There's no point denying it, says Alan Greenspan: the tax increases that will come with any solution to the fiscal cliff will hurt economic growth. And that's fine with him, if it means finally dealing with the U.S. budget deficit.
"If the cost of getting out of this is a modest recession, I think that is a cheap price," Mr. Greenspan, the former Federal Reserve chairman, said at a conference in Washington on Friday.
The United States has run a budget shortfall in excess of $1-trillion for four consecutive years, and the country's debt is on the fast track to unsustainability.
Mr. Greenspan, taking questions at a Peter G. Peterson conference on the fiscal cliff, expressed deep concern about the U.S.'s deficit and debt. He said financial markets could turn on the U.S. at any moment. He said it's "nonsense" to think that investors will continue to favour Treasuries just because America remains the world's biggest economy and the dollar the reserve currency. So the time to act is now.
Now, to be clear, Mr. Greenspan is no fan of raising taxes. He said the U.S.'s budget issue is fundamentally about spending. Even raising the rates of the wealthiest is problematic. The rich save the most, and savings are the basis of economic growth and productivity gains because they support business investment. Mr. Greenspan says that as government spending increases, saving decreases. For the former Fed chief, that explains why U.S. growth and productivity are starting to lag.
But his reluctant embrace of tax increases is a recognition of the politics of government fiscal planning. Voters view Medicare, Social Security and other entitlement programs as just that – entitlements, akin to a contract. Tax policy is less rigid. The public is used to watching their taxes rise and fall.
That makes altering the tax code an easier path in the short term. Spending must be brought under control, but that will be harder. So, says Mr. Greenspan, raise taxes now and lower them again when the budget deficit is brought under control.