U.S. Department of the Treasury

(Archived Content)

FROM THE OFFICE OF PUBLIC AFFAIRS

Let me first of all thank Lord Marshall for that kind introduction. I would also like to extend my congratulations to you on taking up the chairmanship of the Conference Board. In addition, let me thank Charles Shoemate, the outgoing chairman, and Dick Cavanagh, the chief executive.

What I would like to do this evening is reflect for just a few moments on our economic situation, why it is as strong as it is, and what the crucial challenges are for the future.

If it is a strong economy, why is it so strong? The overwhelming credit has to go to the American people and to American business for their hard work, skill and innovation - and especially their capacity to respond to information technology and to take advantage of the benefits that it can bring.

The new economy thrives in large part on the power of markets and entrepreneurship. And the United States has traditionally been a country in which both attributes are relatively highly prized. This must be to be the only place in the world where if you have a sufficiently good idea, you can raise your first hundred million dollars before you buy your first suit.

In many ways, this capacity to take advantage of information technology has functioned, in Vice-President's words, like a reverse supply shock. In the 1970s a big increase in the price of oil, an input that ran through every part of the economy, led to higher inflation, higher employment and slower productivity growth.

Today, of course, we are seeing another increase in the price of oil. But through the 1990s we have also seen a very large positive price shock, in the form of a declining price of information technology -- an input that also flows through every sector of the economy. And that positive shock has led to the reverse of stagflation: a period of lower unemployment, lower inflation, and faster productivity growth.

So the power of markets, private entrepreneurship and technology is an important part of the story of America's recent economic success. But there has to be another part of the story as well, because the American people were creative, hard working and entrepreneurial in the 1970s and 1980s as well.

Another crucial element in our economic success in the 1990s was the progress we made as a country in moving from budget deficits to substantial budget surpluses.

Ten years ago we had an economy where we were caught in a kind of vicious cycle: high deficits led to high interest rates, led to low levels of investment, led to slow levels of economic growth, led to reduced revenues, led to larger deficits, and around and around again.

Through the policies that we as a country have pursued during the 1990s, we have crossed a kind of tipping point, so that today we enjoy a virtuous circle: from budget surpluses, to lower interest rates, to more investment, faster growth and higher revenues, leading to still larger budget surpluses, more investment, and around and around again.

When President Clinton took office the deficit was $290 billion. The latest estimate by the Office of Management and Budget is that this year we will have a unified surplus of at least $230 billion. At 2.4 percent of GDP, that is the largest unified surplus as a share of the economy since 1948. This year alone we have cut the public debt by $223 billion.

As a result of that switch from vicious cycle to virtuous circle, more than two trillion dollars that, on the forecasts that were made in 1992, would have been absorbed in government borrowing has instead been made available for private investments in America's future. It has helped to unlock the energy and creativity that has helped to make this expansion the longest in our country's history.

There is no issue more important to us as a country than the capacity to maintain this economic expansion and to build on our economic progress. That is true in a very direct way because our economic strength determines how well we are all able to provide for our families and live out our dreams. And it has a more intangible importance, because our strength in the world ultimately derives from our economic power and our capacity to produce, and from the power of our example, which itself depends in large part on the strength of our economy.

There are a number of crucial challenges that US policy makers will face going forward if we are to keep this economy strong.

• There is the challenge of an effective public growth strategy that lets markets do all the things that they can do, but ensures that the public sector does what it needs to do. For example: ensuring that regulation does not stifle the growth of the Internet and electronic commerce; while ensuring dramatic increases in the quality and quantity of public investment in America's schools.
• There is the challenge of effective engagement with the global economy, because in an age of integration, the US is not going to continue to succeed without strengthening our connections with the rest of the global economy, and building larger markets overseas.
• And there is the challenge of widening the circle of prosperity, not only as a fundamental moral imperative but an economic one as well. Because, in an economy where the principal challenges lie in bottlenecks and the inability to attract and retain workers, including every part of America in the productive economy becomes an important economic priority in its own right.

These three priorities - building an effective public growth strategy, engaging effectively with the global economy, and widening the circle of prosperity at home - must be integral to our strategy of prolonging this economic expansion.

But, I would argue, there will be no more important choices that we face as a nation than the approach we take to the national budget, and the related question of how we can meet the challenge of the retirement of the baby boom generation. These are the subjects to which I would like to devote the remainder of my remarks.

What fiscal policies would best contribute to strong economic performance in the future? This is an issue that has stimulated a great deal of debate. But we believe there is a compelling argument for setting, as a medium term goal the elimination of the net debt held by the public.

Like tax cuts, reducing publicly held debt also delivers substantial direct benefits to the pocket books of American families:

• First, because it reduces the burden of future payments on interest and principal. For every dollar borrowed in the 10-year bond market today, taxpayers will pay a total of $1.61 in interest and principal. That obligation rises to $2.79 for a dollar borrowed with a 30-year bond.
• Second, because it helps to put downward pressure on long-term interest rates. Indeed, we estimate that as a consequence of our new path of fiscal discipline and the resulting reduction in interest rates, a typical family with a mortgage of $100,000 would save around $2,000 a year on mortgage payments.

