect the environment - use $256 billion of the surplus. (The tax cuts alone total $351 billion, but they are partially offset by proposals to limit the benefits of corporate tax shelter transactions, and end other unwarranted tax benefits.)

The balance of the President's framework policies yields a small net savings. These policies include the President's proposals to restore the farm safety net, the net interest cost of all of these initiatives, and the budget savings that result from the President's tobacco policy.

A balanced approach requires that each element be properly sized. If a tax cut grows within the bounds of a realistic surplus projection, it precludes strengthening Medicare and extending health care coverage through the Children's Health Insurance Program (CHIP).

The following discussion explains the various elements of the President's framework in more detail.

The President's Budget Eliminates the Debt

The President's plan will eliminate the publicly held national debt by 2013. That would be the first time our nation has been debt-free since 1835 - when Andrew Jackson was President. The President's successful policy of fiscal discipline and deficit reduction has already allowed us to pay off $150 billion in debt, increasing to about $300 billion by the end of the current fiscal year. If we maintain our fiscal discipline, and eliminate the public debt, we can devote the savings from debt reduction to Social Security. Last year, the government paid $230 billion in interest costs to finance the national debt - payments that, under the President's plan, will become unnecessary.

The President's Budget Strengthens Social Security

The President's commitment to Social Security has resulted in general acceptance of the need to protect the Social Security surplus. Now, we must meet the next challenge by strengthening Social Security for the future. The President's framework transfers part of the on-budget surplus - $100 billion in 2011, rising to $211 billion in 2020 through 2050 - to Social Security, to extend its solvency to 2050 (2054 with the President's proposed investment in equities). The President's plan to pay down and eliminate the national debt results in savings in interest costs, which fully justify these transfers for the solvency of Social Security.

The President's Budget Strengthens Medicare

The President's framework extends the solvency of Medicare until 2025, with transfers of part of the on-budget surplus - $299 billion from 2001 to 2010, and further transfers in the next five years.

The framework also modernizes Medicare with a needed prescription drug benefit. This plan ensures that seniors get the drugs they need, as prescription drugs are now more central to medical treatment than they were when Medicare was established thirty-five years ago. Prescription drugs can save money by obviating the need for more-expensive subsequent in-patient treatment. Most elderly lack comprehensive and reliable prescription drug coverage. The budget expands access to preventive benefits, and improves Medicare management.

The President's Budget Expands Health-Care Coverage

The President's budget framework addresses other health-care needs as well. For example, the budget expands the successful health insurance program (State Children's Health Insurance Program) for low-income children, and extends it to their working parents. Established with bipartisan support as part of the 1997 Balanced Budget Act, SCHIP has already enrolled two million children of working low-income parents.

The President's Budget Addresses Needs in Farm Country

The budget also provides a comprehensive farm aid package of $11 billion over the next two years, until the next farm bill is enacted. The President's package includes income assistance that responds to falling crop prices; a major farm conservation program; and targeted assistance to certain segments of the farm and rural communities.

The President's Budget Has Fair Middle-Class Tax Cuts

The President's plan proposes $350 billion for tax cuts ($250 billion in net tax cuts) for America's working families.

It reduces the marriage penalty for two-earner couples, by increasing the standard deduction and introducing an exclusion for part of the earnings of a second working spouse.

It expands the Earned Income Tax Credit, to help America's hard-working low income families, especially larger families which are more likely to be poor than families with only one or two children.

It helps families finance higher education, child care and long-term care, as well as expanding health insurance options for those facing unique barriers to coverage.

The President's plan also establishes Retirement Savings Accounts, to give 76 million Americans the opportunity to build wealth and save for their retirement.

The Budget Continues the President's Policy of Investment

Education, in our competitive global economy, has become the dividing line between those who are able to move ahead and those who lag behind. Over the last seven years, we have worked hard to ensure that every boy and girl is prepared to learn, that our schools focus on high standards and achievement, that anyone who wants to go to college can get the financial help to attend, and that those who need another chance at education or to improve or learn new skills can do so. The budget builds on the sustained commitment to make college more affordable by increasing the tax credit than funds higher education and increasing Pell Grants and other college scholarships from the current record levels. It reduces class size by recruiting and preparing thousands more teachers and building thousands more new classrooms, as well as providing for urgent and essential repairs.

The budget expands access to after-school learning opportunities to help children, especially in the poorest communities. It recruits teachers in high-poverty areas and encourages school districts to pay teachers more through peer review. It ends social promotion by expanding after school learning hours to help students to earn advancement. The budget funds monetary awards to the highest-performing schools that serve low-income students, and helps States to identify and change the least successful schools. It invests in programs targeted to Hispanic students. It narrows the digital divide through technology centers in low income areas.

The budget promotes early learning by significantly increasing 21^st Century Learning Community Centers. It makes child care more affordable by expanding tax credits for middle-income families, and establishes a tax credit for businesses to establish child care. It assists parents who attend college to meet their child care needs, as well as parents who choose to stay at home to raise a young child, and makes the Child and Dependent Care Tax Credit refundable. The budget proposes an expansion of the Early Learning Fund and builds on the expansion of the successful Head Start program to help meet the goal of serving one million children by 2002. It increases funding for the Child Care and Development Block Grant for poor and near-poor children.

