Greenspan Sees Room for Tax Cut

Jan. 25, 2001 -- Federal Reserve Chairman Alan Greenspan today gave considerable support to President Bush's push for a tax cut, saying such a measure could do "noticeable good" if the U.S. economy continued to struggle.

In his eagerly anticipated comments, Greenspan also emphasized the slowdown in the economy, giving a broad indication that a further Federal Reserve interest rate cut is on the way.

In a prepared statement he read this morning to the Senate Budget Committee, Greenspan suggested that because of the current budget surplus, a tax reduction would help buttress the nation's long-term economic health.

"The sequence of upward revisions to the budget surplus projections for several years now has reshaped the choices and opportunities before us," said Greenspan. Given such a surplus, he added, "it is far better, in my judgment, that the surpluses be lowered by tax reductions than by spending increases."

The president and other Republicans were quick to praise Greenspan's comments. Bush told reporters at the White House that he believed Greenspan had gotten it "just right. He recognizes that we need good monetary policy and sound fiscal policy to make sure that the economy grows."

But in his initial testimony and under questioning from senators, the Fed chairman was also careful to note that any future tax reduction would have to be enacted with caution, so as not to undermine the projected surplus.

"It is important that any long-term tax plan, or spending initiative for that matter, be phased in," Greenspan said.

In response to questions, Greenspan declined to address directly the interest rate outlook, which is to be the subject of a Federal Reserve board meeting next week. But he pointedly noted "increased slack" in the economy.

"I am looking forward to seeing what my colleagues are thinking about," Greenspan said.

On Jan. 3, the Fed unexpectedly cut rates by half a point.

Change in Focus

The Fed chairman's comments represent a slight shift in his previously stated position on tax policy. Greenspan has long advocated tax cuts, but has indicated a preference for using budget surpluses to pay down debt, rather than using them to reduce taxes.

But in his testimony today, he said the "extraordinary pickup in the growth of labor productivity experienced in this country since the mid-1990s," which has helped fuel growing surplus projections, meant the traditional choice between debt and tax reduction was not an insurmountable problem.

"The most recent data significantly raise the probability that sufficient resources will be available to undertake both debt reduction and surplus-lowering policy initiatives," Greenspan added. "Accordingly, the tradeoff faced earlier appears no longer an issue."

Greenspan also acknowledged that a potential tax cut would be unlikely to have a short-term impact on the economy, saying, "fiscal policy is too blunt a tool" to prevent a recession from occurring. But he emphasized it could be beneficial in case of a longer economic downtown.

"I would not perceive of employing tax cuts to, in a sense, get in front of weakening forces, which could eventually lead to a recession, because history tells us it doesn't work," Greenspan said in response to one question.

But in his prepared testimony, Greenspan also noted, "In today's context … starting that process sooner rather than later likely would help smooth the transition to longer-term fiscal balance. And should current economic weakness spread beyond what now appears likely, having a tax cut in place may, in fact, do noticeable good."

Under questioning from Sen. Paul Sarbanes, D-Md., Greenspan acknowledged the technical definition of a recession did not apply to the current economic situation, although he said growth was "probably very close to zero," and had "slipped very dramatically."

Greenspan also said consumer confidence would be a key in determining whether the economy dropped into a recession. Currently, he said, he does not believe "the fabric of consumer confidence" has been shaken enough to induce a recession. Greenspan also noted that "inflation pressures are well contained."

Bush, Democrats Disagree

Greenspan's comments were welcomed by the White House. Bush has repeatedly said he wants Congress to take up his $1.6 trillion tax cut, a centerpiece of his presidential campaign.

"We're very heartened to see that Chairman Greenspan has weighed in on the importance of cutting taxes to protect the economy," presidential spokesman Ari Fleischer said at a White House briefing today.

Democrats on the Budget Committee were less receptive to Greenspan's testimony, with Sen. Robert Byrd of West Virginia saying he was "somewhat stunned" by the Fed chairman's pronouncement.

Opponents of the Bush plan have argued that monetary policy set by the Fed, not fiscal policy set by Congress, is the proper way to deal with the economy.

Numerous Democrats have also said the size of Bush's tax cut is too great and would be a drain on the budget surplus. They would prefer smaller, targeted tax cuts.

At a Capitol Hill news conference called as Greenspan was still testifying, Senate Minority Leader Tom Daschle of South Dakota said Bush's plan would be "an absolute disaster in the commitment we made to seniors, in thecommitment we must make to baby boomers, in the commitment that we really ought to make to fiscal responsibility."

And Daschle disputed the $1.6 trillion figure, saying increased interest payments and further tax obligations would place the total cost of Bush's plan at $2.2 trillion.

Greenspan did not directly address exactly what size a potential tax cut should be, and declined to comment on it under questioning from senators.

"These are fundamentally political decisions," he said.

But during questioning from Republican Sen. Phil Gramm of Texas, Greenspan said the tax cuts "that are being discussed today, on both sides of the aisle," were "average."

And the Fed chairman indicated he considered elements of Bush's plan to be appropriate, noting, "I have always been in favor of reducing marginal rates."

But he ended his testimony on a note of caution, suggesting that a large tax cut could end up adversely affecting growth.

"We need to resist those policies that could readily resurrect the deficits of the past and the fiscal imbalances that followed in their wake," Greenspan concluded.

The Clinton administration's final budget outlook, released last week, estimated a surplus over the next 10 years of $5 trillion. However, that total includes more than $2 trillion in surpluses in the Social Security program, which members of both parties have promised not to touch.

Finding the Right 'Glide Path'

Much of Greenspan's testimony and the questions that followed from several senators dealt with what he called the "glide path" toward erasing the federal budget deficit: rather than concentrating all efforts on eliminating the deficit, lowering it while still allowing room for a tax cut.

Greenspan warned that abruptly eliminating the deficit could lead to a situation in which "the only alternative to the accumulation of private assets would be a sharp reduction in taxes and/or an increase in expenditures … at a time when sizable economic stimulus would be inappropriate."

Instead, he said, a gradual move toward deficit reduction, along with carefully calibrated tax measures, could help maintain growth.

Sarbanes, however, told Greenspan that his willingness to entertain a tax cut would endanger the deficit-reduction efforts the Fed chairman has promoted.

"I think it's clear that what has happened here today is that you've put us on the glide path to dissipate this hard-earned fiscal restraint," Sarbanes said.