Greenspan Should Have Thought Twice

Federal Reserve Chairman Alan Greenspan’s recent testimony before Congress is being aggressively interpreted as putting his foot on the political accelerator toward a large cut in the income tax rates.

Greenspan used cautious language, including that “today’s euphoria” over the economy must not lead to policies that “could readily resurrect the deficits of the past and the fiscal imbalances that followed in their wake.” But despite these flashing yellow lights, it was predictable that the tax-cut crusaders would see his overall statements as a blessing for their views. For that reason, the comments reflected a rare moment of bad judgment by Greenspan. Here’s why:

Greenspan said tax cuts are OK if they don’t create a deficit, but the Bush tax package now on the table, together with other Bush proposals, certainly could. Once Social Security and Medicare surpluses are properly set aside, the surplus is projected to be $2.5 trillion to $2.7 trillion over the course of a decade, depending on whether you use Office of Management and Budget figures or just-released Congressional Budget Office figures. If you add up the cost of giving the Bush tax cut to all taxpayers, plus the Republican Party’s proposed reduction of the marriage penalty tax and Bush’s promises on education, prescription drugs and the nation’s defense budget—plus lost interest once the surplus is reduced—the U.S. could easily be back in deficit in a few years. How could Greenspan brush aside these risks?

Greenspan’s main argument was painfully strained. He argued that the U.S. is now likely to pay off the debt so quickly that we could find ourselves with hundreds of billions of dollars of surplus and only two choices, both bad. One would be the federal government unwisely investing the excess surplus in the financial markets; the other would be that, having fully paid off the debt, the government at some point later would be forced to return such a vast sum of money to the people in the form of tax cut that it would over-stimulate the economy, causing high inflation.

It was on that shaky basis that Greenspan seemed to endorse passing a tax cut this year that would cost as much as $300 billion a year by the end of the decade. Wouldn’t the far more prudent course be to wait a few years longer before committing to such a large, surplus draining tax cut? Our recent fiscal history has taught one simple lesson: It is far easier to give more tax cuts if things turn out better than expected than it is to cut spending or raise taxes if they turn out worse. Why not play it safer now, and come back later for more politically easy tax cuts if the surplus continues to build?

Greenspan based his new warmth toward a tax cut on the view that under the Bush administration, the debt would be retired by the end of the decade. But this is not a sure thing. For example, President Bush supports a plan to divert hundreds of billions of the Social Security surplus away from debt reduction to partially privatized Social Security accounts. If he is successful in getting Congress to go along, there is no chance of a debt-free America by 2010.

Greenspan mentioned but did not seriously consider using the surplus to enhance individual savings accounts to be used for retirement. This is a missed opportunity. Many Democrats like myself would like to see such accounts done outside of Social Security; both President Clinton and Vice President Gore had plans that would have accomplished that. Republicans, too, have their ideas on this, including making private
individual accounts part of Social Security itself. Whichever way we go, the surpluses will be needed. In addition, all of these proposals have the added advantage of not threatening to overstimulate the economy.

We need to help prepare the United States for the baby-boom challenge. Expensive, surplus-draining tax cuts will seriously hurt this effort. As Greenspan stated in his Senate testimony: “It is not difficult to imagine the hard-earned fiscal restraint developed in recent years rapidly dissipating.” Let’s hope his testimony doesn’t make that unfortunate scenario more likely.