Supporting families. The budget promotes responsible fatherhood by enforcing child support, and aiding the employment and training of low-income parents. The budget allows low-income working families, who need transportation to work, to own a modest vehicle and retain food stamp eligibility. And it provides health care to legal immigrant children, and restores Supplemental Security Income benefits to legal immigrants with disabilities and to legal immigrants in families with eligible children.

Extending prosperity to all of America. The New Markets Initiative provides tax credit and loan guarantee incentives to stimulate billions in new private investment in distressed rural and urban areas. It builds a network of private investment institutions to funnel credit, equity, and technical assistance into businesses in America's untapped markets, to target small businesses and help them to grow. The budget increases the number of Empowerment Zones and Enterprise Communities, which provide tax incentives and direct spending to encourage private investment, and provides more capital to the Community Development Financial Institutions program. The budget also includes significant funding increases for Native American communities, for enforcement of the Nation's civil rights laws, and for the partnership we have begun with the District of Columbia.

Fighting Crime. The budget adds funds to hire 500 new ATF agents and 1,000 State and local gun prosecutors. It funds smart gun technology development. The budget also provides funds to prevent violence against women, and to address the growing law enforcement crisis on Indian lands. The budget strengthens border enforcement in the South and West. It combats illegal drug use, particularly among young people, through treatment and prevention, law enforcement, international assistance, and interdiction.

Research. The budget introduces a Science and Technology Initiative for high-priority long-term basic research, including nanotechnology - the manipulation of matter at the atomic and molecular level, offering the promise that medical science may one day be able to detect cancerous tumors when they comprise only a few cells. The budget also increases the Information Technology Initiative to invest in long-term research in computing and communications. It will accelerate development of extremely fast supercomputers to support civilian research, enabling scientists to develop life-savings drugs, provide earlier tornado warnings, and design more fuel-efficient, safer automobiles. The budget provides strong support for the Nation's two largest funders of civilian basic research at universities: the National Science Foundation and the National Institutes of Health.

Environment. The Nation does not have to choose between a strong economy and a clean environment. The past seven years are proof that we can have both. The budget establishes dedicated funding and increases resources for the historic interagency Lands Legacy initiative to preserve the Nation's natural and historic treasures. The budget also supports the Clean Energy initiative, to reduce the threat of global warming, and Greening the Globe, to save tropical and other forests around the world. It supports farm conservation to upgrade water quality, the Clean Water Action plan to clean up polluted waterways, climate-change technology to increase energy-efficiency, and renewable energy to strengthen our economy while reducing greenhouse gases.

National security -- diplomacy and defense. Our Nation now has the greatest opportunity in its history to advance American interests and values while building a better and more peaceful world. However, doing so requires leadership and engagement. This budget supports a democratic society and stronger economy in Kosovo. It proposes increased funding to ensure the continued protection of American embassies, consulates and other facilities, and the valuable employees who work there. It supports significant increases in funding for State Department programs to address the threats posed by weapons of mass destruction. In a fiscal year 2000 emergency supplemental, the budget provides critical assistance to the Government of Colombia in its fight against narcotics traffickers. It proposes funding to promote international family planning, contain the global spread of AIDS, and promote debt forgiveness for the world's poorest countries. The budget also increases programs that support U.S. manufacturing exports and continues our long-standing policy of opening foreign markets.

This budget builds upon our major commitment last year to maintain our military readiness. It provides additional resources to ensure that the military services can recruit and retain quality personnel, meet training standards, procure new equipment and spare parts, and maintain equipment in top condition. In addition, this budget provides resources for the Department of Defense and other agencies to combat emerging threats - including terrorism, weapons of mass destruction, and cyber-crime against critical infrastructure. It supports counter-narcotics efforts, including a 2000 supplemental to increase assistance to the Government of Colombia in their fight against narco-traffickers. It also provides additional funding for contingency operations in Kosovo.

The Budget Continues the President's Drive for Better Management

This Administration set out to create a governent that works better, costs less and gets results Americans care about. We have streamlined Government, cutting the civilian Federal work force by 377,000, giving us the smallest work force in 39 years. While we have made real progress, there is still much work to do. We have set a list of the highest priorities: 24 Priority Management Objectives are listed in this budget. It is a mark of our success that in early 2000, we were able to remove last year's number one objective from the list: Manage the Year 2000 (Y2K) Computer Problem. We will continue to address other priorities, including modernizing student aid delivery and completing the restructuring of the Internal Revenue Service. The steps we have taken to change and improve the way government works have also changed the way Americans view their government, increasing the confidence and trust of the American public.

We must Choose Now to Maintain Fiscal Discipline

The President has recognized the need to maintain the fiscal discipline that has brought us not only unprecedented budgetary progress, but also the strongest economy in memory.

Under the President's leadership, we have maintained the surplus for the last three years. We can do it again. In the face of the demographic pressures that will begin to burden the budget in less than a decade, we must stay on this course - and create the right processes and policies to maintain that fiscal discipline.

Again, the President has measured the future in realistic terms, set his priorities, and made balanced choices. We are proud of our budget, and we commend it to your consideration.