Addressing the U.S. Deficit Problem

Thursday, November 10, 2011

Jacob J. Lew, director of the White House Office of Management and Budget, analyzes the effect of the political gridlock in Washington on fiscal policies, and discusses the domestic deficit challenges faced by the White House.

This symposium is presented by the Maurice R. Greenberg Center for Geoeconomic Studies and is made possible through the generous support of Stephen C. Freidheim.

GILLIAN TETT: Well, good morning, everybody, and welcome to the second session of this fascinating debate.

Those of you who were in the first session will have heard Alan Greenspan say that he thought the major problem in the United States is Europe. Well, I think there are plenty of people in the U.S. today who might beg to differ a bit because America is not without its significant problems as well. Never mind that the economy remains at best stagnant or troubled, there's also the problem of rising budget deficits, rising debt levels and, of course, a political system which appears to be pretty dysfunctional right now in terms of dealing it -- with this. Not quite at Italian level, the dysfunctionality, but not far off, necessarily, at times.

And I can't think of a better person to discuss this than Jacob Lew, who is coming up for an anniversary. Next week he will have been director of the Office of Management and Budget for exactly one year. I don't know whether to congratulate you or commiserate -- you -- (laughter) -- perhaps congratulate you for surviving this far.

And those of you who have got his bio in your pack will see that there is scarcely anybody better placed to hold this position. In fact, much of his life, thus far, his career, has been a dress rehearsal for this position. You have already served in this position before, but you've been around in Washington since the late 1970s and as far back as 1983 were involved in bipartisan discussions to try and tackle the problem of Social Security. I'd like to ask you if you feel a certain degree of "Groundhog Day" about your job right now.

JACOB LEW: Almost every day. (Chuckles.)


TETT: (Chuckles.) Well, the good news is, you have plenty of training for this role. The bad news is that the problems look more insurmountable than ever before.

So I'd like to start by asking you: We are all awaiting the verdict of the supercommittee, which is due to report, I think, on November the 21st. How optimistic are you that the supercommittee will actually make any breakthrough in terms of tackling the mounting fiscal problems?

LEW: I have lived by the principle that if you become a pessimist, it's a self-fulfilling prophecy. So I am self-avowedly more optimistic than the norm. I think one of the diseases in Washington is that everyone is afraid that they're going to appear naive, so they predict failure.

There's reason to be cautious now. The substantive challenges the supercommittee has very substantial. The political issues that they're grappling with are very substantial. But I still think that the right bearing is that they have a couple of weeks, they have an important job to do, they need to be given the space to do it. I think you're seeing on a daily basis that conversations are continuing on very difficult subjects.

I wouldn't say we've seen the kinds of breakthroughs that would make me say it's 80-20 going to be a huge success. But I think it's substantially premature to write it off as having failed. I think if you look at complicated and controversial undertakings like that which is the mission of the supercommittee, it almost never looks like it's going to come together until the very end.

We're now in a critical period. I think if you look at the importance of what they're doing, the need to act is, I think, clear, and I think the need to act sooner rather than later is clear. The same action taken today versus a year from today would be much more powerful in terms of restoring confidence both in the United States and in the international economy.

So you know, the president spent much of the summer deeply engaged in negotiations; in the course of those negotiations showed that he was willing to go quite a substantial distance to reach a balanced, fair compromise, to do something quite big.

That obviously failed. I would contend it failed because there was an obstacle on the other side in terms of dealing with taxes as part of a balanced package.

I think that the supercommittee is now grappling with that same set of issues. I hope that all the parties are willing to move on these kind of core issues. I think we've seen some movement, some hints of movement. We will in the coming days whether they can -- they can close.

You know, the president submitted to the supercommittee in September his own unilateral plan of how we could reduce the deficit, the debt by $4 trillion. There were items in there that have been little noticed but in any other period that I've been in Washington would have been seen as acts of supreme courage to go out on your own and propose them.

So between the negotiations and the plan that the president submitted in September, we've tried to give as clear a signal as to where we think the lines are for a reasonable, balanced package. And we remain engaged in conversation, though this is really their job and they need the space to do it. And sometimes in Washington that means going into rooms and having private conversations, which is what they're doing.

TETT: So what for you would constitute a success on November the 21st? A clear-cut plan to get 4 trillion (dollars), 1 1/2 trillion (dollars)? You know, what for you are the benchmarks of success?

LEW: Look, the president made clear in the document that he submitted to the supercommittee that there's a path to $4 trillion that is achievable. There's no doubt that would be a powerful signal to the markets, to the economy, to the Americans who are looking to see: Can their government function?

I think realistically they have a mandate to do $1.2 trillion of deficit reduction in order to avoid having draconian cuts come in a year from January that would cut an enormous amount out of defense and domestic spending.

