14th Annual Roundtable on the President's Budget and the Economy

ROBERT REISCHAUER, Urban Institute: Okay, why don't we get under way? Let me welcome you all to the 14th Annual Urban Institute Roundtable on the President's Budget and the Economy. This is intended to be a wide-open discussion, and everyone in the room is welcome to participate. And we only ask people to identify themselves and to keep their remarks short.

We have a number of people up here at the front who are going to start off with very brief—meaning three-minute or so—observations on the president's budget or the state of the economy as a way of priming the pump. They are individuals who need no introduction to those of you who are budget groupies in this town, and so they will get no introduction, at least from me.

The session's going to be moderated by Gene Steuerle, and I thought I would just capture my three minutes by discussing a couple of handouts that you have in front of you, just to set a little bit of the context. The first of them is simply a comparison of the average deficits under the Reagan budgets, the Bush I budgets, Clinton and Bush II, pointing out what Mitch Daniels and others in the administration have said over and over again, which is that, relative to the deficits of the past, the administration is moderately well-behaved. Of course, the Reagan and Bush budgets are ex poste, and the Bush II projections have an element of hope in them.

The second chart in that table is to underscore another thing that Mitch Daniels said, which was, while deficit reduction is a priority, there are other important priorities that the administration had. And I thought it was nice to point out that if policy were left unchanged, the cumulative deficits over the next five years would come to $114 billion. But under the administration's policy, which places deficit reduction just among its many priorities, they have multiplied that number by 10.

The final handout in that packet is another way of shedding light on the question of, do deficits matter? And this is just to focus on the net interest costs that the government has experienced in recent years and point out that as a percent of total outlays, the interest spending has gone from a little over 15 percent down to somewhere in the neighborhood of 7.5 percent, and is now poised to rise. And in dollar terms, we are spending some $80 billion less a year than we did just six or seven years ago.

Finally, let me refer to the two-sheet handout. To make the point that, viewed over the long perspective of our budget, the proposals of the Bush administration don't suggest radical changes in the large components, and so historians looking back, should all of this come to pass, will say, well, it wasn't a big deal, like compared to the Reagan years. From '80 to '87, we had real nondefense spending cut by 20 percent and real defense spending rise by 47 percent, and the comparable figures for the Bush administration are plus 1.7 percent and plus 7.8 [percent]. The fact that the large components don't shift I think is misleading because the composition of those components, or the way the programs are structured, will change significantly, and probably others here will discuss that in some detail.

Gene, you're on.

EUGENE STEUERLE, Urban Institute: I'd also like to welcome everybody here, and just mention also one other aspect: The people at the table are no more important than the people that ended up coming in later and ended up sitting on the sides. We just only have so much room in this building, and this really is meant to be a roundtable, and that's one reason our remarks are really meant to be short.

The two points I want to make are reflected in some handouts also I have. The first one is this total receipts and entitlement spending is a percentage of GDP, and there's something on the back of it. It's called projected change in federal expenditures and revenues, and then there's a follow-up on that that has basically the same title, except for a number of years.

If you look at the first graph, I think it makes clear the first point I want to make, which is that the squeeze between entitlements for the elderly and receipts basically continues, that this is basic budget story we've had for a number of years, and it continues. Large outlay increases, mainly in health and large revenue reductions in—or moderate-sized revenue reductions, depending on how you look at it—are basically still squeezing everything else, and everything else is getting squeezed quite a bit, and it's just gradual year from year. The current budget adds to that by basically adding to Medicare expenses, and Medicaid expenses are—some other speakers are going to talk about whether in the long run the projected changes are going to get health costs under control.

But you can see the squeeze there, and if you look then at the graphs, which show projected changes in federal expenditures and revenues, I invite you first to look at the 2001-08 story, because it sort of bounces through—or skips through the economic cycle. And there it's a very interesting story, because if you accept what the administration projects in this budget, it ends up having revenue reductions of about 1½ percentage points to 2 percentage points of GDP, and it has outlay increases of about 1 percentage point of GDP, very largely in the health and Medicare and national defense areas. And that's the story there—maybe a touch of increase in international affairs and education and training.

But now look at the same projections, once you skip from 2001 to 2003, and go to the 2003-08 period. Then you can see that the administration is actually counting on a lot of things to come together to get its projects back into place. In fact, it's projecting a significant increase in revenues from the period from 2003 to '08. That's partly due to recovery of the economy, partly due to—as Len Burman will probably mention, huge increases in the number of people going on the alternative minimum tax, and partly due to a projected increase in capital gains realizations that will somehow or another swing back in for us and help us. That's somewhat questionable whether that'll happen; at least we don't know. It also now decides to turn tail and basically have a decrease in outlays as a percentage of GDP. You'll see that even includes a decrease in outlays in national defense by the time you get to the end of the five years.

It also shows, I think for the first time in many years I've been doing this, a significant cut in the Income Security budget. A lot of people I know in this town have felt that the Income Security budget has always been insulated from this squeeze between entitlements from the elderly and revenues, and it's clear in this budget it would not be.

The second point I want to make is reflected a bit in an economic perspective column I included there, and that is a matter of fiscal policy. I don't think any economist is going to argue that we need more stimulus right now, at least if stimulus is defined in terms of putting cash back in the economy. No recession in history, as far as I can measure, has ever had as much cash put back into the economy as this one, relative to the size of the recession. In fact, the rise in the government deficit, as best I can measure it, is greater in size than the entire size of the downturn. That is, we put back more than 100 percent of the loss in income in the economy back in the economy, although you may question who got the cash, vis-à-vis who suffered the downturn. But nonetheless, in terms of putting it back, it's a very large, large stimulus, if that's what you think you want in terms of cash in the economy.

The debate in this budget—and I think if you read through the administration's comments you'll see it somewhat clearer—the debate in this budget is really over the structure of the expenditure in tax systems, and I think that's going to be further reflected in the comments of a number of our panelists.

And with that, I'm going to turn the floor over to Rudy Penner.

RUDY PENNER, Urban Institute: Thanks, Gene. As I look at this budget, I can't resist using a line I used to describe Reagan's budget initiatives. The good news is that I agree with the main philosophical thrust of many of President Bush's tax initiatives, if not with the details. The bad news is that we can't afford all that good news. (Laughter.) As Bob noted, President Bush is a piker in defense increasing and deficit increasing compared to Reagan, but the overall pattern is similar.

Now, I promised to discuss the macro-effects of the policies, and I'll implausibly assume that they're all enacted. The short-run fiscal stimulus provided in '03 and '04 is small compared to that of '02, because as Gene noted, the stimulus of '02 was just astonishing. The actual deficit swing in that year in a stimulative direction was 2.8 percent of the GDP, an amount exceeded only once in four decades. The standardized deficit, which tries to remove automatic stabilizers, swung by 2.3 percent, an amount never exceeded since that was first calculated by CBO [the Congressional Budget Office] in 1960. Now, some stimulus obviously came from the tax cut, but the nonlegislative fall in revenues relative to incomes was very much more important. And it was probably mainly related to the stock market's effects on rich people's incomes. The total stimulus, I think, helped keep this recession very, very shallow.

Now the stimulus in '03 and '04 will be very much smaller. The actual '03 deficit increases by less than half the '02 changes, and then does not change significantly at all in '04. Policy changes—no standardized deficit's been computed yet, but the policy changes amount to less than a half a percent in GDP in '03, and then 1 percent in '04. And I think that the bang for the buck of these changes is going to be very much less than it was in '02 because the permanent tax cut probably stimulated consumption much more per dollar than will just the temporary effects of accelerating future rate cuts. And of course there's a kind of discord because most of the tax reform proposals are aimed not at increasing consumption but reducing consumption and increasing saving.

Now, it's difficult to judge the long-run effects of these tax reforms. Personal tax on new equity and interest income would essentially disappear. The main taxes remaining on capital would be the corporate tax, the estate tax while it lasts, some taxes on real estate transactions and collectibles, and on the capital income of sole proprietorships and partnerships. What I find very difficult to figure is how all this compares to the mess we have today. For example, financial experts expect just current 529 plans to amount to hundreds of billions of dollars in very few years. But assuming the policies further decrease tax burdens on saving significantly, there's no consensus among economists about the effects of such incentives, namely whether they increase private savings sufficiently to make up for the revenue lost to the Treasury. I tend to be optimistic on such matters, but more important, so does Glen Hubbard and his earlier academic contributions to the debate.

