Tax Cuts May Lead To Higher Interest Rates Warns Greenspan

by Leroy Baker, Tax-News.com, New York

02 May 2003

Speaking to a Congressional committee this week, Federal Reserve Chairman Alan Greenspan reiterated his cautious approach to President Bush's proposed package of tax cuts saying such deep reductions in tax should be matched by equivalent decreases in public spending.

The Federal Reserve chairman cited a recent federal economist's study that linked high levels of fiscal deficit with increasing rates of interest. He warned that the US may well travel down this route if fiscal responsibility is not fully observed, and ultimately, the benefits of the tax cuts could well be cancelled out by monetary tightening.

"There are powerful reasons to suspect that the elimination of the double taxation of dividends and cuts in marginal rates will elevate long-term productivity," he said. "If, however, in the process we get a significant increase in deficits, which induce a rise in long-term interest rates, that will be a significant undercutting of the benefits achieved by tax cuts," reported CNN.

The study that Greenspan referred to found that there is a close correlation between increases in government debt and rises in interest rates. The results estimate that for every one percentage point increase in the budget deficit as a proportion of GDP, the interest rate would likely rise by twenty five basis points. Therefore, if the deficit increases three percent, accordingly the interest rate should rise by 0.75 percent.

"Somewhat to my surprise, this came out as a far more robust relationship, indicating the greater the deficit, the greater the long-run interest rate," Greenspan said in his testimony to the Congressional committee.

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