Transcript: Testimony of Dr. Kevin Hassett on the fiscal cliff before the Joint Economic Committee
Edited by Jenny Jiang
Testimony of Dr. Kevin A. Hassett, Senior Fellow and Director of Economic Policy and the American Enterprise Institute, on the fiscal cliff before the Joint Economic Committee on Dec. 6, 2012:
Thank you, Mr. Chairman and members of the committee. It’s always a pleasure to appear before this committee.
I wish the rest of Washington could study the Joint Economic Committee. I think under your and Mr. Brady’s leadership, this has always been a very collegial place to testify. I’m not trying to pre-empt tough questions later on but thank you, it’s an honor to be here.
My testimony is broken up, really, into two parts.
In the first part, I discussed the short-term consequences of going off the fiscal cliff. And in that section of my testimony, I concur with Mr. Zandi that if we were to go off the fiscal cliff, with no policy changes, then the near-term negative economic consequences would be significant and would almost surely throw us into a recession.
Then in the second part of my testimony, which I’ll focus on in my spoken remarks, I discuss the trade-offs that we face, however, between putting off the tough problems for tomorrow because we’re worried about near-term effects.
And I think that the evidence in the long-term effects of high government debt and high government debt to GDP ratio is really now quite overwhelming.
At the end, with an early analysis by [Carmen] Reinhart and [Kenneth] Rogoff, two analysts who analyzed the impact on economic growth of high debt levels, and subsequent work by economists at the IMF [International Monetary Fund] [Manmohan] Kumar and [Jeajoon] Woo confirmed their findings that high levels of government debt would lead to lower levels of growth.
In fact, the paper that I like the best now, because these literatures have all gotten more sophisticated, is a paper by [Mehmet] Caner, [Thomas] Grennes, and [Fritzi] Koehler-Geib. And they identified, actually, a tipping point in the gross debt to GDP ratios where if the gross debt to GDP gets above 77% – and we’re above that now – then it has a significant – very significant – negative effect on economic growth.
To put their results into perspective, in my testimony, I did a simple calculation, which provides some intuition for the results. If we were – all else being equal – run a deficit of 6% to GDP for the next 10 years, then that would add to the debt to GDP ratio by about 60% – not quite because GDP is growing. But then that increase would be enough that at the end of the decade to reduce, according to these econometrics debts, to reduce annual growth forecasts by about a whole percent a year. These long-run crowding out effects are very, very significant.
Now, that growth story might be alarming, but the picture looks even worse if you think about the potential financial calamity and the kind of risks that we’re seeing actually becoming reality in Europe.
This year, much of Europe has been in turmoil because of the Greek debt crisis. But in many ways, the sickest European nations are actually in better shape than us.
While the U.S. debt may seem manageable to many who look at struggles in other countries and take consolation in our relative stability, the situation in the U.S. today when taken in the long-run is actually farther from debt stability than many other developed countries.
I cite in my testimony, a recent study by the OECD that examined long-term projections for OECD countries’ debt burdens and found that the U.S. needs a bigger fiscal adjustment than any of the European nations. I think that puts in perspective the urgency that we have to try to act.
Given the previous research that’s estimated the effect of higher debt to GDP ratios on economic growth, it’s also possible to theorize about how a continuation of today’s policies could hurt growth farther out into the future.
I cite in my testimony a recent paper by Stanford’s Michael Boskin who shows that if we don’t act on this, then we basically are producing a fundamentally different America than we’re used to. Boskin’s estimates, which again are based on this widely-accepted literature, that suggests that we’re going to move into a world by, say, 2040 where economic growth in the U.S. is not what we normally expect to see each year, that there’s so much crowding out of private activity by the government that we’re in a world where you don’t wake up each January and expect it will have a positive GDP growth that year. So that’s how urgent it is to act.
So then, what should we do? In my testimony, I cite another now large emerging literature that looks at fiscal consolidations using my own study as an example.
Along with two colleagues, I’ve written analysis exploring policy mixes of successful and unsuccessful consolidations and our metric of success is that they just achieve their own objectives of deficit reduction.
Based on our analysis, we found that the fiscal consolidations that were very heavily weighted toward spending were much more likely to be successful than fiscal consolidations that were heavily weighted toward tax increases.
We speculate, Mr. Chairman, in our study that this is because we find this result because the tax-heavy fiscal consolidations tend to not take tough choices on entitlements and because spending reductions are more real and more sure than tax revenue increases when you lift marginal tax rates.
I know it’s very easy for an economist to discuss the forms that could put the U.S. back on a positive trajectory. I think Mr. Zandi and I probably agree pretty much on the rough outline of what that would look like. And I know that the political challenge is a very, very heavy one.
But I think if you look forward to the America that we’re creating with this large and out-of-control deficit, then we all have to agree that the stakes cannot possibly be higher.
Thank you very much, Mr. Chairman.
- Written testimony submitted by Dr. Hasset on Dec. 6, 2012 (PDF)
- Joint Economic Committee: Hearing on the “Fiscal Cliff: How to Protect the Middle Class, Sustain Long-Term Economic Growth, and Reduce the Federal Deficit”