Macroeconomic Advisers has modeled the effects of the president's budget, but I don't know the details. The reports in the Washington Post make it sound like their results are almost identical to Alan Auerbach's analysis of the effects of the 2001 tax cut. He got highly positive net effects on economic growth that lasted about 10 to 16 years. After that, things turned negative, as the negative impact of the bigger deficit began to accumulate. Ten years out, his growth effects reduced the static estimates of the revenue lost by between 35 and 45 percent, and interestingly, Glen Hubbard has used almost identical estimates for the effects of this tax cut.

EUGENE STEUERLE, Urban Institute: Thank you, Rudy. Gordon?

GORDON ADAMS, George Washington University: I'm always the odd person out at these events. I'm delighted to be at them because I bring a subject matter that is directly relevant to what you all are talking about, but not normally in the conversations. It's also good to be here and to see a few of the graduates of the Clinton administration around the table—Peter Orszag and Gene Sperling and others still in this arena, still working on these issues, and that's very important.

Seeing Gene when I came into the room reminded me of a conversation that he and I had some years back when we were both working for Bill Clinton. When he came up to me and waved his finger in my face, something that he was not usually prone to do, but in this case, did, and said, "You guys—you defense guys—you've got him right where you want him!" I don't know if Gene remembers saying that but, Gene, if you think we had him right where we wanted him, you ain't seen nothing yet till you've seen this administration.

I mostly learn at these events, and I'm delighted to learn because a lot of people around the table know a good deal more about broader budget issues than I will ever know, so it's great for me. But it's useful, I think, to talk a little bit about what's happening in the broader world of defense and national security, and I use the phrase advisedly for reasons I'll say in a moment, because as Willy Sutton said of banks, "That's where the money is."

So if you're looking at the growth vectors in this budget, you're going to find them in the national security arena, and laying some tracks for budget difficulties that are going to happen down the line as a consequence of decisions being made now. I like to call Don Rumsfeld "Lucky Don" because if you'd sort of scoped his political future as of September 10, 2001, it wasn't a very long suit. As of September 11, 2001, he became a very lucky man indeed, and I mean that in the budgetary sense, because a choice that was being forced upon him inextricably, a large part enforced by the Social Security lockbox, to choose between modernization programs and the Pentagon and the transformation desires that he clearly wanted to implement. That choice was being imposed on him September 10th very strictly by budgetary constriction and the desire, at that point of the administration, to avoid the lockbox.

As of September 11th, of course, all that restraint went away, and that's made it very possible for Secretary Rumsfeld and his crew to have their cake and eat it too, by which I mean have their transformation cake and eat their modernization cake at the same time. And a fight that was clearly brewing between the uniforms and the office of the secretary of Defense simply disappeared in the budgetary sense. And this budget is a very clear reflection—this is the first Rumsfeld budget that you can say really has the stamp of this administration on it. They have several opportunities—'01 amendments, '02 amendments, '03 budget—to lay out a track in the area of transformation and military change. They did not choose to take those routes. While they increased defense enormously, it was mostly to pay must-pay bills in areas of personnel and areas of health care.

This is the first one that, in the hardware arena and in the R & D [research and development] arena, clearly carries the stamp of transformation, but as I said, the Department's been able to have its cake and eat it too. They have won—having come into office as the administration committed to leapfrogging a generation of technology, they have leapt exactly one system, which was a Crusader. The army's gun system and the Crusader funds have been turned around in roughly a $500 million package into a next-generation gun system, so it wasn't entirely leapt even at that.

All other programs, some reduced to be sure, survived to fight another day in budgetary terms: Comanche, Army's Future Combat System, the V-22, the vertical and horizontal takeoff program for the Marine Corps, F-22 fighter, the Joint Strike Fighter, a very large increase in this budget in the ship-building budgets now and in the out years, Trident conversions, a new carrier, new destroyers, a new literal ship coming along in four or five years. But to have their transformation cake and get to consume that piece as well, there's a big increase in space funding, laser communication system, new military satellite network, unmanned aerial vehicles, unmanned combat aerial vehicles, command control, intelligence funding—large increases across the board for major programs.

At the same time, they have made no reductions in people, so there's no trade-off against the size of the forces. Research and development spending has increased dramatically again for a third year running, and they have introduced, I think, statistically inadequate increases now and over the future in operations in maintenance funding. That's funding that provides for the operations of the forces outside of war, and usually grows at 2 to 3 percent per year above inflation. They've budgeted it to grow at about 1½ percent per year, so we're going to have a problem in the out years.

That's a descriptive—I'm going to come back and talk about some problems in a moment in the Defense Department. I get a new department this year. It's called the Department of Homeland Security, so it's a new—a whole new arena to talk about that is going to face some major challenges, and that's increased as well to roughly $36 billion—if you count all the Homeland Security in the whole budget, about $41 billion—in a variety of areas. They have there, of course, a huge integration challenge: 22 agencies and departments' activities to pull together, 170,000 people, four separate border agencies. You think that the absorptions the defense industry did when it went through the buying spree in the '90s constituted a digestion problem; it's going to be years before some of this, in my judgment, is settled in the Department of Homeland Security, but major funding growth, and in anticipation, I believe, of funding growth in the future, largely politically driven.

One thing that I think this administration discovered since September 11th is that the terrorist attacks and the fight over homeland security have turned national security into a backyard issue in a way almost no another piece of national security-related spending has. It's not clear everybody else in the political system has learned that lesson, but this administration surely has.

Thirdly, I want to say something briefly—and Gene asked me about this when I came in and I'd already made some notes, so I felt like I'd anticipated his question. You begin to see some tracks for growth in the future laid in an area that we almost never talk about, which is International Affairs funding, Function 150. And I just wanted to note for the record three areas where that growth is quite apparent: overall budget—or BAs to grow 11.6 percent this year, over enacted 2003, which is huge growth in Function 150, which is often frequently a reduced, a cut element, has generally been housed in the nondefense discretionary spending part, and pays the price; big jumps, $2.3 billion, to vulnerable states, all tied into the war on terrorism, and this will continue. There is going to be even more with supplementals of programs to invest in countries that surround Afghanistan or Iraq that can be potentially friendly, that are in the arc of crisis, as it's called, between the Mediterranean and Indonesia. There will be large growth in economic support fronts and federal military financing in those areas, and that's likely to continue.

Secondly, this major commitment to the fight against AIDS, the international fight against AIDS—$15 billion over five years, $2 billion of it laid down in this budget request. And thirdly, a whole new development assistance program called the Millennium Challenge Fund, which gets $1.3 billion of new monies in this budget, $5 billion by 2006. In a way, you have to say Colin Powell has been one of the most successful secretaries of State in modern history in terms of increasing resources and beginning to develop new programs in Function 150.

Briefly then, what grows out of all of this? The biggest problems I can point to in the out years that emerge from this are that the Department of Homeland Security will need more money than it has, and will politically get more money than it's gotten. Congress is likely to add to that budget; it wouldn't surprise me at all. The Department of Defense is going to get supplementals. I haven't mentioned there will be about a $20 billion supplemental this year for the war on terrorism that has nothing to do with Iraq.

If we go to war in Iraq—and anybody who saw Secretary Powell yesterday who doesn't believe we'll go to war in Iraq is obviously a candidate for the dementia lab—is going to be a $50 billion to $80 billion supplemental this year in order to prosecute a war in Iraq. So DOD will have increased funding, and they have a huge out-year problem tucked into their out-year forecast in the budget, which is they can strain the growth of procurement resources until 2006, where there's a big jump in procurement resources in the out-year monies. This is your classic procurement bow wave, as the systems they are now building—the JSF [Joint Strike Fighter] begins to enter production, the new shipbuilding program enters into production, the UAVs [Unmanned Aerial Vehicles], the UCAVs [Unmanned Combat Air Vehicles], all the hardware that I talked about is all going to head for production decisions 2006-2007—big pressures to grow the budget.

I anticipate large pressure—and something we don't talk much about, but growth in the intelligence budget. There's some satellite programs that will be relevant to that, human intelligence expansion that will happen around the war on terrorism, and lastly, as I pointed out, a large increase in the 150 baseline that is going to become a pressure for continued increases in funding in the future. So those are just some things to flag.

EUGENE STEUERLE, Urban Institute: Thanks, Gordon. Belle?

ISABEL SAWHILL, Brookings Institution: Thanks, Gene. I think that my role here is to say something about domestic social policy, and I want to start by reminding everyone that the administration says that they're committed to leaving no child behind. And what I want to argue this morning in my three minutes is that children, especially children in lower-income families, are being shortchanged in this budget. To some extent, this is the Steuerle squeeze that you heard about earlier that's been going on for some time, but which I think will be exacerbated by what we're seeing now.

