Greenspan: Tax overhaul will do 'very little' for growth; inflation is biggest danger

Key Points
  • Former Fed Chair Alan Greenspan said the Republican-sponsored tax overhaul plan will do "very little" for economic growth.
  • Instead, he said in an interview with CNBC that Congress should focus on the deficit or risk inflation getting out of control.
  • Greenspan cautioned in 1996 about "irrational exuberance" in the stock market, and earlier this year warned that a bubble in the bond market was about to pop.
Alan Greenspan: We're about to go from stagnation to 'stagflation'

The Republican-sponsored tax overhaul plan will do "very little" to spur real economic growth but could push inflation dangerously higher, former Fed Chair Alan Greenspan said Wednesday.

Greenspan said the GOP plan, endorsed by President Donald Trump, instead should focus on reducing the deficit and heading off inflation.

Under the proposal, the corporate tax rate will be slashed from 35 percent to 20 percent while individual rates also will be cut. Analyses of the plan show it could add $1 trillion to the budget deficit, though the White House maintains the tax cuts will pay for themselves through gains in gross domestic product.

"This is a terrible fiscal situation we've got ourselves into," Greenspan told CNBC's "Squawk on the Street" in a live interview. "The administration is doing tax cuts and a spending decrease, but he's doing them in the wrong order. What we need right now is to focus totally on reducing the debt."

The Senate has approved the plan, which is now under joint review with the House. If all goes according to schedule, the tax overhaul bill will be on Trump's desk before Christmas.

However, critics argue that in addition to blowing a hole in the budget, the benefits are skewed toward the richest Americans. Greenspan said he worries of imbalances the plan could create.

"We're in a stage where if nothing is changed, we're about to go from stagnation to stagflation, with a significant rise in inflation and a wholly significant imbalance in the economy, which is very difficult to anticipate at this stage," he said. "But the outlook is not exactly terrific."

Stagflation refers to a condition of high inflation but low wage growth and high unemployment, a condition that prevailed in the late 1970s and early 1980s. Rising deficits are thought in some quarters to push inflation as government policies pump more money into the economy.

White House officials estimate that the tax plan, coupled with deregulation and higher infrastructure spending, will create economic growth of at least 3 percent. GDP in the second and third quarters was 3.1 percent and 3.3 percent, respectively.

Greenspan predicted that GDP gains in the fourth quarter would be "significantly slower" than in the preceding two quarters, though the assertion does not square when compared with various growth trackers. The Atlanta Fed sees Q4 at 3.2 percent, CNBC's Rapid Update puts the number at 2.4 percent and the New York Fed forecasts 3.9 percent.

The high unemployment component of stagflation also is unlikely to prevail; current Fed forecasts have the jobless rate at 4.1 percent through 2019, the lowest since December 2000.

Asked how much he thought tax reform would contribute to growth, Greenspan said: "Very little. The tax cuts, remember, at the same increase the deficit. All the econometrics that I've seen over the years tell me that when you increase the deficit and you increase the demand for funds, you're crowding out capital investment, and capital investment is the key statistic determining output per hour, that is, productivity."

Greenspan chaired the Federal Reserve from 1987 to 2006, leaving just before the financial crisis hit.

Among other things, he is known for his 1996 warning of "irrational exuberance" in the stock market during the dot-com boom. Earlier this year, he cautioned that a bubble in the bond market was about to pop because of the persistence of "abnormally low" interest rates.