So I think that the (band ?) for the supercommittee is, can it take that minimum action to avoid what I think all parties agree is an undesirable set of policies? It was designed to be an undesirable set of policies, because it was meant to be a lever to focus Congress on acting, and replace it with a sensible, balanced package. A first step would be better than no step at all. You know, a big step would be better than a small step.

TETT: So 1.2 (trillion dollars) avoids the fail and 4 trillion (dollars) gets you a straight A?

LEW: I think 4 trillion (dollars) would be seen by almost everyone as a very substantial accomplishment. I would not hold out a high degree of optimism at the high end. I think that the question now is, is there something in the not-failing category that could both be accomplished and restore confidence.

I think if you look at the political debate in Washington, really this whole year, it has not been a good thing for the country and for confidence in our institutions to be hours away from a government shutdown in April, and really not necessarily, because the agreement that was reached should have been reachable without that kind of, you know, drama and brinksmanship.

July and August was very damaging -- the notion that there were a significant number of members of Congress who actually were arguing that the default of the United States was an acceptable policy option. Now, that obviously wasn't a view shared by the president; it wasn't shared by the responsible leaders, but we got right down to the wire. I think the fact that Congress is now beginning to try and find a way, you know, one way or another, to do its business in a more business-like way, both in terms of funding the government for the next year and in terms of dealing with the supercommittee's challenge, the small accomplishments would be a big reversal from what we saw earlier in the year. And I think that would, in addition to the economic impact, be quite important.

TETT: Right.

Well, I'm going to get granular in a minute and ask you a bit about defense and entitlements and taxes. Before I do that, though, I'd like to ask: The president is currently en route to Honolulu, I believe, which sounds to me like a vastly nicer place to be than in Washington and spending time hanging around the supercommittee. But at what point does the president actually get engaged in the supercommittee? I mean, is he going to stay on the sidelines (right the way ?) through? Do you think he'll come in and try and break any deadlock?

LEW: I think the president's engagement in the fiscal policy debate this year has been anything but on the sidelines. He spent months in March and April, in June, July, August, not engaged on a periodic basis but an almost full-time basis. The end result is, there is total clarity of his views on these subjects, an unprecedented amount of clarity.

Usually, you start a negotiation not knowing where the other party was willing to go. There is now a blueprint of what we would do on our own, where we would have gone in a true big bipartisan deal. And there is a political challenge for members of Congress to come together and do their work. So I think that being in the room and being on the sidelines are not the issue.

We have -- we have, I think, done the right thing by putting a comprehensive plan in front of the committee. I frequently refer members to that plan. I think it's actually been helpful to them as they've gone through the issues. They have some fundamental political challenges that they're working through. Subsequently, the administration has laid out a very detailed set of ideas.

And in terms of the president's kind of physical whereabouts, I think, you know, it's safe to say that the president is never out of reach. He can reach us whenever he needs to, and we can reach him whenever we need to. The president has a lot of responsibilities. You know, organizing a session like the one he was going to, where we get together with our trading partners and try to develop a future vision of Pacific trading that will grow the American economy -- that's also part of the president's job. And the president is doing his job, and it's really time for Congress to do its job.

TETT: Right.

And one other question on the president and the political climate. I remember talking to Secretary Geithner earlier this year when he was meeting with European investors and then the Asian investors, who were completely befuddled by what was going on and shocked by these threats of a government shutdown and default.

And the argument that was emanating from parts of Washington back then was: Don't worry. This may look completely bizarre to the rest of the world, but this is normal American politics. And this has been going on for decades. It's a game of brinkmanship. This is just how policy is made.

Given that you have been around Washington since the late 1970s, do you agree with that verdict in terms of what's going on now? Or do you think something has changed fundamentally in the political climate and the machine, which is making it actually harder than you've seen in your own career to get an agreement?

LEW: I would actually go to both ends of that, both what is happening in Washington and what is the context in which Washington's actions are playing out. And let me start with the second because I actually think it is the bigger factor.

You know, in a -- at a time when the economy is smooth and there's not a world that's on the edge of chaos in a number of important places, Washington brinksmanship is very deep inside the newspaper, and it may not be highly consequential. At a time when there is a recovery from the deepest economic downturn since the Great Depression, when there are very substantial challenges in Europe that all of us in this room and all of us in Washington follow on a day-to-day basis, there is an extra urgency for Washington to show that we can take the things that we control and that we can do it in a way that meets a standard of performance that the public expects. That's what the president was calling on Congress to do.

