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The 'kiss of death'
Warning of growing budget deficits, Greenspan again undercuts Bush, GOP arguments for tax cuts.
February 12, 2003: 2:18 PM EST

NEW YORK (CNN/Money) - Alan Greenspan stepped up his warnings about budget deficits Wednesday, forcing the White House to admit the Federal Reserve chief was at odds with President Bush's push for quick moves to stimulate the economy.

In his second day on Capitol Hill, Greenspan told the House Financial Services Committee it was crucial that policy-makers ensure that "growing budget deficits [do not] again become entrenched.''

Bush's $695 billion stimulus plans forecasts record budget deficits this year and next -- drawing criticism from opposition Democrats. Administration officials contend the deficits are modest given the size of the $10 trillion U.S. economy and are needed to spur job creation and ultimately, more tax revenues.

But Greenspan warned that a "state of relative budget tranquility'' will end abruptly as Baby Boomers start retiring in a decade. He said now was the time to prepare so that Social Security and other government programs can bear the strain.

The central bank chairman made similar points in his testimony to a Senate panel Tuesday in what was widely seen as a blow to the Bush plan. Under questioning, he amplified that concern by saying he considered stimulus "premature'' because it was hard to gauge the economy's underlying health amid Iraqi war fears.

Though Greenspan 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.

"There should be little disagreement about the need to re-establish budget discipline," Greenspan said in his prepared remarks, especially considering the Baby Boomers' retirement, which will put a strain on Social Security and Medicare programs.

In response to legislators' questions on both days, he also warned against Congress making spending and tax plans -- including Bush's plan to make 2001's $1.35 trillion tax cut permanent and immediately effective -- without safeguards to keep them from wrecking the budget. The 2001 tax cut was originally intended to be phased in over a period of years -- a plan Greenspan supported.

Bush has said that ending the dividend tax and accelerating the 2001 tax cut would help stimulate the U.S. economy, which has been struggling for months 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.

"[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 did not return repeated calls seeking comment, but officials tried to put the best face on Greenspan's remarks.

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CNNfn's economic correspondent Kathleen Hays takes a closer look at Federal Reserve Chairman Alan Greenspan's testimony on the economy and uncertainty.

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"There is somewhat of a difference about the stimulus, the need for stimulus, and in that there is reasonable disagreement," White House spokesman Ari Fleischer said, Reuters reported Wednesday. "The president will err on the side of helping those who look for work."

Democrats expressed glee about Greenspan's remarks, while Republicans circled the wagons in defense of the tax plan. Sen. Tom Daschle, D-S.D., called Greenspan's criticisms "the kiss of death" for the Bush plan, while Senate Finance Committee Chairman Charles Grassley, R-Iowa, called the plan "very good policy," according to Reuters.

But Greenspan also undercut the Democrats' plans by rejecting their call for giving federal money to cash-strapped states and by questioning whether any stimulus package was necessary at all.

Greenspan said 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. Once the risk of war with Iraq is lifted, the Fed believes, businesses will be 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 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.

Undercutting GOP arguments

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 deficit spending is desirable when the economy is slow, a theory with which Greenspan did agree, but about which he was not very enthusiastic.

"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."

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Bush and supporters of his plan have suggested 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 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 Congress and the administration will take the necessary steps to restrain growing deficits.  Top of page

-- Reuters contributed to this report

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