Currently at the federal level, we spend about 2 percent of GDP on children. That's less than what we spend for interest on the debt, and much less of course than what we spend on programs for the elderly. As a percent of GDP, spending on children has been relatively flat, while spending on the elderly has grown sharply in recent decades and will continue to do so. In your packet there is a chart that shows all of this. It comes from a very excellent publication of the Urban Institute of which Gene Steuerle was an author.

Although children have not done well in any recent budget, they fare especially poorly in this one. Most of the programs that represent investments in the health, education, and well-being of children are included in the nondefense discretionary portion of the budget, and if we take out Homeland Security, that portion of the budget is now declining modestly in real terms.

It's true that the administration has supported an increase in the child tax credit and wants to accelerate the phasing in of those tax benefits, but they have not proposed to accelerate the portion of the children tax credit that's partially refundable, and that is the only part of either last year or this year's tax bill that has any significant effect on families with incomes below about $30,000 a year. At the same time, the administration proposes to spend another $400 billion on Medicare over the next 10 years, and that, together with its tax proposals, leads to deficits, of course, as far as the eye can see.

In addition, the administration has shown a preference in this budget for block granting a variety of programs that are important to children and other younger Americans. This includes Medicaid, Head Start, child welfare services, job training, and housing assistance. It includes, in addition, the so-called super-waiver proposal that the administration first advanced last year in the context of welfare reform reauthorization, and which would permit governors to apply for waivers leading to combining or consolidating cross-existing programs for low-income families.

Block grants are, in my view, in many respects, desirable. They provide flexibility to state governments and can produce much needed innovation in a more seamless set of services for families. They can even produce more effective policies and free up resources that can be used for other purposes. But offering states block grants in the middle of the most severe state fiscal crisis we've seen in a long time, with little or no new federal aid, almost guarantees that states will either fail to take up the option, or that, if they do so, they will use the money in inappropriate ways.

The result of all of what I've said is that low-income children are being hit with a triple whammy: first, because the programs that might help them to develop into productive citizens are being cut back or level-funded at the federal level; second, because they will be stuck with paying the bill for the benefits their parents are going to get in the form of tax cuts now and health care and retirement later; and third, because states are being forced to cut programs, such as spending on education, child care, and health care, that are important for children's futures. So my conclusion, not to put too fine a point on it, is that compassionate conservatism is dead.

EUGENE STEUERLE, Urban Institute: Marilyn?

MARILYN MOON, Urban Institute: Well, I'm going to talk a little bit about health care, and that's largely going to be referred to in terms of the seniors that Belle was talking about getting a lot of resources. And I really want to make three points today. One is that Medicare and Medicaid share one important aspect in this budget, and that is I think that the theme for both of them is that there's going to be a shifting of risks off of the federal government and onto either the state government, in the case of Medicaid and hands-on beneficiaries potentially, and in the case of Medicare, onto either plans or beneficiaries. We don't know yet much of the details of the plans that are proposed, and I'm certainly not going to talk very much about Medicaid, as John Holahan and Alan Weil here are much bigger experts than I am, and that'll help me keep into my three minutes, I hope.

Medicare also—I would characterize what we've seen so far is essentially a faith-based initiative, and by that I don't mean religion in the traditional sense; I mean in terms of faith that the private market will do better than Medicare has done, although there exists no evidence that I'm aware of that's legitimate that suggests that that's true. Private plans are no guarantee of saving resources over time. Since 1981, it's been kind of the magic bullet that we've looked at and talked about, and the golden age of managed care, which is part of all of this in many cases, is over. I also believe that was sort of a brief period of '92 to '96 when we shifted out of expensive indemnity plans for private insurers to managed care with lots of discounts from hospitals and doctors, and that looked really good. The problem in Medicare is that they've already gotten the discounts in doctors and hospitals, and private plans that have tried to go into the Medicare area have found that it's hard to compete on that basis.

The second major point I want to make is that the drug benefit is going to be a problematic one, as it has been for years. And one of the things that is the big unanswered question so far, and has gotten a lot of attention, as it should, I believe, is whether or not this drug benefit is only going to be available to people who shift out of the traditional Medicare program. You will get some people who will shift right away. If that's the case, you will have a lot of people who rely on three or four physicians who don't want to join a private plan and have shown they don't want to and can't: the very old, the most vulnerable folks who will stay in traditional Medicare. And there will, and I think should be, a big hue and cry about that issue, if that's the way this administration wants to go.

Even without this, though, the tax cut—the traditional program is likely to be in an untenable position if, for example, we allow a lot of PPOs [preferred provider organizations] and other kinds of private plans that are competing in the fee-for-service world, largely because people will join them on the hope that they'll be much like Medicare but have a prescription drug benefit. But instead, what they will find is that things like physicians' services and so forth are likely to be much more expensive to beneficiaries. In my PPO, when I go out of network, I pay approximately a 65 percent co-pay, which is really one of the ways the PPOs save money.

Back to the drug benefit. Over 10 years the administration is saying it would spend about $380 billion. That's 95 percent of the $400 billion, which is about as close as we can get to anything specific that I've seen rung out of this administration as yet. Over the 10 years in the CBO numbers on spending by Medicare beneficiaries on prescription drugs, that would cover about 22 percent of the cost of Medicare. If you ignore the first two years, where it would take time to get it started, that would cover about 25 percent of the costs of prescription drugs to this population. And in your handout you'll see something I did where conveniently the administration is right in the ballpark of a study I did last year.

And finally, the real fiscal danger is a section in the budget which offends me deeply, and so I'm going to take a minute to talk about that. It's subtitled "Entitlements on the Brink." And while I totally agree that we have problems in terms of how much we're going to spend on seniors and persons with disabilities through Social Security and Medicare, the administration chooses to ignore current law, which is pretty much not what you're supposed to do in providing baseline information. And in the Medicare shortfall of $13.3 trillion that it indicates there, there is really only about 37 percent of that if you include the requirement that general revenues actually be contributed to Medicare, which is and has been, since the beginning of the program, part of current law.

It means that the shortfall is only a little bit greater than Social Security if you do it by that account. Now, there ought to be a way to account for the increased projections of cost for Part B of the program and the fact that it would rely a lot on general revenues, but if you use their logic and apply that to, for example, defense, you would find, since it's fully funded by general revenues, that we have an unfounded liability of $30 trillion, if all you did was assume $400 billion a year forever over the next 75 years.

So we have to put these things in context and think about what it is we're making promises for. Thanks.

EUGENE STEUERLE, Urban Institute: Thanks, Marilyn. Joe?

JOSEPH ANTOS, American Enterprise Institute: Well, I agree with what Marilyn had to say in large part, but let me start with the same section, except I thought you were going to mention the title of the whole chapter, which was, "The Real Fiscal Danger." I think that is an apt indicator of what we're faced with with entitlements. We can argue about the numbers, but the fact of the matter is that we are talking about substantial increases over the long term in real resources going toward Social Security, Medicare, and Medicaid. And that is of concern, especially in the case of Medicare and Medicaid, if we're not buying what we want, and that's the point. You know, talking about how you finance things is really great, but that's the second question. The first question is, are you buying what you want?

Now, turning to Medicare, I think the philosophy behind the administration's fairly abbreviated words on Medicare reform have to do with ultimately trying to connect up what people think they want or need, and what they can get in Medicare. In fact, that's why we're arguing about prescription drugs in Medicare now. Everybody else has had prescription drug coverage in their comprehensive health insurance for probably at least a decade, maybe more, but seniors have not. So really, the fundamental question to me is, how do we use the resources appropriately? And to answer that question you have to get at consumer demand. And this is a program that doesn't do that very well.

I've got to say, I thought, Marilyn, you should have been harder on some of these numbers. There's a—sorry I don't have a handout, but you'll find it on page 33 of—I guess it's the budget volume—you'll see a nice chart here that shows the $13.3. trillion perpetual—or sort of present value eternal shortfall in, we call it dedicated revenues or revenues that come—sort of new revenues to Medicare as opposed to intergovernmental transfers. And then you see a nice chart here that shows that if you add the House Republican bill that was passed last year to that, you increase that shortfall by $4.6 trillion. And then if you look at a more generous proposal, the Graham-Miller proposal, that actually adds to the $13.3 trillion shortfall $6.9 trillion.

I'm personally not hung up on the precise numbers, but I think this does make a really good point, and that is, if you do add a big, expensive benefit, it costs more money—kind of obvious, but it's good to keep in mind. Now, what's also good to keep in mind is that the Thomas bill, $308 million last year; that might be about in the same ballpark—it's kind of hard to know—as the president's drug proposal that we don't know too much about. So the president's drug proposal would add about $5 trillion to the shortfall. That means he has to answer his own question. How is he going to reform Medicare? I think that's a real good question. We don't have, really, any information on that, and I think we deserve some sort of a plan to get there.