I think Congress did, in a way, handle it the way Congress normally handles things, which is you wait till the last minute. You don't make a concession that could be difficult until it was clear you had no choice. And you know, I, for one, was quite outspoken in cautioning members that this was not a time when that was a good way to proceed, that if -- accomplishing an agreement on the debt limit when we did had less value than accomplishing that same agreement a month before without the drama. Now, I think it is fair to say that that -- you know, debt limit votes have had that kind of last-minute quality before. I think it's more consequential now.

I do think inside, the system has become more polarized. There is, I think, the ability for a relatively small number of members with rather extreme views to kind of force issues into sharp focus and contrast that makes it harder to move to where the reasonable compromise is. Were there a willingness today to do things in a truly bipartisan way, as there were at moments in the '80s and the '90s, I think there's a broad consensus about some sensible things to do. But that requires leaders being willing to take action with part, but not all, of their caucus. I don't think we see that as much today as we have at some other points.

And ironically, in the end of the day, you look at how the votes have finally broken the logjam -- they've had that familiar pattern. You know, there have been, you know, 50 or 70, you know, extreme votes that wouldn't go along with a reasonable compromise. But it was just very difficult to get to the point of that being accepted as the reality. If you went in knowing that and said, what can we do that could get a majority on both sides, I think it would expand the scope of debate, and it would be a much more civil discourse because people would get out of their corners.

TETT: But in practice, almost the only time you've seen bipartisan agreement or action in the last years was in the autumn of 2008, when the markets were crashing so dramatically that it actually prodded Congress into passing the TARP. Do you think it's going to take a market crash, a real swing in Treasury prices to actually get that kind of gridlock broken in Washington? Because right now, of course, America is being giving -- given pretty much a free pass because everyone is watching Greece and Italy.

LEW: I think that if you look at the actions that Congress has taken this year, there were some moments of bipartisanship. The trade agreements -- they were very important economic policy, and they were passed on a bipartisan basis -- on, you know, some smaller issues, but not insignificant, like patent reform, things that are very significant to our long-term economic growth.

On these high-profile fiscal policy issues, in the end of the day, the votes were actually bipartisan. The funding bill that passed in April was passed in the House with Democratic votes. It couldn't have passed with only Republican votes. The debt limit increase ended up passing with bipartisan votes. What you did not have was a process of accepting the fact that we have to do this in a bipartisan way and negotiate so that's a victory, as opposed to the consequence of getting to the end. In the 1980s, in 1983, Social Security reform reflected that kind of coming together. Tax reform reflected that kind of coming together. In the 1990s the balanced budget agreement reflected that kind of coming together. I think it would be a good thing for the country.

That's what the president was engaged in in June, July and August. It was politically risky for him. He was engaged in negotiations where he was putting things that were considered sacred cows to most Democrats on the table. And his view then was that to do something big and to have the ability to stabilize confidence and the direction of the U.S. economy was worth taking that kind of political risk.

I think, quite unfortunately, the issue of taxes polarized the debate at the end. And, you know, I hope that that changes now. I hope the supercommittee, whether it's small or large, is able to get the kind of balance -- but that's going to mean, you know, both sides moving out of their corners; it can't be just one side. It won't be just by more spending cuts; it will require revenues and spending cuts.

TETT: Well, having been involved in the agreement of 1983 to look at Social Security and reform Social Security, do you think that it is possible for the supercommittee to do anything meaningful without addressing the entitlement issue? I mean, do you expect them to address the entitlement issue?

LEW: I think everything is a matter of degree. I think what would be in a small package, or the minimum package, would be different than what would be in the larger package. I don't think it's reasonable to have a view that: Let's start with savings and entitlement programs, and talk about revenues later.

If you look at the agreement on the debt limit, we essentially took one-third of the decisional areas and resolved them in the debt limit bill. We said that annual discretionary spending will be under very tight limits for the next decade. We saved a trillion dollars. I'm now putting a budget together in those limits. I can tell you, these are serious limits. It will mean choices; it will mean real restraint in spending. I think we can balance our priorities if we make the choices and live within it. But a trillion dollars in a decade has real impact.

We now have to move to the other pieces, entitlement savings -- and which are not just Social Security and Medicare. There's a broad list of things that are entitlement savings, many of which the president unilaterally put forward ideas for hundreds of billions of dollars of savings in September.

And there are revenues. I think in a package that actually addresses the $4 trillion challenge -- and just to be clear why $4 trillion, it's not a random number. It was the number that I think there was a broad consensus would bring us to, you know, primary balance in a reasonable period of time. That's not our ultimate goal. Our ultimate goal is to have a lower deficit, so we're buying down the debt; but you can't buy down the debt until you stop adding to it with new spending. And that's what the $4 trillion gets you to: It's a minimally sustainable place, so that you then can make the next set of decisions. One trillion dollars more doesn't get you there. The $4 trillion total -- which is $3 trillion more than we did over the summer -- would get you there.