The crucial point is that debt reduction can provide these kinds of benefits to American families in a way that will also support the long-term strength of the economy. We do not believe that alternative approaches offer the same prospect.

Paying down the debt also represents the best course for our economy as a whole, for three reasons.

As Chairman Greenspan and others have emphasized, the return on investment is probably greater today than it has been in a very long time, because of the opportunities that new technologies afford. The more we save through debt reduction, the greater will be the level of investment in the productive economy.

In contrast, measures that reduce potential national saving threaten to reduce domestic investment and thereby constrain potential growth. For example, under reasonable assumptions, a tax cut of $1 trillion over 10 years would reduce business investment in equipment and software alone by about $350 billion over the same period.

Today, when our challenges are increasingly on the supply side, with businesses struggling to find workers and to find capacity to expand operations, the priority for policy must be to increase the supply potential of the economy. Policies that boost demand, without increasing supply potential, run the risk of higher interest rates, higher inflation and greater economic instability.

A strategy of eliminating net publicly held debt provides the best prospect for maintaining the expansion, because it better safeguards against the risk that market interest rates will rise sharply in the future in response to unsustainable growth in demand. By contrast, policies that would use the surpluses in ways that substantially promote either public or private consumption raise the risks of economic instability in the future.

We are fortunate in the current strength of the economy and in the current strength of our economic forecasts. But the experience of businesses is that they most often fail when a period of strength leads to excessively optimistic plans - and then they grow right out of cash. In the same way, it is essential we recognize the enormous uncertainty surrounding any budget projections that are made today. On more than one occasion, budget projections have swung by literally trillions of dollars within the space of a couple of years. It is therefore essential to avoid making permanent and irrevocable commitments.

Debt reduction as a strategy has the central virtue of preserving our flexibility and leaving us with options, not merely if projections turn out as we hope, but also if they do not. Equally, debt reduction today leaves us room for the automatic stabilizers to provide a counter-cyclical response in the event of future negative shocks.

So debt reduction should be at the heart of any long-term strategy to maximize our economic growth. But it also provides a key to solving a major demographic challenge for this nation that draws nearer every day.

The coming retirement of the baby boom generation combined with rising life expectancy and the increasing cost of health care will increase pressure on the two cornerstones of our social policy: Social Security and Medicare. We can and should begin to address these future burdens today.

The best way we can begin an effective approach to this issue is to assure that the revenues dedicated to these programs are used only for their intended purpose, by establishing a Social Security lockbox, and building on that action, by establishing a Medicare lockbox, so that the revenues earmarked for these two programs are inviolate.

To be sure, establishing a lockbox significantly constrains our ability to cut taxes or to increase spending. That is why it is so important. Indeed, a crucial test of any budget plan in the years ahead should be whether it ensures that both Social Security and Medicare are off-budget.

However, the unfortunate reality is that as our society ages the simple act of taking them off-budget will not be sufficient to assure there are adequate resources for paying out benefits in the future. That is why the President and the Vice-President have proposed transfers to the Social Security and Medicare Trust Funds based on the savings achieved by paying down national debt and reducing government interest rate payments.

The President and Vice-President have also proposed supporting the valuable objective of promoting individual wealth accumulation, through individual accounts financed outside of Social Security, from inside the non-Social Security and Medicare budget. This approach, then, adds to the resources available for meeting our commitments to our retirees.

There are, to be sure, alternative approaches that would divert a portion of the Social Security tax base itself to the creation of individual accounts. There are certainly logical arguments for such an approach. A comparison of the rate of return for Social Security and financial assets is not one of them. Why? Because more than 80 percent of Social Security payroll taxes are not invested at all, but rather go to meet the needs of existing beneficiaries.

This points up the other difficulty with diverting revenues from the Social Security tax base. It robs the Trust Fund of resources that would otherwise be available to pay promised defined benefits. Indeed, diverting 2 percentage points of the payroll tax would reduce available revenues by approximately $1 trillion over the next ten years alone. This would lead to an excess of benefits over tax revenues by 2005, and the total exhaustion of the Trust Fund in the early 2020s, or within the life span of those retiring this year.

That is why many advocates of individual account proposals call for the use of general revenues. Those who do not believe in the use of general revenues and who are not prepared to "claw back," or recapture, a large fraction of individual account withdrawals recognize explicitly the need for substantial cuts in defined Social Security benefits.

As a matter of fiscal policy, sufficiently large cuts in defined benefits could avert these budget problems. But as a matter of social policy, such an approach is highly problematic. The lack of new resources would likely force sizeable reductions in total retirement income, even including withdrawals from individual accounts -- cuts in the region of 20 percent, by some estimates.

Moreover, the larger cuts in defined Social Security benefits that would be necessary would expose individuals to large risks, depending on how financial markets perform in the period preceding their retirement, and it would potentially undermine the progressivity that has been inherent in Social Security since its inception.