Now, we've all heard some words that, as far as I can tell, most people don't understand. That phrase—well, we're going to make sure that seniors get the same kind of choices and the same kind of generalized drug plan as your senator or your congressman—sounds great. That's the Federal Employees Health Benefits Program. And in fact, I think that that's a program that for the last 30 or 40 years has been quite successful in doing several things, first of all in helping to match what employees want from their health plan, and keeping up with changes in medical practice; two things that I don't believe the Medicare program has done very well so far.

But, you know, the kinds of proposals that we've seen so far from everybody, and certainly the rumors that we've read in the newspaper that might have been the administration's plan at one time and might still be for all we know, really does not, in an important detail, emulate the Federal Employees Health Benefits Program at all. And that important detail is that federal employees actually get to choose what they want, and the choice is largely unrestricted, keeping in mind that the unrestricted part of it is that it starts off with a very rich benefit package, which is what we have in Medicare, except for prescription drugs, but then go on from there.

All the proposals that we've seen last year and all the rumors we have heard this year are for a kind of false reform, sort of a repeat of what we have done in the past, and in particular, one where the government decides, we need a drug benefit; let's figure out what people need and let's give them what they need because we'll figure it out for them rather than letting private health plans gauge the market and try to structure a set of benefits and premiums and so on that would then stand the market test and either pass or fail, depending on what people actually want. It will be an exciting year.

EUGENE STEUERLE, Urban Institute: Thanks, Joe.

Well, Len, in your few minutes you're going to summarize for us the entire tax package and its implications. Is that correct?

LEN BURMAN, Urban Institute: Yeah. (Laughter.) Actually, I can talk about its implication in about 10 seconds. (Laughter.)

There are, I think, three themes that are reiterated. We've seen them before in this year's tax package. One is that the administration wants to reduce the progressivity of the income tax; two, that they want to exempt savings from tax; and three, that they'd like to make the government smaller by basically starving it for resources. And if this budget were enacted I think it would move a long way toward all three of those goals, none of which I actually share.

The total budget—and I guess the ugliest handout I've ever produced is a very short spreadsheet that we passed around just showing the president's budget tax proposals, the main elements. The total package, including 2003, which actually isn't in the budget period but in which $30 billion of costs are incurred, would be $1.5 trillion. Basically what they did was they started with last year's tax proposals, which we couldn't afford, and they doubled them.

The main new element is the so-called economic growth package. It would speed up all of the tax rate reductions that were enacted in 2001 to take effect in 2003, and some other provisions. As Belle pointed out, it wouldn't do anything at all about the provisions that actually affect low-income working people. It wouldn't accelerate the refundable portion of the child credit or the EITC [Earned Income Tax Credit] portion, the marriage penalty relief. Ironically, both of these things would reward conservative values, work and marriage, and it wouldn't cost much; it would be about $9 billion. Actually, table 4 in one of the handouts in your packet shows the distribution of the benefits of that proposal. It would help $9 million low-income people who, arguably, need help more than anybody else right now. The largest new element is the dividend relief proposal, which from 2003 to 2013 would now cost almost $390 billion, according to the administration's estimates.

The idea of relief from double taxation is a good idea in theory. I don't think any economist would argue with that. The problem of course is that while they're trying to eliminate double taxation, they're not making any effort at all to guarantee that income from capital is taxed even once. There are revenue-neutral options that could advance the same goal. I have a paper that was in this week's Tax Notes, and it's also on our web site, that would just say once you've done this there is no reason to have a capital gains preference anymore. It was the only really good argument for a capital gains break as a relief from double taxation, which we're taking care of. That would be revenue neutral, or even raise a little bit of money over 10 years. But you don't have to look at my proposal. Glen Hubbard, who is the intellectual mind behind all of this, proposed his own revenue-neutral proposal in 1992, and arguably it would be as good an idea to not bust the budget with this now as it was then.

The two new things that came out in the budget that was released on Monday—or is part of what's called a simplification package—it's actually got four items. The biggest ones, although they don't show up as costing any money, are two new kinds of tax-free savings accounts, so-called lifetime savings accounts, which would allow you to set aside up to $7,500 per year for any purpose, and it will be tax free forever; and retirement savings accounts, which would set up the same kind of an account but for retirement, and that would replace existing IRAs.

Simplification is obviously a good idea, and this actually started as a plan to consolidate lots of different kinds of tax-free accounts—college savings plans, 529 accounts, medical savings accounts, education savings accounts—but it actually didn't propose to eliminate any of those things. What they did is they said for middle-income people you can use these lifetime savings accounts, and that will take care of—it actually is a simplification for them; you don't have to worry about all the other complexities. High-income people, of course, who are saving as much as they can tax free can also put a couple of hundred thousand dollars in their kids' 529 plans and take advantage of these other accounts.

The worst thing about this, from my point of view, is that it actually represents a pretty cynical budget gimmick. It shows up as not costing anything over 10 years. The reason is that they're allowing people to roll over their own individual retirement accounts into these new back-loaded accounts that are tax free forever. And effectively what you're doing is—the reason people would do this is because it allows them to vastly increase the amount of tax-free savings, say by as much as half, for a high-income person just by paying the tax now and having the funds be tax free forever. So the stuff that shows up as revenue in the short run is actually costing the government as much as $1.40 for every $1 raised over the long run. It's also very skewed, which is consistent with the rest of the package.

I've got some tables showing some of the other elements of the package in your handout. One of the things that is particularly notable is that extending the 2001 tax cuts would provide 44 percent of the benefits to the top 1 percent of taxpayers. The thing that's left out from this $1.5 trillion package is dealing with fundamental structural problems in the income tax. They don't do anything about the alternative minimum tax. The president promises to take care of that after he's reelected, and that'll be another $1.5 trillion package.

There's a lot more, but I'm going to stop right now.

EUGENE STEUERLE, Urban Institute: Excellent. Thank you very much.

Our ground rules, as we open it up here, is identify yourself. We're interested in your opinions, not just your questions, so statements are appropriate, and you can ask questions of other people in the audience as well as the people on the podium. We do ask that you try to be somewhat brief, following some of our examples, maybe not all. (Laughter.) And if you're press, you may ask questions—or you may get comments from government officials, but we ask that the government officials who talk, whether in the congressional branch or the executive branch, be off the record in terms of their public comments. If you want to approach them on the side if you're press, that's fine, but we'd like to give them the opportunity to speak out without having to worry about being quoted.

Gene?

GENE SPERLING, Council on Foreign Relations: I have an appointment on the Hill at 10:00, so excuse me for my aggressiveness in putting my hand up. Just a couple of things. If I leave and Gene Steuerle says anything intelligent, you're all free to remember it as being from Gene Sperling. (Laughter.) And I'm officially going to steal Marilyn Moon's faith-based line. Damn, wish I'd thought of that.

But I do want to make a couple of notes, and maybe just a couple of examples from, kind of, family budgets, so, on just the notion of what the overall budget deficit is. I don't have a problem with Mitch Daniels saying that a 2 or 3 percent deficit as a percentage of GDP in a time of recession and war is not a major concern. The problem in the family example I'll use is it has a little bit of the feeling of a family who saves up a certain amount of money, they come to kind of a difficult time, the father or mother can't work for four or five months but they make it through the year okay because they have accumulated savings, and the conclusion they draw at the end of the year is, boy, saving for a rainy day is—you know, who needs to save; we made it through this year just fine.

Now, there was a $300 billion surplus projected for 2003, and so we had a very dramatic swing. Because there had been a previous commitment, bipartisan for a few years, of saving the surpluses, that is the thing that is most responsible for that swing leaving a 3 percent deficit as a percentage of GDP. Had the policies in the late '90s been geared towards running perhaps moderate deficits, you could easily be seeing deficits now of $6 [hundred billion], $7 [hundred billion], $800 billion, which I don't think anybody would regard as moderate or not constraining. So, to me, we're letting the lesson of, isn't it a good idea to save for a rainy day because you could have war and recession at the same time, and if you have built up surpluses you can survive that, that is somehow being used as the lesson of what a foolish thing to worry about having surpluses in the future.

Secondly, if I can draw another family example, when we talk about the deficit as a percentage of GDP going out, it's a little bit, again, like a family when they had no kids saying, we had a certain amount of savings and now we have triplets who are 14 years old and all headed for Ivy League schools and it's okay if we have the exact same amount of savings. The whole thing we're looking at in the entitlement, and the whole notion of increasing the savings now, is that we were entering a period in which we were, by demographic destiny, designed to have more borrowing in the future, and the question was, could we build up our rate of national savings over this time period and higher productivity and higher savings so that we'd be able to handle that better?