The extent to which there are the difficult choices will depend on there being difficult choices on both sides of the ledger. It would be the right thing for the country for us to get the bigger package done. That's why the president spent July and August the way he did.

TETT: We were talking to some senior members on the Democrat side recently who were suggesting that they might be willing to compromise on the tax side, the revenue side, if there were significant defense cuts. Do you see that as a potential form of compromise going forward? And, you know, what would you define as significant defense cuts?

LEW: I think that the question of defense spending is a very important and complicated one. The agreement over the summer calls for very substantial reductions in defense spending -- almost $500 billion over the next decade. We're now engaged in a -- in a substantial strategic review with the Pentagon, with the secretary, the Joint Chiefs. And I believe we can come out of the review with $500 billion of savings and a defense posture that not only meets our national needs, but in some ways leaves us leaner and stronger.

I don't think there's an infinite amount we can reduce defense spending and still be able to make that statement. Defense reductions, like every other area, have to be driven by a strategy: What are our strategic requirements? The Defense Department even itself admits that the last decade, decade and a half, have basically been unconstrained. In an unconstrained environment, every institution behaves the same way: They forget the difference between the "need to have" and "nice to have."

This $500 billion of savings is forcing those kinds of decisions through, I think, a very clear, strategic lens. And it's actually one of the best strategic discussions I've been part of in my years in Washington, where everyone -- uniform, civilian, White House and military -- are coming at it with the same question: Where does the United States need to be in the world, and what can we do to put it there, while we're saving money?

The proposals to do almost double the savings --

TETT: A trillion dollars.

LEW: -- a trillion dollars -- I do not have a strategic frame to get there, you know, so I can't sit here today and say that you could achieve that level of savings consistent with meeting the strategic requirements.

That's not to say that we can't perform better than the 500 billion (dollars) in the summer. Certainly it would make my life a lot easier if the result of the strategic review showed that we had some more headroom. But I think it's dangerous to pocket what was accomplished and assume we're starting from where we were a year ago.

This is a serious exercise in cost reduction. You know, when the Bowles-Simpson commission came out, it had a substantially higher defense number. It was one of the things that we were concerned about. Not that we didn't want it to be true. You know, if we could save a trillion dollars instead of $500 billion, it would be a good thing. But we can't make the decision that we're going to save a trillion dollars and then find out that it leaves our national security exposed. We have to move the strategic review with it.

The secretary of defense and the president and I have all said the sequester, if it were to hit, the enforcement mechanism if the supercommittee fails, would be very damaging to our national security. That's an additional $55 billion a year for 10 years of cuts. So it can basically get you to just over the trillion-dollar mark. That's not the same as saying on the margins there's -- you fall off a cliff if you go from 500 billion (dollars) to 510 billion (dollars). And we're in a process now where it has to be policy driven.

TETT: And if you were a betting man or in the markets right now, what probability would you attach to the chance that the supercommittee will end up suggesting some tax increases?

LEW: I think that in order for the supercommittee to succeed, it will have to address taxes in some way. So I think it's really the same question as asking what do you think are the probabilities that the supercommittee would succeed. And I still think that there's a better than even chance that they can get something done.

TETT: OK. And then as offset, what proportion -- what probability will you attach to the idea the supercommittee will end up including tax increases for the wealthy?

LEW: Well, you know, tax increases for the wealthy are obviously a central part of the broad tax debate. You know, whether or not to extend the tax cuts in the top two brackets, we've taken the clear position they shouldn't be extended. It's a matter of some significance to the other party that they be made permanent.

I think that in the debate over tax reform, there is the useful reality that if you do tax reform, the current rate structure becomes less relevant, and the test is, is the system at the end of tax reform more progressive or less progressive than the current system? I think any tax reform coming out will have to be, you know, more progressive, not less progressive, than the current system, and in all likelihood it will be, if and when it happened, the rate structures that make this question of the old rates much less relevant perhaps irrelevant. If you'd lower the top rate, then -- and broaden the base by closing loopholes, then you've kind of addressed that issue.

So I think the question of progressivity is central. I think if you look at income distribution in this country, there's no secret that we have a kind of disparity of income distribution that is a serious concern.

The administration has taken the very strong positions that there has to be fair balance in what we do. If you look at entitlement savings, the numbers don't sound dramatic to a person, but a hundred dollars, $500, a thousand dollars, if you're living on $20,000 or $30,000 a year, that is a big sacrifice if you're seeing a few hundred dollars or a thousand dollars of lost income or benefits. You can't call for that and say we're going to allow people who have the highest incomes and have been the most successful to pay (low/lower ?) effective rates than people at much lower income levels.

