- The Washington Times - Thursday, March 3, 2005

The nation faces a future of economic stagnation, rising interest rates and budgetary crisis unless Congress takes major steps to cut deficit spending, Federal Reserve Chairman Alan Greenspan warned yesterday.

In his most stark assessment of the consequences of “unsustainable” budget deficits that hit $412 billion last year, the Fed chairman told the House Budget Committee that Congress will not be able to “grow out of the deficit” and that the only solution is to cut spending, curb Social Security and Medicare benefits and possibly even raise taxes a little or allow some tax cuts to expire.

“Our budget position is unlikely to improve substantially in the coming years unless major deficit-reducing actions are taken,” he said. “The fundamental fiscal issue is the need to make difficult choices among budget priorities, and this need is becoming ever more pressing in light of the unprecedented number of individuals approaching retirement age.

“Very grave damage to the economy” could result in particular if Congress does not get a handle on the runaway growth in Medicare spending in the next decade that will result from increased use of health care by an aging population and more expensive medical technologies, procedures and drugs, he said.

“If we effectively create very large deficits and we are unable to bring them [down] in a reasonable period of time, we will find that we will very significantly destabilize the system,” he said.

“Interest rates would rise as a consequence, and we would have very grave difficulties in restoring balance to the American economy.”

The inevitable rise in interest rates, he added, at some point might make it difficult to keep servicing the government’s debt, which totals $4 trillion, raising the possibility of a budgetary crisis or paralysis.

“The system becomes fiscally destabilizing, and what you end up with is probably a stagnant economic system.”

Although the Fed chairman did not see any immediate problems in financing the nation’s large and quickly growing debts to the rest of the world, he warned that “down the line,” foreign central banks and other creditors might balk at providing more loans.

The strains facing the Social Security and Medicare retirement programs, he stressed, will begin when the baby boom generation starts retiring in three years, and curbs in benefits will have to be made to prevent funding shortfalls even if Congress approves a system of private accounts for younger workers.

“I fear that we may have already committed more … resources to the baby-boom generation in its retirement years than our economy has the capacity to deliver,” he said.

Fiscal 2004 spending for Social Security, Medicare and Medicaid totaled about 8 percent of gross domestic product, he said. Government projections show that will rise to 9.5 percent by 2015 and will reach about 13 percent by 2030.

Congress should consider raising the retirement age among other possibilities, he said, to ease the funding crunch, because advances in medicine have enabled people to live for decades in good health beyond the retirement age of 65.

“If existing promises need to be changed, those changes should be made sooner rather than later. We owe future retirees as much time as possible to adjust their plans for work, saving and retirement.”

With deficits equal to 3.5 percent of the economy’s yearly output, Mr. Greenspan stressed that both spending and taxes must be scrutinized to regain control over the budget, although he prefers spending cuts.

Although he argued against large tax increases that could hurt economic growth, he said small ones would do little harm.

He added that although President Bush’s $2.3 trillion tax cuts helped the economy when it was emerging from the 2001 recession, some of them might have outlived their usefulness and should be reviewed and subject to offsetting spending cuts or tax increases.

“The economy is now developing its own momentum” without the need for tax cuts, although they did provide “a goodly part of the support” during the recession, he said.

A first order of business for Congress should be to reinstate the pay-as-you-go rules and discretionary spending caps that prevented Congress during the 1990s from approving large new spending increases or tax cuts without offsets elsewhere in the budget, he said.

Those rules are widely credited with helping to produce a balanced budget and surpluses during that era.

Congress also should consider adopting rules for reviewing and terminating programs that do not achieve their stated goals, because political dynamics make it extremely difficult to cut or eliminate spending programs once they are enacted and attract a constituency, he said.

“The consequences for the U.S. economy of doing nothing could be severe. But the benefits of taking sound, timely action could extend many decades into the future.”

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