Bernanke frowns on tax cuts

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Federal Reserve Chairman Ben S. Bernanke urged action yesterday to balance the budget and curb income inequality through better education, saying such goals should take priority over tax cuts.

"I can't speak to the overall combination of taxes and spending, other than to say that they should be in balance. But I will go so far as to say that I think that there's a significant return to investing in young kids," the Fed chairman told Sen. Bob Casey, Pennsylvania Democrat, in response to a question about whether Congress should vote to extend tax cuts or increase funding for the Head Start program for poor children.

Mr. Bernanke said taxes have an "important" role to play in narrowing the widening income gap between rich and poor through income-transfer programs, and Congress needs to balance that goal against the desirability of tax incentives that spur innovation.

"The tax code has an important role to play in generating more equality," he said, although "entrepreneurs and the people who take risks -- we have to give them incentives to take risks" as well.

He said the benefits from raising revenues by letting President Bush's tax cuts expire in 2010 must be weighed against the growth impact from higher taxes. He strongly urged Congress to strive to improve the government's balance sheet and said his biggest worry is the government is not prepared to finance baby boomers' retirement starting in 2011.

Mr. Bernanke's remarks before the Senate banking committee were received warmly by Democrats and were his most forceful testimony on political matters since he took office a year ago.

He was praised by committee members for adroitly steering the economy to a "soft landing" that has maintained robust growth with lower inflation. His willingness to go further in recommending action against income inequality and other economic problems appeared to reflect increased confidence after a successful year in office.

At the urging of nearly every Democrat on the committee, Mr. Bernanke elaborated on a speech he gave last week outlining the reasons for the increasing income gap between wealthy Americans and most wage earners.

Like his predecessor, Alan Greenspan, Mr. Bernanke blamed the gap primarily on differences in education and skill, with the most-successful workers those who can employ advanced technology and education to compete in the global marketplace.

"The very important drivers of economic growth and prosperity in this country include free and open trade and technological progress. It's very important to allow those forces to continue to operate in our economy," he said. "However, we do have to recognize ... they may create greater income possibilities for some than others.

"To retain support for policies of free trade, open borders, technological change, flexible labor markets, we need to make sure that the gains and benefits from these powerful growth-producing forces are broadly shared and that people understand that these things are good for the American economy and good for people generally in the economy."

Mr. Bernanke endorsed setting minimum international labor standards in trade agreements, such as banning child or slave labor. But he questioned whether increased unionization would reduce the income gap and said Congress should focus most of its efforts on ensuring equal access to good quality education and job skills.

"My wife is a teacher. I've been in education for a long time. I was on the school board for many years," he said. "We've been worrying about educational quality for a long time, and it's a difficult thing to achieve."

While the U.S. maintains a "substantial leadership" position in college-level education and research and development, he said, it is falling short at providing adequate education at lower levels, especially in math and science.

In discussing risks to the economy, Mr. Bernanke said the substantial drop in housing last year had less of an impact than expected. "We've not seen substantial spillovers from the housing slowdown to consumer spending or to other parts of the economy," but "it's early to say that this problem is over."

A "significant concern" is recent "distress in the subprime area" of the mortgage market, where default levels have surged to recession levels, he said.

"I'm obviously following it very carefully, both in terms of the impact it has on the borrowers and also, you know, see what effects it has on lenders as well. I don't think that it has at this point implications for the aggregate economy in terms of the ongoing expansion, but as I said, it is an important issue for those sectors."

Referring to recent announcements of losses in mortgage trading and lending at HSBC Bank and the New Century Corp., a major subprime lender, Mr. Bernanke said: "Evidently, there are some loans that have been made that are not turning out well and to the detriment of both the lenders and the borrowers. We will certainly be watching that carefully and trying to provide guidance and oversight to minimize that risk going forward."