The right way to do it is through tax reform, through base broadening. And, you know, I think the sooner we get on to that debate the better. I think that's where a lot of the conversation in the summer and in the supercommittee, as well, has been. That's obviously a very challenging undertaking, because it is a -- it's both complicated, and every decision you make changes the incentives in one or another part of our economy.

TETT: Well, I'm going to open up to questions in just a minute, but one other quick question from me. Are you worried that unless the supercommittee does come up with something sensible, between 1.2 (trillion dollars) and 4 trillion (dollars), then we will have the Italy/Greece situation play out in the U.S., namely a loss of market confidence in the government and a potential roller coaster ride in the markets?

LEW: I think it's very important to look at the fundamentals and to avoid treating all of the issues going on in the world as if they're the same.

This summer when the rating agencies took a look at the political debate in Washington, they fundamentally reached a political decision, a conclusion that there was political gridlock, that action would not be taken in a timely way; therefore, we're going to downgrade.

They didn't make an economic judgment. They didn't say that the United States was out of control and that action couldn't be taken.

I think that that actually is a significant difference that sometimes is lost. You look at some of these other international challenges, and the underlying fundamental economics are much more challenging.

I think that if you look at the market reaction in the summer, it was actually also striking that when the rating agencies' downgrade came along, consumer confidence or the market confidence went the other way and the price of, you know, U.S. debt went down, not up.

Now I don't think we should sit back and say there's not a problem. I think that the display of political gridlock in Washington in July was one of the most corrosive things that I've seen in terms of American public debate in my career. At a moment when the public desperately wanted to see Washington able to just get its work done, it showed that inability. That was why the president went farther than most in his own party wanted him to go. But it takes, obviously, two to put that kind of approach together.

I think that -- I think that the members of that committee and the leadership of Congress understand that their success in meeting a measure of expectations that they can do their work is actually quite important.

That's why I'm kind of a little outside of the normal market assessment of the probability of success. I do not believe that a week from now, when those 12 members and the leaders get together, failure's going to be something that they want, because they're going to say we need to show we can do something.

Now they now may not succeed. One of the important things about the way this mechanism was set up that I think's quite important to keep in mind is that if they fail to meet the deadline in November or in December, in the full bodies, nothing actually happens until January 2013. So the enforcement mechanism, which is draconian across-the-board cuts in defense and nondefense, are set up to take effect in January 2013.

Well, in January 2013 it's also the time when the tax cuts that were extended last December expire. So it's kind of a perform storm that brews next fall into January, and I think it's hugely preferable for Congress to get its work done this year. But I think it's a mistake to think that if Congress were to fail this year, that therefore the -- you know, the seams split open and everything comes apart. I think what you see then is a national political debate, an election and action afterwards.

So I think there will -- I'm highly confident there will be action. I think it's highly preferable the action come now, but I think it would be a mistake -- and that has to do with public confidence and market confidence -- if it's understood that there will be action, that -- that that should be a factor that's taken into consideration.

TETT: Or to put it another way, we may get a bit of a break between the perfect storm in Europe and the perfect storm in the U.S. that way.

But I'd like to open up to questions now, please. I'd like to remind everyone that this session is on the record. I know there are many members who'd like to ask questions, so please keep your questions short and concise and to the point.

We have a microphone and we're -- aside from people in the room that are participating, do remember that there many members also participating by teleconference.

And lastly, it would be courteous but not compulsory to state your name and affiliation.

So, question over there and then one, two, three.

QUESTIONER: Thank you. Jamie Metzl with the Asia Society. As you know, President Obama called for the doubling of U.S. exports. And my question is, to what extent do you believe that China's policies on currency and intellectual property are impeding progress towards reaching that goal?

LEW: Yeah, I think we're actually making good progress towards reaching the goal. We've obviously made clear that we have concerns that there be both a fair balance of monetary policies and a fair treatment of intellectual property rights. We've made some progress on the intellectual property rights in discussions this year. It's an issue that I think is going to be ongoing. It's not something that we're going to be able to check the box and say it's resolved.

I think if you look at the balances of trade, the -- we are selling, actually, a good deal of services in China, raw materials in China. And I think that it is very important that globally, we stay focused on the -- on achieving the goal. And it's something that we are very much focused on as we put our resources to work in terms of trade promotion activities and the things that we can directly control that ease the trading relationships.

TETT: We have a question, I think. OK, there.

QUESTIONER: Good morning. My name is Andrew Gundlach, Arnhold and S. Bleichroeder. Obama might have done some courageous things on the fiscal front, as you say, but one thing that he did not do is get behind Simpson-Bowles at all. Many within his administration and many Washington insiders consider that his most important political mistake, even more important than pushing health care. Some even claim that he didn't even read the report. Those same people also believe that Simpson-Bowles will be enacted either -- and the only question is 2012 or 2013. Your thoughts?