And so the notion of increased savings and trying to reach near debt was not that debt free was so important, but that in this particular time period it is, just as a family would have to increase savings when they know they have a larger debt coming down the road. And that also becomes extremely important because if we then say, but what we really need to do is fundamentally change Medicare and Social Security, even then all of us know from almost every example, one has to essentially have some transition funding; one tends to have to buy off the current group to kind of allow a transition to a new pre-funded type of savings.

All of these things argue much more for the type of saving surpluses policies we had, and I just think that's being kind of lost in the current discussion and even in our opening presentations.

EUGENE STEUERLE, Urban Institute: Thanks.

John or Alan, Medicaid came up but nobody really talked about it. Do you guys want to add a comment on it?

JOHN HOLAHAN, Urban Institute: The Medicaid proposal is a block grant that's voluntary for the states. They would get a little bit more money, 2 percent in the first year and then 1 percent over the next—it's 1 percent total over seven and then it's all given back, so it's budget neutral over 10 years. And those are additional amounts relative to some formula that hasn't been stated, which really makes it very hard to figure out what this is all about.

But if you take the block grant option you get more flexibility over what is about two-thirds of your spending. Two-thirds of Medicaid is optional, either optional people or optional services. But when you really look at it, the optional services are a lot of long-term care, a lot of prescription drugs, a lot of services that are pretty hard to cut. I mean, they are optional; states don't have to cover them now. In fact, they don't even have to have a Medicaid program if they don't want to. But these services are optional; they could make these cuts. They're not making them now. What this does is allow them to distinguish between populations. And so you could have a more restricted benefit package for some people than you do for people who are, say, more needy.

In reality, that was probably going to affect things like dental, vision, hearing services, chiropractors, podiatrists, maybe some co-pays on drugs, emergency room care. There is not a lot of money in this. So what states who would take the block grant would be buying into is a little bit more money now in exchange for a little flexibility over things that are pretty small items, and have the risk that employer coverage could drop off, affecting a lot of low-income people, health care costs could rise and they're stuck with a fixed allotment that, as I said, we really don't know what that is right now.

So I think it's a big risk to a state to take this on, and my guess is if they look pretty carefully at it they won't be interested, but who's to say? The short-term benefits are clearly there, and if you figure, I'll take the short-term benefits and I'll be out of office by the time I've really got the problems, then it could be attractive.

KEN SIMONSON, Associated General Contractors of America: My organization is supportive of the dividend relief proposal, but I am concerned about companies that are in a loss position, which I expect to see a lot in my industry, unfortunately. But throughout the economy in 2003, an unheralded part of the dividend relief proposal is to cut back the net operating loss carryback from two years to one year, and under the stimulus package for tax years ending in 2001 and '02 there was actually a five-year carryback. It seems like a harsh time to be reducing the ability of companies to smooth out fluctuations in earnings flow, and I wonder if Gene or Len or Bill Gale or Peter Orszag would have a comment on that.

LEN BURMAN, Urban Institute: The first comment is why does your organization favor the dividend exemption relief proposal?—(laughter)—if it has its features?

KEN SIMONSON, Associated General Contractors of America: Well, a lot of companies feel that they would benefit, either directly if they are profitable C corporations or if they have operated as S corporations or partnerships strictly to avoid what they see as double taxation, and that this would allow them more flexibility in setting up ownership changes and other features that are available only to C corporations.

LEN BURMAN, Urban Institute: I think what this highlights actually is the enormous complexity of the proposal. Part of the problem is that the double taxation relief proposal is supposed to make sure that people get relief from dividends to the extent the companies pay tax, and there is a lot of concern, of course, that companies will try to manipulate it so they can both avoid tax and provide tax-free dividends to their shareholders.

So my guess is that part of the NOL [Net Operating Loss] carryback was related to that. If you can carry back losses I think that creates additional complexities because I think under the proposal, if a company has a loss, it doesn't have to necessarily—I guess if the company has a loss and it has previously been paying taxes on the gains or had taxes that it was allocating to shareholders, they can allocate the loss to shareholders through a reduction in basis rather than other adjustments. But it's mind-bogglingly complex.

Do you have a simple solution, Ken?

KEN SIMONSON, Associated General Contractors of America: No. (Laughter.)

EUGENE STEUERLE, Urban Institute: I'm going to let you guys resolve that later.

Peter?

PETER ORSZAG, Brookings Institution: I guess two comments, and I'd be interested in any thoughts. One is that the budget does refer to Social Security and Medicare as "a real fiscal danger," but I just want to at least try to put some things in context.

The tax cut in 2013 is 1.8 percent of GDP. That is artificially constrained by the fact that the administration has not addressed the AMT [alternative minimum tax], which reduces that measure, and artificially constrained by the savings proposal where the costs are beyond 2013. So, if anything, the real tax cuts involved here are much larger than 1.8 percent of GDP.

The Social Security actuaries tell us that the actuarial deficit in Social Security over the next 75 years is 0.7 percent of GDP. That includes the Trust Fund. If you don't count the Trust Fund, so you're just looking at the value of the future cash flows, then it's 1 percent of GDP. Take either measure you want. Someone explain to me how the real fiscal danger is Social Security, when that's, at most, 1 percent of GDP, averaged over the next 75 years, and the tax cuts are closer to 2 percent of GDP. I'd be interested in that.

The second thing is I think it's worth discussing a little bit more these savings proposals. They are often described as the movement towards a consumption tax, but as Bill and Len and I and others have discussed, it's actually more a movement toward a wage tax because the returns to old capital are not taxed. Under a consumption tax they are; under this proposal they would not be, especially given the conversion provisions.

I would be interested in any thoughts anyone had about the claims that the pension lobbyists make about incentives that would be created for small business owners to either not set up or drop retirement plans in small businesses because of the increased opportunities for tax-free savings outside of the employer-based system, which has led to very striking statements by pension lobbyists that this will basically destroy retirement plans in small businesses.

And then, finally, I just want to note that the apparent—even the cost that's shown in the budget for the savers provisions appear to be stacked after the dividend proposal, and the cost of the savings proposals would clearly be dramatically less if you've already exempted a good portion of capital income from taxation because of the dividend proposal. But since, at least in my opinion, the dividend proposal is in some trouble, it's at least worth thinking about the costs of the savings provisions if that dividend proposal didn't exist. And there I think you'd see much more substantial costs.

BOB BIXBY, Concord Coalition: One thing that's very significant about this budget is not just that we're going back into deficit, and deficits as far as the eye can see, but that we're doing it as a deliberate choice. I think Bob's chart at the beginning showed the baseline versus the post-policy baseline.

You can make good-faith arguments that we would be in a deficit no matter what we had done two years ago. And there are good reasons for running deficits in the short term, but what is striking, and I think disturbing, about the budget is the deliberate decision to break with the political consensus that the budget balance over the long term is something that's an important goal. Once you break that consensus and sort of make light of deficits and invite these long-term deficits, then I think we're really at risk of running even larger deficits because there's no need to make any trade-offs. I mean, the constraining device is gone, and there aren't any budget enforcement rules anymore. So there's no political consensus; there's no budget rules.

(Audio break)—which is something that the Concord Coalition has supported, is somewhat undercut by the fact that it would exempt its own proposals. So it's sort of like, we'll do pay-go after we get everything we want. And it sets itself up as its own standard, which is a rather bizarre fiscal standard because it's very arbitrary.

The other thing that I find odd about the budget is—to get back to this, "The Real Fiscal Danger" chapter—now, of course, that's a point that the Concord Coalition has been making ad nauseam for years. It's the reason that the organization exists, I suppose.

So, on the one hand, it is gratifying to see a chapter—and, again, to Marilyn's point, there are any number of ways you can discuss these numbers in terms of present value and what you count and what you don't count, or do you do cash deficits or—it all gets extremely confusing, but I think the bottom line is we all—maybe we don't all agree, but I think the current system is still unsustainable. We have to do something about it, to get back to Gene's point about increasing savings.

But it just seems odd in this budget, and very inconsistent, to highlight repeatedly in this budget the unsustainability of the long-term situation to talk about the real fiscal danger, and then have nothing in the budget to do anything about it. It says, if you think about it, this is the real danger, and we're making no proposals that are going to make this any better. In fact, what we're doing is probably going to make this worse. And so I think there's that internal inconsistency in the budget. And I think it's too bad because it does end, I think, any possibility of doing Social Security reform for as far as the eye can see. We'll have a debate about Medicare reform this year.

