Greenspan's Brave New World Has Room for Bush's Tax Cut

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Fed chairman Alan Greenspan testifies before the Senate Budget Committee

Alan Greenspan has embraced the future again, and the good news for George W. Bush is that there's plenty of room in it for a tax cut.

Greenspan went to the Hill on Thursday to testify before the Senate Budget Committee with Washington and Wall Street listening not for clues about next Tuesday's FOMC meeting — "I want to emphasize that I speak for myself and not necessarily for the Federal Reserve," Greenspan reminded the senators at the start — but for Father Greenback's word on whether or not Bush's $1.3 trillion tax cut is a good idea.

What Bush got was a relatively hearty endorsement along with Greenspan's terms. Because the Fed chairman, it seems, has not only accepted the existence of the ballooning budget surpluses — fueled, he said, by the increases in productivity growth and taxable incomes that have changed the fiscal landscape — but has begun to wonder if debt reduction is actually happening too fast.

The high cost of not being in debt

Not that a shrinking federal debt doesn't remain a good thing. "The rapid capital deepening that has occurred in the U.S. economy in recent years is a testament to those benefits." (That's Greenspan for "I told you so" after corralling Clinton into that 1993 deficit reduction plan.) But, the Fed head said, "the most recent projections, granted their tentativeness, nonetheless make clear that the highly desirable goal of paying off the federal debt is in reach before the end of the decade."

And that could be a bad thing.

Running surpluses without a debt, Greenspan warned, would result in the "longer-term fiscal policy issue" of a government paying off its debt, particularly long-term Treasury bonds, before the bonds mature — costing it extra money by buying back those securities from private investors before they mature. Which is very expensive — better to buy back only matured bonds, which won't be possible until at least 2011.

Now, we know how Greenspan feels about reducing surpluses via additional spending — he doesn't like it. And that leaves tax cuts, which by halfway through the speech were an integral part of a budget strategy "that is consistent with a preemptive smoothing of the glide path to zero federal debt" and aimed at "making the on-budget surplus economically inconsequential when the debt is effectively paid off."

Puts the ball in the politicians' court

REALITY CHECK: Greenspan, of course, has the luxury of living in the economists' world provided by the budget projections of Clinton's Office of Management and Budget, a world of consistent spending and political discipline. A world that does not exist in Washington. And lest the assembled senators start scouring Greenspan's bank statements for big checks marked "GWB," the Fed chairman closed his prepared remarks with a big fat disclaimer and smacked the ball back into the politicians' court.

"But let me end on a cautionary note. With today's euphoria surrounding the surpluses, it is not difficult to imagine the hard-earned fiscal restraint developed in recent years rapidly dissipating. We need to resist those policies that could readily resurrect the deficits of the past and the fiscal imbalances that followed in their wake."

During the Q&A that followed, Maryland Democrat Paul Sarbanes accused Greenspan of "making a considerable contribution to that dissipation" with all this surplus talk, but then followed that with a major faux pas: "I take it interest rates will be reduced further next week?" (Greenspan only smiled behind his hand, and the betting remains that Sarbanes is right.) The dissipation — Greenspan bemoaned in particular the pork-barrel parade at the end of October's budget negotiations — is a Hill thing, and there the responsibility stays. The message: If Bush's tax cut busts the budget, it'll be your fault, not mine.

Markets get only a mild boost

Just as incoming treasury secretary Paul O'Neill had in his confirmation hearings before the same body last week, Greenspan doubted that a tax cut could come fast enough to salve the current economic malaise (Greenspan pegged growth as currently "close to zero"), but allowed that if things got worse, the tax cut might well do "noticeable good," and it might as well be "sooner rather than later"(a bone for his new president). And like his friend O'Neill, Greenspan put fiscal discipline above all else, suggesting that the tax cut be "phased in," along with provisions for reducing it in the face of "any disappointments that may occur."

The markets didn't get much out of the testimony, just a mild rally. But George W. Bush got more than enough sound bites out of the day's hearings to get his go-ahead — maybe more than he was expecting. But he also got some clear parameters as to how the tax cut ought to be done — and what sort of rhetoric should properly accompany it. The Democrats are still looking for ways to kill the cut's momentum, and Sen. Hillary Clinton, in full-on, uncoiffed, out-of-the-spotlight mode, talked about a "balanced approach" and "necessary spending" just long enough to make herself sound smart and score a few Democrat points along the way.

But Greenspan still gave the tax cut as good a sell as Bush ever could, though his newfound sense of urgency about "reducing the surplus" isn't likely to start any rallies in the streets — or across the aisle. Greenspan is still the pinnacle of credibility when it comes to economic matters, and the fact that he's not worried one whit about this tax cut's potential for disaster will make it hard to resist.

The tax cut battle will sound a lot like the campaign — Republicans will call smaller, targeted tax cuts un-American, and Democrats will call big, across-the-board ones unfairly skewed to the rich. And with the Senate split down the middle and the House close to it, Bush will need all the help he can get.

But at least Alan Greenspan says size doesn't matter.