LEW: Well, there are a lot of people who think a lot of things that don't have a lot of connection to what happened. So I'm going to address what happened.

You know, the Simpson-Bowles commission did an enormously important job, which we said at the time and we have said consistently since. In my conversations with both Alan Simpson and Erskine Bowles, I've said it to them. I've heard the president say it to them. I've been there with him. We embraced an awful lot of the approach of the Bowles-Simpson commission. If you look at the debate over the summer, the debate over the summer was highly informed by the Bowles-Simpson commission.

There are aspects to the Bowles-Simpson report that are challenging. Go back to the defense discussion that we just had. It calls for defense savings that are roughly twice what we know how to achieve. The president is commander in chief. The president is responsible for making national security decisions and not just fiscal policy decisions. And as his budget director, I'm responsible for balancing how would you do it, not what is the number.

I think that the balance between saying enormous progress was made putting a bipartisan consensus together, let's work with that to get something done, and signing on the dotted line are very different. So I think that there have been many who've tried to make it seem as if we did not embrace things that we did embrace. I can't sit here today and say I know how to achieve a trillion dollars of savings in defense without undermining our national security. So that's a challenge if the president is asked to sign onto a plan.

On the revenue side, you know, it was a hugely important accomplishment to get bipartisan conversation and agreement on the notion that base broadening would be a way to raise revenues that might be a place where the parties could come together. It has shaped the conversations that have gone on since. You know, I think the total number that was in there is one that probably would be more pleasing to me and to the president than to many Republicans in Congress. If that became the thing we demanded in order for there to be a deal, I think it probably would not achieve the kind of broad, bipartisan support that it would need.

I think if you kind of leave the position of kind of who said what to whom, which is the way, in Washington, things are often covered, the substance of Bowles-Simpson is very much behind what's been going on ever since, which is why it was such an important thing to do and a report that will have enduring value. The test of the value of a commission is not did it get picked up and voted on, but did it change the debate in the way that's going to change action going forward. And I believe it did, and it -- and it will.

TETT: Thank you. Any more questions? One and then two.

QUESTIONER: I'm R.P. Eddy from Ergo. Thank you very much for your time. A lot of cynics believe that at the end of this supercommittee, 14 months from now, if they haven't achieved a consensus, the draconian cuts won't actually occur because Congress will step in and sort of change the rules. Do you think that this is likely, or can you share any thoughts on that?

LEW: I think it is -- it is a challenge when there is subsequent action that could be changed by legislation to speak with certainty that nothing will happen to change events. So I understand that there is legitimate skepticism that hard things will happen if there's the opportunity to turn them off.

I would challenge that, though, in this case. I think if you look at the history of enforcement mechanisms like this, the threat of very unattractive policies is sometimes a very effective way of kind of concentrating political institutions to make hard decisions. In 1990, the Budget Enforcement Act came out of such a moment. There were, at the time, across-the-board cuts that were going to take effect if Congress failed. It was not, at the time, considered politically acceptable to just turn it off. I don't think it would be considered politically acceptable to just turn it off now, either.

I don't believe that it will be necessary for those across-the-board cuts to happen. That's a different question. If the reason they don't happen is because the fiscal discipline was turned off, that would be a very bad thing. If the reason it doesn't happen is because Congress comes together and reaches an alternative approach to accomplish the fiscal goal, that will mean that the mechanism actually accomplished its purpose. The purpose of the trigger was not to put across-the-board cuts in a way that would cause deep damage to our defense and domestic priorities. The reason for that mechanism was to say, it will be unthinkable to do nothing. Congress will have to make decisions. They will be hard choices. But when the choice is the hard choice of deep defense cuts and deep domestic cuts on the one hand and balanced mixes of spending and revenue proposals on the other, Congress will choose the balanced approach, which is what happened in 1990.

TETT: Let's hope that (work plays ?) out again.

Question there.

QUESTIONER: (Name inaudible.) Could you share with us the rough dollar amount or percentage of the domestic discretionary budget that is represented by pass-throughs to state and local governments? And would you agree with the often-expressed proposition that that's probably the part of the federal budget that's most vulnerable to the cuts that are inexorable in -- over the next few years?

LEW: I don't have the percentage off the top of my head, but you know, it is -- it is a (not insignificant ?) number. You know, between transportation and law enforcement and community development block grants, there are -- health care, the Medicaid program -- the dollars are quite large. I think they don't fall into the same categories easily, because you look at Medicaid, it is a very different kind of a system than a block grant which says you're going to get money to hire police or you're going to get money to do community development activities. It's very much tied to minimum standards of health care and state plans to accomplish that. So the biggest item is health care, and it is different in kind from the others.

