By Edward Krudy
NEW YORK (Reuters) - Former Federal Reserve chief Alan Greenspan said on Wednesday all Bush-era tax cuts should be allowed to expire at the end of the year in order to rein in the budget deficit and stop it from crowding out private investment.
Reversing a long-standing aversion to tax increases, Greenspan warned of "very grave problems ahead" if the budget deficit, swollen to around $1 trillion by massive amounts of stimulus spending, is not tackled soon.
"I am in favor for the first time in my memory of raising taxes," Greenspan told an audience at the Council on Foreign Relations in New York.
"I would love to see taxes go down, and I would hope that what we would do is we allow the tax cuts, the so called Bush tax cuts, all to lapse as they will ... on December 31 and then gradually bring the level of expenditure down," he said.
The President Bush-era tax cuts, which were supported by Greenspan in 2001 and 2003, are set to expire at the end of this year. President Obama says he wants to cap taxes on middle and lower income households but allow income tax rates to revert to higher levels for the wealthy.
Investors are hoping that dividend and capital gains taxes will be capped at 20 percent, or less, compared with the current 15 percent. Letting the cuts expire could see those rates jump to as much as 39.6 percent for high earners.
"We should not have tax cuts with borrowed money, but we should have tax cuts, and the more as far as I'm concerned the better, but only in the context of bringing the deficit down," he said. "Unless we do that, I think we have very grave problems ahead."
The tax issue is key in the forthcoming mid-term elections in November, with Republicans pushing to keep the lower rates and saying higher taxes will dampen the economic recovery.
Greenspan said the choice over whether to raise taxes was between "terrible" and "worse." Letting the budget deficit run rampant was the worse option, he said.
Greenspan warned that the budget deficit was crowding out capital investment and said stimulus spending had been less successful than anticipated.
He said the stimulus plan had probably reduced private investment by one-third to a half of the total plan.
"We have to find a way to simmer down the extent of activism that is currently going on and allow this economy to heal. That is a very minority view in this country," he said.
Greenspan headed the Federal Reserve for almost 19 years until he retired in 2006. Now 84, he was regarded as an oracle on the economy before the financial crisis.
However, suggestions that his loose-money policies in the early 2000s helped inflate the U.S. housing bubble hurt his reputation. In a Time Magazine list of people responsible for the economic crisis, Greenspan was named No. 3.
(Editing by Padraic Cassidy)