NEW YORK (CNN/Money) - Federal Reserve Chairman Alan Greenspan dealt a blow Tuesday to President Bush's hopes for massive tax cuts by stressing the need for budget discipline and saying economic stimulus efforts should be put on hold until uncertainties about Iraq dissipate.

Though the central bank chairman, in his semi-annual Congressional testimony about the state of the economy, supported Bush's plan to eliminate the taxation of some dividends, he said such a measure should only be passed if other revenue could be found to replace the lost tax revenue, so as to keep swelling federal budget deficits under control.

"There should be little disagreement about the need to re-establish budget discipline," Greenspan said.

He also warned against Bush's plan to make 2001's $1.35 trillion tax cut permanent and immediately effective without safeguards to keep it from wrecking the budget. The tax cut was originally intended to be phased in over a period of years -- a plan Greenspan supported.

Bush has presented the dividend tax cut and the acceleration of the 2001 tax cut as a way to help stimulate the U.S. economy, which has been in the doldrums for months, struggling to recover fully from a recession that began in March 2001.

Democrats say Bush's tax cuts, which would mostly benefit higher-income families, are not stimulative enough and are so large they'd create massive deficits. They've offered a plan of smaller tax cuts and spending programs that would come with a smaller price tag.

CNNfn's economic correspondent Kathleen Hays takes a closer look at Federal Reserve Chairman Alan Greenspan's testimony on the economy and uncertainty. Play video (QuickTime, Real or Windows Media)

"[Greenspan's testimony] certainly raises the probability that the structure of any eventual stimulus plan passed by Congress will move closer to that favored by Democrats, a plan that has clearly been associated with lower revenue losses," said Anthony Chan, chief economist at Banc One Investment Advisors.

The White House could not be reached for comment.

But Greenspan also questioned whether any stimulus package was necessary at all, saying he suspected the economy's biggest problem was lingering uncertainty about the prospect of a U.S.-led war in Iraq and the kind of effect such a war might have on the economy.

Greenspan said the Fed believes that, when the risk of war with Iraq is lifted, businesses will feel more confident about making spending plans, and the economy will rebound.

"Unless and until we can make a judgment as to whether there is underlying deterioration going on -- and my own judgment is I suspect not -- then stimulus is actually premature,'' Greenspan said in response to a senator's question.

On the other hand, he also warned that fixing Iraq might not be a cure-all for the economy, and that the Fed might need to again cut short-term interest rates -- already at 40-year lows -- if weakness continued beyond the resolution of the situation in Iraq.

"If these uncertainties diminish considerably in the near term, we should be able to tell far better whether we are dealing with a business sector and an economy poised to grow more rapidly ... or one that is still laboring under persisting strains and imbalances that have been misidentified as transitory," he said in his prepared remarks.

Last week, President Bush presented a budget to Congress that projected a record $304 billion deficit for the current fiscal year and deficits until at least 2008. These projections, which Greenspan called "sobering," do not include the possible cost of a war or post-war rebuilding in Iraq and are based on assumptions about economic growth that some economists think are overly optimistic.

The Bush administration and some economists have argued that deficit spending is desirable when the economy is slow, a theory with which Greenspan didn't disagree, but about which he was not very enthusiastic.

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"You can have, in today's environment ... modest, small deficits. That's not inconsistent with stability," he said in response to a senator's question. "But if we get into a position ... where we are finding that the debt-to-GDP (gross domestic product) ratio begins to accelerate, we have to be very careful."

Bush and supporters of his plan have suggested that tax cuts would spur economic growth, which would in turn lift the government's tax revenues and control future deficits.

Greenspan also undercut this argument, saying, "Faster economic growth, doubtless, would make deficits far easier to contain. But faster economic growth alone is not likely to be the full solution to currently projected long-term deficits."

Greenspan also disagreed with the notion, offered lately by some Republicans and economists in support of the President's tax plan, that deficits can rise without having an impact on long-term interest rates.

"There's no question that when deficits go up, contrary to what some have said, it does affect long-term interest rates, it does affect the economy," he said.

Greenspan did agree with Republican arguments that a permanent tax cut would be more readily accepted by businesses and individuals and could lead to greater spending than would a tax cut that would eventually be phased out.

But he also warned such tax cuts should be flexible, subject to checks and balances that would keep them under control if they threatened to create big deficits.

"It would be desirable to have permanent, irrevocable fiscal policy. But if it adds up to a claim on resources which exceeds what is available ... something has to give," he said in response to a question.

Greenspan was unequivocal in his support of Bush's plan to eliminate dividend taxes, saying it was "a sensible long-term program." However, he also said such a plan should be "revenue neutral," meaning Congress should find a way to make up the revenue lost by eliminating the tax.

Greenspan called for changes to the formula used to calculate cost-of-living increases in federal benefits and changes in federal income tax brackets that he said would have reduced the federal budget deficit by $40 billion through reduced outlays and increased tax collections. He seemed pessimistic that Congress and the administration will take the necessary steps to restrain growing deficits.

"At the present time, there seems to be a large and growing constituency for holding down the deficit, but I sense less appetite to do what is required to achieve that outcome," he said. "Re-establishing budget balance will require discipline on both revenue and spending actions, but restraint on spending may prove the more difficult."

In more positive outlook, he said in response to questions that he believes that the Sarbanes-Oxley Act, passed last year to address accounting scandals, had gone a long way toward stemming misbehavior by corporate executives.

"I'm not going to deny we'll find additional examples of atrocious accounting, atrocious behavior," he said. "But I'd be very surprised if [any problem uncovered] was initiated beyond mid-2002." He said that the greater federal attention to corporate oversight had, "chastised the business community in a way to eliminate almost a high fever that had gripped people who were otherwise very ethical."

He also said he was not overly concerned with the risk of a decline in the price of housing, saying that even with a rise in mortgage debt levels, lower interest rates had kept the housing-related debt in line with consumers' incomes.

Greenspan said Fed economists expected gross domestic product (GDP) growth in 2003 of between 3.25 and 3.5 percent, with unemployment of between 5.75 and 6 percent. The forecasts were slightly more pessimistic than the outlook he offered in July, when the Fed expected GDP growth of between 3.5 and 4 percent and unemployment of 5.25 to 5.5 percent.