In terms of their exposure in this process, you know, I think it's fair to say that everything is exposed in a process where you're not -- you're not just not keeping pace with inflation, but you're seeing nominal reductions in resources that are available. The grant programs, you know, are important in terms of the goals that they accomplish, but they compete against core federal functions in some cases.

And you know, we're going to have to strike the right balance. As I look at the budget for 2013, one of the things that I'm very sensitive to is that state and local budgets are going through a lot of stress right now. We're seeing reductions in local employment that are actually creating headwinds that are making it very difficult to bring down the unemployment rate. We look monthly at the unemployment numbers, the private sector is starting to produce jobs at a decent rate -- not high enough, but it's showing recovery patterns. And you have reductions in employment at the state and local level bringing that down so that instead of seeing unemployment drop, you see it hold constant for now a couple of months running.

I think we have to be very sensitive to that as we look at how we make these decisions. While it can't be that state and local issues are completely off the table, we have to, I think, be very mindful of the fact that a reduction today in state and local funding is more likely to lead to reduction in employment and service reductions, neither of which in the current climate are particularly desirable.

So it is -- the reality of a trillion dollars of savings against what would have been your baseline otherwise over 10 years means we're going through a decade of belt-tightening. It will feel like belt-tightening. How we make the allocation decisions is going to reflect kind of core values and what is dispensable and what is not. We're certainly not approaching it from the point of view that there's some big cushion of reserve out there that the states can absorb anything that -- or the local governments can absorb anything that comes with no impact. But I can't in any area of the budget say that it will beyond scrutiny.

TETT: Well, as you know, we have a number of members who are outside New York participating via password-protected teleconference, and one of those is Carlos de la Cruz in Florida, who is chairman of CCI Companies, who's asked a question which leads on very nicely from that, which is: Are you familiar with the sensitivity of the size of the projected annual deficit for 2012 and 2013 to different projections for variations in nominal GDP, unemployment, interest rates and inflation -- to which one might add, and the prospect of the eurozone collapse?

LEW: Budget projections are always made in the context of economic forecasts that, unfortunately, have to be made, you know, many months before a budget actually comes out. In normal times, making assumptions in November for a budget that's printed in February is not an interminable period of time. In an environment like we're in right now, you know, the world can change in significant ways from day to day and certainly from quarter to quarter.

You know, we have tried to maintain as much flexibility as we can while still making policy judgments to respond to our updated assessment of what we see as likely GDP growth, what we see as likely external economic factors. You know, to the extent that the world changes, it is not an uncommon practice for budgets to have to adapt to it later. You always do the best you can, either try not to be unduly optimistic or unduly pessimistic.

In the 1990s I'd say our budget projections were based on economic forecasts that were wrong every time, and the world was always better than we'd projected. That was a fairly good place to be. It wasn't so hard to figure out what do you do when the situation gets better. You try to avoid being in a place where the world deteriorates and you can't deal with it. You know, in an environment that could be rather volatile in terms of some of these indicators, I look to my colleagues, you know, like Alan Krueger at the Council of Economic Advisers more than I ever did before for constant guidance.

TETT: But do you have a sort of shallow set of projections for what things would look like if, say, the eurozone does go into a deep recession, if there is real financial turmoil in America?

LEW: Normally budget projections don't assume dramatic events occurring. The way budgets are traditionally done is that you assume there is a likelihood of dramatic events at some point in the window and you kind of average it out over the period, because trying to figure out in advance when dramatic ups and downs will happen is almost impossible.

So, you know, in the broad sense of there being kind of -- limits to growth that are a function of the environment having risk, that's kind of part of the long-term macro-forecast. We don't try to pinpoint what happens if to specific circumstances.

TETT: Right. Any more questions? We have time for one or two more questions, I think. We have a very active -- (word inaudible) -- group here. Any questions over this side before I -- OK, right. One in the back, and then come forward.

QUESTIONER: Do you think the supercommittee can reach -- a budget commitment, budget agreement is coming two weeks before the Thanksgiving Day -- has been scheduled? And what's the possibility to adopt the tax increase for the rates? And what's the influence from the Occupy Wall Street movement to the negotiations in the supercommittee?


TETT: OK. So is the holiday period going to disrupt the talks any more than anything else? And to what degree do you see the Occupy Wall Street movement or protest impacting on the debate about taxing the top 1 percent?

LEW: I think if you look at the history of decision-making in Washington, holiday breaks are often a very helpful action-forcing event. (Laughter.)

TETT: No one wants to go back to their family and say they're going to have a rush back to the office again tomorrow.

LEW: Deadlines matter. And you know, we were talking before about some of the brinksmanship. It would have been a good thing if there had been some intervening date that drove things other than when do you run out of money to -- you know, to run the federal government or when do you lose the ability to pay the federal debt. So I actually view things like Thanksgiving and holiday breaks as helpful, not hurtful to the process.