You know, Social Security reform requires a lot of resources up front. They're not there anymore, particularly if you want to do carve-out accounts. And you could do add-on accounts if you want to do accounts, but that would be rejected, I'm sure, as a tax increase.

So there are—you know, I think this is a significant budget. I don't know that it's going to be adopted, but I think the dangerous thing about it is the deliberate decision to break with fiscal policy as a goal. And by the way, if you haven't seen the—in the analytical perspectives they don't do 10-year numbers anymore but they do show chart 3-3 and chart 3-4 on page 42 and 43 of the analytical perspectives—do show a long-term budget trend which shows it never going back to a balance, and then even under their own projections going deeply into deficit after that, and presumably that's with the stimulative effects of the tax cut.

EUGENE STEUERLE, Urban Institute: Do you want to comment?

LEN BURMAN, Urban Institute: Sure. One thing is if you look in the blue book that's on the Treasury web site, that does have 10-year numbers on at least the revenue provisions.

One thing that's really striking—and Peter touched on this—is that the revenue costs are very backloaded. And it's consistent with your point that if two-thirds of the costs of the tax cut package are in the second five years, and if you added in AMT relief, which the president says he's going to do in 2005, it would make it more like 80 percent. And if you add on top of that the backloaded savings incentives, the fact that over the—basically we're promising the savings that goes into these accounts will never, ever be taxable, so that 30, 40, 50 years from now, when the budget situation is really, really bad, there's going to be a huge stock of savings which the government's promised not to touch.

BOB BIXBY, Concord Coalition: Sorry to butt in again, because you reminded me of—the idea of minimizing the importance of the deficits in the short run is perhaps a warm-up for things yet to come, so if we all get sensitized to deficits again—because of the things that are left out of the budget, you know, there's probably going to be a lot of homeland security, probably going to be AMT reform, as you mention. And so, basically they're saying, don't worry about these deficits because you ain't seen nothing yet. And so, I guess—(laughter).

MARILYN MOON, Urban Institute: I'd just like to add, Bob, to what you said, that I think it's ironic that it's the baby boom that's going to cause problems, and forever, essentially, to Social Security and Medicare, but it's the baby boom that's going to really benefit from a lot of these tax cuts. And this is the time, if we want the baby boom to pony up something, to think about it in that way as well because we're only got about 15 years to get stuff out of the baby boom to help that transition.

EUGENE STEUERLE, Urban Institute: Bill.

BILL GALE, Brookings Institution: All right, thanks. I find myself agreeing with a lot of this stuff that is being said, so I'll try not to be repeating what people have said.

I actually want to start out on a positive note, which is that I think that corporate integration and simplifying retirement savings are really good ideas, but you don't have to do them in ways that are extraordinarily regressive and that drain enormous amounts of revenue over time. And what always strikes me about the administration's proposals is they start out with some basic principle that you can't really object to, like simplification, and, boom, it becomes a tax cut for high-income households somehow.

So it's important to note that there are some good ideas in here. So I guess this is sort of—I'm one-tenth as far as Rudy Penner is in sort of liking some of the ideas but not liking the implementation. I really don't like the implementation although some of the ideas are worthwhile.

Point two, I think the most important number in the budget to think about is that in 2008, with the economy at full employment, with the president's plans enacted, with war presumably over, etc., the structural deficit is 1 percent of GDP in the administration's budget. This is in table 2-5 in the "Economic Assumptions" chapter. And the reason that's important is that what the president is saying is that the best way to get out of this fiscal situation is tax cuts that make the economy grow, all right? His own budget belies that claim. Even his budget, with his assumptions, shows that we never get back to zero on a structural basis. And that seems to me to be pretty damning evidence about the logic and wisdom that the tax cuts will create big enough effects to let us grow out of this situation, and that seems to be an under-highlighted number.

Then two points about the saving proposal I just want to put out there. One is that if the saving proposal were enacted it would severely reduce the ability of the dividend tax cut to give corporations good incentives to report income. Let me say that again. (Chuckles.) The dividend proposal that came out on January 7th works; it gives firms incentives not to shelter income and not to retain earnings to the extent that their shareholders would otherwise be taxed on the dividends and capital gains that they receive. If the shareholders are not taxed on the dividends and capital gains they receive, then the dividend tax cut proposal gives firms literally no incentives to reduce sheltering and no incentives to reduce retained earnings.

So, among all the other things that people were talking about on the dividend proposal and the saving proposal, it's important to note that the saving proposal undercuts whatever positive impacts that the dividend proposal might have.

ISABEL SAWHILL, Brookings Institution: Can I just ask about that, because I don't understand. What was the purpose of having both proposals? They do seem somewhat redundant.

BILL GALE, Brookings Institution: Well, there is probably a political explanation, and if someone in the administration were here they could talk about it. You're right; it is odd that they're both being brought at the same time, but the factual matter is that one would undercut the effectiveness of the other. That's the point I wanted to make.

The last issue is on the saving plan. People are having a little bit of a hard time thinking about this in the context of income tax cuts. I wanted to provide sort of a way to think about it. A family of two, say a couple, can contribute $15,000 a year to a lifetime saving account. If you think of them earning, say, 6 percent on that return, that's $900 in interest dividends, capital gain income they would get the first year, that would be tax free.

Well, the next year they could contribute another $15,000. That would be another $900 plus the accumulated interest. So after two years it's like—so after one year it's like an exemption of $900 of interest capital gains dividend income. After two years it's like an exemption of $1,900, with accumulated interest. After 10 years it's $10,000. After 20 years it's even bigger. So you can think of this as sort of the gift that keeps giving in the terms of it's an exemption on capital income where the effective exemption keeps growing over time—infinitely, basically.

So after 20 years—you can model this proposal as saying, we're exempting the first $20,000 of income, capital income, for married couples. And when you do it that way you get the sense pretty quickly that this is both a very expensive and a very regressive proposal.

EUGENE STEUERLE, Urban Institute: Howard.

HOWARD GLECKMAN, BusinessWeek: A quick comment and then a question, I think, for several people here.

The comment kind of goes to what Bob Bixby was talking about. It's curious to me, you know, the constraint on deficits. It always seemed to me wasn't pay-gos or budget rules or anything else, it was the bond market, and the bond market doesn't seem to care at all. While there is all this hand-wringing inside of Washington about what's going on with long-term deficits, the bond market seems extraordinarily sanguine. And I know about the business cycle and that, but it's kind of curious to me.

The question I've got kind of goes to the bottom line of all this—and maybe Bill or Ken and some other folks can get into this too—is, bottom line, does this proposal, the whole budget package, grow the economy more than it otherwise would have? Is this a growth package as the White House says it is?

EUGENE STEUERLE, Urban Institute: Want to try to answer that, Bill? (Laughter.)

HOWARD GLECKMAN, BusinessWeek: I don't mean to put Bill on the spot.

EUGENE STEUERLE, Urban Institute: Anyone else?

RUDY PENNER, Urban Institute: Well, I think that the kind of modeling of it that you will see would suggest, yes, it is a growth package for a while. And, as I said, if you looked at Auerbach's analysis of the 2001 cut or the way these things play out in macroeconomic models, at first the incentive effect predominates and at first, in the Auerbach effect, it's 10 to 16 years, depending on what you assume. But the problem is that you have to borrow to finance the revenue loss, and then you've got to borrow to finance the interest on that borrowing and the interest on the interest and so forth, and the negative effect of the deficit ultimately predominates and the whole thing turns negative if you literally do absolutely nothing about the revenue loss. And it's a very common effect.

GORDON ADAMS, George Washington University: In addition, that really isn't the right question, because if you were going to spend this amount of money or give up this amount of revenue each year, are you getting the biggest bang for that amount of money? And, you know, I think Peter and others would argue that there are other ways either to spend money or to forgive taxes that might have more of a short-run growth impact.

EUGENE STEUERLE, Urban Institute: A simple example, by the way, Peter, would be the administration, because it's so afraid to take on losers in any of these packages, was not willing to give at the huge arbitrage opportunities in the savings incentive, so it created enormous opportunities to borrow and put money in tax-free savings accounts, so that money clearly does not provide incentives. That's just one example of how you might prove that.

Let's get somebody else on here.

(Cross talk.)

BILL GALE, Brookings Institution: I just wanted to briefly adjust the question. The structural deficit of 1 percent of GDP that I mentioned, you would need the economy to grow by 5 percentage points by 2008 to get that structural deficit down to zero, basically. So whatever you say about the growth package, the growth effects, they're not likely to be anywhere close to 5 percent. They're likely to be in order of magnitude smaller than that.

