Global Policy Forum

By Nell Henderson

Federal Reserve Chairman Alan Greenspan said yesterday, for the first time explicitly, that he expects tax increases to be part of any eventual agreement to reduce the federal budget deficit. Greenspan, appearing before the Senate Budget Committee, also acknowledged that his support for tax cuts in early 2001 unintentionally led to policies that helped swing the federal budget from surplus to deficits. In pointed comments, Greenspan addressed recent Democratic critics who have sought to blame him for the return to deficits.

Greenspan reminded lawmakers that government economists at the time predicted budget surpluses "as far as the eye can see." Yet Greenspan had warned then in congressional testimony that the forecasts might be wrong, and he recommended some "trigger" mechanism that would limit the tax cuts if certain budget targets were not met. Greenspan said he thinks "it's frankly unfair" for critics to blame him now for the fact that Congress chose to "read half [his] testimony and discard the rest."

Sen. Paul S. Sarbanes (D-Md.) said he believed it was "fair to consider how your message would be taken" and that lawmakers saw Greenspan's 2001 remarks as "providing a green light" for tax cuts, which were enacted without triggers. "I plead guilty to that," Greenspan said. "If indeed that is the way it was interpreted, I missed it. In other words, I did not intend it that way."

The deficit hit a record $412 billion last year and is projected to expand dramatically as the huge baby boom generation starts retiring and collecting Social Security and Medicare benefits. "The federal budget deficit is on an unsustainable path, in which large deficits result in rising interest rates and ever-growing interest payments that augment deficits in future years," Greenspan said in his prepared testimony yesterday. The economy is "expanding at a reasonably good pace," Greenspan said, without commenting on the recent slowdown in spending and hiring or the outlook for inflation and interest rates. But, he said, the economy's "positive" short-term prospects contrast with longer-run concerns that unrestrained growth in the budget deficit will eventually "cause the economy to stagnate or worse."

The Fed chief called for "major deficit-reducing actions" and proposed several procedural steps Congress could implement to restrain the deficit's growth. Greenspan has frequently said he would prefer the deficit be shrunk as much as possible through spending cuts -- including reductions in Social Security and Medicare benefits -- before taxes are increased. He said yesterday that he believes raising taxes restrains economic growth and that there is "no way you can raise tax rates enough" to cover future spending commitments.

But he also implied that reaching a bipartisan agreement to reduce the deficit will require some compromises, saying, "We can raise taxes, and I don't deny we probably at the end of the day will do them [tax increases] in order to get an ultimate resolution of this." Republican congressional leaders have ruled out tax increases to shrink the deficit anytime soon. On the contrary, they are pushing to extend President Bush's expiring tax cut provisions and to pass new tax breaks for energy companies.

But Senate Budget Committee Chairman Judd Gregg (R-N.H.) said after the hearing that he agreed with Greenspan that "both sides of the ledger will have to be looked at" to address the long-term budget challenges. "We're going to have to reduce the benefits, and we're going to have to look at revenues." Gregg added, "I'm not sure there will be an ultimate agreement." Greenspan has endorsed extending the recent tax cuts. But he has always done so while urging Congress to restore budget controls requiring lost tax revenue to be offset by similarly sized spending reductions, so there is no net growth in the deficit. The White House and congressional Republicans support applying the rules to spending increases and not tax cuts, because they would make it nearly impossible politically to extend the tax cuts.

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