You know, and I think that the general sense in the country that we need to do something is pretty strong. It comes from right and left. You know, and I think that, you know, there's an aspect of the public's demand for action which is to do something specific, and there's an aspect of it which is to take control and make decisions and take charge.

I think the income, you know, disparity issues are quite important. I think that it's not because of one or another protest. I think if you look at the poverty statistics that came out, if you look at the trends over the last few decades -- I've talked to friends in, you know, the financial community who worry deeply about the polarization of American society. It's not just the top and the bottom, it's at the pressure on the middle. It's in their -- that ability -- it's not a good thing if middle-class families start to say, I don't know if I can send my kids to college.

And I think we're at a point right now where we need to address the anxieties that Americans have about the current economy and the very legitimate expectation that they want to have that the world in the future will be a world of opportunity for their children. And you know, you can call it class warfare, or you can call it the American spirit. I mean, the American spirit is if you work hard and play by the rules, you ought to be able to succeed. And that's what I think it's really about.

TETT: We have probably the last question over there. Oh, sorry, actually, the lady in purple, and then the man in -- behind her.

QUESTIONER: Hi, Sangeetha Ramaswamy with Eton Park. So one of the -- obviously, one of the big surprises that happened over the summer is that the U.S. had its sovereign rating get downgraded. And there has been some discussion that if these talks, you know, don't materialize in sort of reaching some sort of a conclusion, there's that potential again. So I was curious the extent to which the administration is, you know, obviously working behind the scenes to prevent that from happening, but also sort of what measures would you potentially take if it happened, you know, potentially now twice in one year?

TETT: So are you living in fear of Moody's? (Laughter.)

LEW: You know, I think that we actually have a commonality of interests in the sense that if you look at what we've stated to be the economic imperatives, they are the same as the economic imperatives that outside financial observers have seen: identifying the size of the problem, being on a path towards dealing with it. We're going to do the same thing. If it doesn't work in November, we'll still be at it. I mean, it's not as if the issue goes away if the deadline is missed.

I don't -- I -- it's hard to speculate on what happens -- if you look at the downgrade over the summer -- and it was certainly not something that we thought was a good turn of events. You know, you don't want to see a downgrade of the United States either for political or economic risk. But as I was saying earlier, it is very significant that the language in those reports was almost entirely focused on political risk in terms of the rationale for the downgrade.

So in a world where we know there are economic solutions -- and I'm rather confident that in a meaningful time frame we will make decisions in Washington in a timely way to avoid the kinds of adverse consequences -- I think that my political judgment is that whether it happens in November of 2011 or December of 2012, we will avoid the economic conditions that would give real reason for that downgrade.

I said earlier -- and I really believe it -- I think action now is, you know, worth a lot more than action later. And it's not because of the rating agencies. You know, when I -- when I hear people who are not in government -- you know, you go into a store in your neighborhood, and the shopkeeper is worried that things are out of control and they don't think that their government can get over this kind of political dysfunction -- that's a bad thing. It's a bad thing, and it's not -- it's not something that has to show up in a rating agency report for us to see that we need to do something about it.

Right now, you know, we talk a lot about confidence. And it's important that we in government do what we can do to show that there should be more confidence. The president's trying, in a world where Congress is gridlocked, to do as much as he can with executive actions to demonstrate that we're using the levers at our disposal in an effective way. I think it'll be quite confirming if Congress acts.

I think that there will be action taken in a meaningful time frame, and I hope it's this year and that it's soon and that it's substantial.

TETT: Well, I think we can all echo that. We are out of time now, so I just want to thank you for your comments.

My own personal takeaway -- perhaps three very brief one-sentence takeaways: One is that, having heard the challenges of creating a sensible fiscal policy, it's very clear to me that if the eurozone does go into significant crisis your challenges are going to be that much worse, and that's scary -- very pertinent for the next session.

Secondly, the sheer difficulty that the U.S. government faces and that the Congress faces in coming up with a sensible policy -- even though the U.S. economy is probably slightly recovering, and even though you haven't got the markets punishing you yet, and even though you've only got one government, not 17 -- is again extremely sobering when you look at the eurozone and think: How on earth is the eurozone going to put its house in order?

And just thirdly, the thing I always am very forcefully struck by every time I hear somebody like you speak is that, these days, it's not really just about the economy, stupid; it's about the politics, stupid, and above all else, about the sociology today which, as someone who trained in the social sciences for many years, I find fascinating. I think today really is the revenge of the political scientists and anthropologists over the number crunchers. (Laughter.)

So I just wish you the very best luck in finding a way through this sociology and these fiscal challenges. Thank you very much, indeed.

LEW: Thank you. (Applause.)






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