Second—

EUGENE STEUERLE, Urban Institute: They're already built into their assumptions, so don't add them again.

BILL GALE, Brookings Institution: No, I understand that. I'm telling you that's the magnitude of the—that's how much growth you would need above the assumptions in the budget in order to get the structural balance back to zero. I'm not advocating that as a reliable estimate.

The growth effects of the saving proposal are going to be real tricky because what you're doing is providing big incentives for very high income people, and the literature suggests pretty strongly that contributions by people way up there that have lots of liquid assets do not represent net additions to saving. And the effects of the dividend proposal depend almost entirely on whether you're a new viewer or an old viewer. New viewers would give you a big stock market effect and no investment effect; old viewers would give you exactly the opposite.

EUGENE STEUERLE, Urban Institute: Just a comment. The administration—the CEA, the Council of Economic Advisers, put out an economic estimate for three days and then withdrew it, that said that within one year they got half the revenues back. I think it's 2004 they had like a 1 percentage point increase in GDP. A more recent one says that they get, I think, one-third of the revenues back over five years or something. And there was some claim that that was not fully built into the assumptions, that they went with the assumptions and they didn't even fully make use of this economic impact. So this is the dynamic analysis scoring issue bouncing around in the midst of the budget.

ROBERT REISCHAUER, Urban Institute: Well, Gene, just to pursue this one more bit, do you agree with that analysis?

EUGENE STEUERLE, Urban Institute: I'm more along the lines of where Rudy is. I think it's pretty hard to have dramatic impacts of that magnitude. And I'm also bothered by the notion that—you know, some of these models people are running, they can't decide whether they want to put in a Keynesian effect or not in terms of the cash flow in the economy as well. You're really talking about long-term incentives. It's long term. I don't believe you get that type of impact up front.

There are several people—Peter Gosselin, I think, was—

PETER GOSSELIN, Los Angeles Times: Two questions. First, the press has had, as evidenced by the coverage, some problem grasping these new accounts. And those problems have been made even more difficult because the administration portrays the effects as so moderate—the revenue-raising effects as so moderate. Do any of you who have looked at this have any sense of what their—the revenue bump they get in the early period presumes about rollovers? It seems to be in the tens of billions of dollars. It suggests that there's almost no rollover at all. Everybody sort of says, well, it's nice they're out there, but we'll judge them later and we'll leave everything in place.

And the other question is just more generally about the budget. I guess I wonder whether—and I want to tap the budget wisdom of this group and ask whether, you all having looked at budgets over a very long period of time, we have had as much, if you will, full disclosure about the out-year effects, maybe just accidentally because we, this year, brought the budget window down to five years. But I'm impressed about how much we know about and how much the administration says about how much of the cost is outside the window. I mean, did Reagan's budgets to that? Did Clinton's budgets do that? Did Bush I's do that? There is, at least to this extent, some full disclosure here that we, I think, have not seen before.

EUGENE STEUERLE, Urban Institute: Peter, you might want to answer that.

PETER ORSZAG, Brookings Institution: Sure, let me try to answer the first question on the savers accounts and the rollover activity. Of course Treasury hasn't released exactly what conversion rate they're assuming, but a number of about $40 billion in conversion revenue would seem consistent with—roughly consistent with the numbers. Just to give you the span of uncertainty involved in these sorts of things, there are about $2.5 trillion in IRA assets, traditional IRA assets, or so, outstanding, but maybe a little bit less. If even, you know, say, a trillion dollars of that were converted at a tax rate of a third or 25 percent, you're talking about $250 [billion] or $300 billion in revenue, not $40 billion, up-front revenue.

But two things are worth noting. One is that households with AGI [adjusted gross income] under $100,000 have been able to covert their traditional IRAs to Roth IRAs since '97, and the conversion activity there has been very, very modest. And if you try to come up with the factors that would allow you to get conversion rates for that group that are consistent with the—observe reality, you come down to numbers that seem to be about in the range of what Treasury is assuming.

I would just note it's just very difficult to know how relevant that experience is. The up-front tax payments for someone at $50,000 in income may be much more of a deterrent to converting than for a household at $500,000. So there is a large sort of shot in the dark here, and there is at least the potential that, given—oh, another fact: Households with incomes above $100,000, and therefore not able to roll over the traditional IRAs now, own between $900 billion to maybe $1 trillion dollars in traditional IRA assets. So that may give you another indication of the potential amount of assets that could be rolled over.

So what I would say is it's very uncertain. There are scenarios that you can come up with that try to match the historical experience that get you down to the numbers that are sort of—appear to be consistent with the Treasury figures, but there is also at least the potential that higher-income households that have more liquid assets, and that have more sophisticated tax advice, and that are more likely to be constrained in their tax-free savings would be much more likely to roll over their traditional IRAs, and then the shifting from the long run to the present in terms of revenue could be much larger than what's shown in the Treasury numbers.

The only other thing I'd point out is, again, this proposal appears to be stacked after the dividend one, and that will affect both the ongoing revenue costs and, frankly, the incentive to convert because the incentive to convert really relates to whether you've maxed out your tax-free saving vehicles and if you can effectively save tax free in a "taxed account" if the dividends—and capital gains adjustments mean that they're not being taxed; the incentive to convert could be reduced also. So we're working on it.

EUGENE STEUERLE, Urban Institute: Belle, do you want to say something?

ISABEL SAWHILL, Brookings Institution: I just wanted to say something about this growth question that Howard raised, and Bob's comment that the right question may be, are there better uses of the money? And I just want to remind people that we totally leave out, usually, in these discussions—for some good reasons, perhaps—the spending as opposed to the tax side of the budget. The spending side could have growth effects too.

You know, I think there's a usual presumption that most of the spending is for consumption—some of it is probably ineffective, possibly even inefficient—and that if we reduce the size of government, that would perhaps have no effects on growth at all; it might even have positive effects. But if you get down to a situation where you are putting increased mandates on the states and you have this fiscal situation at the state level that is almost unprecedented right now—I was given the material from the National Conference of State Legislatures yesterday; they got new estimates that for fiscal [year] '03 the total gap at the state level is now $75 billion. They've closed about $50 [billion] of that and they have about $25 [billion] more to go. Of the two-thirds of states that have reported so far on fiscal [year] '04, it's already at $58 billion, and headed much higher.

With those kinds of fiscal challenges at the state level, you know, I think you're going to see cutbacks in some pretty basic services, including education, for example. And, you know, money isn't everything. Obviously we could do—our health system and our education system badly need structural reform, but I would worry that if we have a sustained period in which we are cutting back on these services and in which, without any money, it becomes much more difficult to make the structural reforms, that we could get a long-term negative impact on productivity from the failure to invest in younger people—kids—right now.

RUDY PENNER, Urban Institute: Can I say a word on the projections?

EUGENE STEUERLE, Urban Institute: Sure, go ahead.

RUDY PENNER, Urban Institute: We didn't do 10-year projections until 1997. And in retrospect, I believe strongly it was a bad mistake to go to the longer period. I used to call them noise but now I would call them terribly misleading. We went from—the first projections showed deficits as far as the eye can see, the second set showed huge surpluses as far as you can see, and now those have disappeared, and it isn't policy largely, it's just simply economic and technical assumptions.

This budget is a hodgepodge, and in a sense it's this kind of hodgepodge that I would like to see. I think you shouldn't bother projecting the baseline out 10 years, but it is reasonable to project the effects of changes and policy out 10 years. They tend to be more accurate. Frankly, the recent CBO documents suggest even five-year projections you have to worry a lot about. They have this famous fan that shows a 90 percent significance interval, and the range of possibilities for the budget balance in the single year, 2008, is almost $1½ trillion dollars.

So the discussion today sort of falls into the trap of regarding all of these numbers as point estimates when, frankly, we don't have much of a clue what 2008 is really going to look like.

EUGENE STEUERLE, Urban Institute: Van, I've been skipping you for a while—sorry.

VAN OOMS, Committee for Economic Development: I just wanted to comment briefly on the thing Rudy was just talking about, which is the sort of bottom-line deficit picture and the long term.

I mean, Rudy is certainly right that there is an enormous band of uncertainty around any of these estimates, and I think, in a world where everyone was aware of what the context was, that simply presenting the policy changes and their effects over many years might be the thing to do. I guess what worries me is that I think anyone who writes about this and anyone who thinks about this, outside of the people in this room and a few others, don't have the context to put that in. And the first question you're going to get, I know from my experience on the Hill, is, you know, what is that likely to do to the deficit? And you can hem and you can haw and you can qualify one way or another, but that question is going to be there.

But I would like to speak to a related point, which is what I think is an enormous asymmetry of risk that is involved in the budget. The point has been made that these deficits don't look very big in relation to GDP compared with the Reagan deficits. The administration makes that point continually. The problem is that we are now 20 years closer to the one thing that we do know about the future with great certainty, which is that we have a demographic transition that is going to be enormously costly in terms of Social Security and Medicare, and to some degree Medicaid. And if you apply any kind of reasonable discount factor to the difference in the deficits, I think you come up with a very different answer.

The other asymmetry is that it is so hard to fix the deficits once you've created a path for the long term. We've heard a number of reasons for that around the table today. You enact the new savings accounts and you effectively make a promise that you're never going to tax those. Can you see the government at some point coming back and taxing them? Well, perhaps you can, in the same way that you can see them changing Social Security benefits.

But it is not easy to do politically. The last time we went through this same sort of exercise it took us essentially 15 years of hard work and bad policy, in many respects I would say, to get rid of the deficits. I was on the Hill during a good part of that period, and enormous amounts of damage, I think, were done to tax and pension policy. For instance, over that period, because every year the only exercise in the Congress was for the budget committees to go around with hat in hand and try and pick up a nickel here and a dime there in order to reduce the deficit. And the way you did that, basically, was by fussing around with the tax code and with the pension code.

So it seems to me that, given the difficulties in redeeming ourselves, if we are on that kind of path, and given the fact that we are so close to the one thing that we do know about the future, which is the demographic explosion, it would be extraordinarily imprudent to continue along this same budget path, but we seem to be headed there one way or another with all sails to the wind.

Thank you.

EUGENE STEUERLE, Urban Institute: Go ahead.

MARIE COCCO, Newsday: I'd like to just open this question up to anybody. There has been lots of hand-wringing here, but in fact, if you look at the Medicaid proposal, for example, a version of that was passed by the Republican Congress in 1995; it was vetoed by a Democratic president. I personally have not seen a tax-preferred savings vehicle that Congress has ever rejected. I'm wondering if you could sort of put your heads together and give us a rundown of what you think is most likely to actually become law.

MARILYN MOON, Urban Institute: If I'm a betting person I'd bet on gridlock again in Medicare. I think it's entirely possible we'll see something on prescription drugs because so many promised for so long that we'll do something. But I would think that it would have to be scaled down from the $400 billion that people are talking about now, so I would think it might be directed at low income, and perhaps even, if they did wise policy, take a little burden off the states by taking over some of the burden of prescription drugs from the states in the Medicaid program, but I'm not sure I'd bet on wise policy either.

LEN BURMAN, Urban Institute: On the tax area, the two provisions that are new this year, the dividend relief provision and the savings provisions, I don't think are slam dunks. The dividend provision, because of its complexity, I think is in trouble, and because of its costs, and because, frankly, corporate executives really don't want to pay dividends or have to have—the things that economists like about this are things that corporate CEOs don't like.

On the savings provisions, I don't think it would die on the merits, but the reason that they might die is because—it was mentioned that the pension community isn't really thrilled about the idea of giving employers an incentive to dump their 401(k) plans. And the lifetime savings accounts, the things that are good about those, that they actually could supplant 529 plans, are also the reason why they're probably in trouble, because 529 plans are now a huge constituency.

EUGENE STEUERLE, Urban Institute: Lifetime savings accounts don't work either, too, is the real problem.

Julie.

JULIE KOSTERLITZ, National Journal: I just wondered if you would talk about contrasting this budget overall from a policy standpoint. I know Bob Reischauer already mentioned from a fiscal standpoint how this compares with the Reagan budgets, but just in terms of boldness or breaking new ground, how would you compare this with—how much of this is retread and how much of this is really new? I guess in the tax area we see some new stuff, but just overall, would you just contrast this both with the Reagan budget and maybe with the Contract with America?

MARILYN MOON, Urban Institute: In the health care area, there's a lot of retread here. We've talked about block grants and Medicaid before. We've talked about more private plan activity, and tried it to some extent with the Medicare program, and we've certainly talked about prescription drugs for a long time. So I think the thing that's new about this that seemed to be bold was the notion of really forcing people out of traditional Medicare and essentially putting it in such an untenable position that it could not survive very long, and that's the thing I suspect this administration will back away from very quickly.

EUGENE STEUERLE, Urban Institute: I think the big difference for me, Julie, is after 1981, the Reagan administration and many fronts—and even in '81 if you take some of the stuff they did on the social side, they were really willing to take on losers—create losers. You know, they didn't like social programs that were willing to go after a few of them, whether they succeeded or not. In '86 we made a lot of trade-offs to get rate reduction. We did a lot of deficit reduction, and the Reagan administration went along with a lot of those items in order to get the budget under control.

Now, some people said it was the '81 cut that caused it. I think it's a little misleading because there were a lot of other things going on, including entitlements, spending growth, and everything else. But regardless, there was a willingness in that administration, after the first year or so, to really take on—and even then a little bit—to take on losers. And so far this administration has not been willing to create the structural types of reforms where you really have to create losers as well as winners. You know, just getting rid of arbitrage in the savings accounts would be an example. The one exception might be Medicare, if they really proposed something here, but I don't know.

JOSEPH ANTOS, American Enterprise Institute: And let me just comment on that. It's probably premature to know whether fee-for-service Medicare was in an untenable position or not. I actually think that—well, my personal reading of what we read in the newspaper, since we haven't read it from the White House, is that Congress would have intervened and traditional Medicare would have been secure forever, in some sort of nonfinancial sense. I think literally nothing would have happened if we were going down the road that we thought we were when we read the newspapers. Senator Hagel said that he was going to add a prescription drug benefit to people who were going to be in traditional Medicare, and I think that pretty well writes the story.

ROBERT REISCHAUER, Urban Institute: Let me make two comments on Julie's question. One is that Reagan had a lot easier time shifting relative priorities because we had very rapid inflation. And so you can change relative priorities while giving everybody nominal increases. And while inflation did fall very rapidly—you know, I mentioned the huge drop in nondefense discretionary spending. That wasn't reflected in a nominal drop that was anywhere near as big as that. So, you know—and this town is very shortsighted; you know, lobbyists look at nominal numbers, often not real numbers.

The second point I'd make is that on the tax side I think Grover Norquist was quoted as saying if you want fundamental tax reform, that's the last thing you should say you're doing. What you should do is go forward on a piecemeal basis and clothe it in simplification, new incentives for retirement, and maybe nobody will notice that we've gone from a progressive income tax to a nonprogressive wage tax in the end, but in many ways, you know, the package that's been proposed is more radical than what Reagan was proposing in that it's suggesting a change in the nature of how we go about taxation.

ISABEL SAWHILL, Brookings Institution: Can I add a couple of points on his question?

EUGENE STEUERLE, Urban Institute: All right, last comment.

ISABEL SAWHILL, Brookings Institution: I mean, the most obvious difference, that I think hasn't been mentioned yet, is that in 1982, under Reagan, we raised taxes under TEFRA [Tax, Equity, Fiscal and Responsibility Act], as it was called then, by a large amount because people saw that these out-year deficits were large and they were concerned about them. I think it goes back a little bit to what BOB BIXBY was saying earlier, that although there was the same kind of supply-side rhetoric about revenue reflow and all of that, there was a concern that the deficits had gotten out of hand and that we had done too much.

ROBERT REISCHAUER, Urban Institute: There was a Democratic Congress and a president with a very low popular opinion rating at that time.

ISABEL SAWHILL, Brookings Institution: Well, so, you know, that's a big difference. The other thing to keep in mind is that in 1986—again, [not] only because of the administration, but in part because of it—we had a very important structural reform package in 1986 that lowered rates from that base.

And finally, I do see at least a lot of effort in this budget to sort out good programs from bad programs. Now, I don't always agree with the way they're sorted, but they are trying to set up a system of performance assessment and rate programs and begin to cut back or eliminate the ones that haven't been effective. I think they, in many cases, won't be successful because they're political nonstarters. Previous administrations have tried to cut some of these programs as well.

One area where I think privatization is badly needed, if it's needed anywhere, and where you'd expect a conservative, private-oriented administration to take on some issues, is in the Veterans Affairs medical budget, which is very large and which got a huge increase, and which is very, very inefficient. I had responsibility for it when I was in OMB [Office of Management and Budget], and if you were worried about health care costs in the private sector, you should see what's happening to them in the public sector.

EUGENE STEUERLE, Urban Institute: Thank you very much. Thank all of you for attending.

(Applause.)

(END)

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