Sluggish economy leaves door open for Congress to pass tax cut legislation.

WASHINGTON -- Next spring may not be too late to enact a tax cut bill aimed at stimulating the economy, but Congress will have to craft the package carefully to avoid riling the bond market and sending interest rates soaring, the Congressional Budget Office director testified yesterday.

"The good news for Congress" is that, despite long delays and much political infighting over whether to do anything about the economy, legislation still could be passed shortly after congress reconvenes in January that would have a good chance of "adding to the recovery" without causing a lot of offsetting damage to the economy, Director Robert Reischauer told the House Budget Committee.

"Because the recovery will be rather weak, there is little danger that actions you might take would overheat the economy" and send inflation and interest rates sharply upward once again, he said.

Echoing the current consensus among economists, Mr. Reischauer said the CBO expects the economy to remain sluggish until the middle of next year, when a full-scal recovery will begin. But even after the economy starts to pick up speed, it probably will not attain the robust rates of growth that have characterized previous recoveries, he said.

Meanwhile, in the next few months, the economy is in danger of slipping back into a "double-dip" recession, he said. But he put the odds of that happening at "well below 50%," addind that it depends on how much the current dramatically lower interest rates help to spur spending a job creation.

The challenge before Congress is to design a tax package that would increase consumption immediately to "jump start" the recovery but that would also promote savings and investment to cure the economy's long-run ills, he said.

Ironically, if Congress does too much to promote spending now, debt consolidation and savings needed to lay the groundwork for long-term growth could be hindered. Conversely, if Congress concentrates on fostering long-term investment and savings, short-term growth could be hurt, he said.

One thing that would drive up interest rates and permanently harm the economy would be to pass a big tax cut that increases the deficit without paying for it. "That could spook the financial markets," he said.

But he appeared to agree with suggestions by Rep. Barney Frank and other Democrats on the committee that a tax cut could be allowed to cause a temporary spike in the deficit next year, as long as that is offset in the next several years with spending cuts or increased taxes. Such a plan would require a change in the 1990 budget agreement to allow cuts now that will be paid for later.

Committee Chairman Leon Panetta, D-Calif., who has been working behind the scenes on a budget restructuring package airmed at promoting long-term growth and investment, said he shared many of Mr. Reischauser's concerns.

"I remain skeptical that the long-term problems which caused this recession and are preventing a normal recovery can be overcome with a sort-term quick fix," he said. After the debt-financed spending splurge of the 1980s, "does it make any sense for us to tell people to go out and borrow and spend more?" he asked.

"The reality is that the problems we are facing today are a direct result of the shortsighted actions and attitudes of the 1980s. We are reaping the whirlwind, and the last thing we need to do is to repeat those mistakes."

Rep. Alex McMillan, R-N.C., the committee's acting ranking minority member, also cautioned against a rush to enact tax cuts. "Unless we restore confidence, anything Congress does is likely to add to the problems," he said.

Mr. Reischauer declined to offer suggestions on how congress could bolster consumer and business confidence. Many private economists are blaming Washington's mishandling of the economy for pushing confidence lower. "Only a swift resolution is likely to restore confidence that Congress and the White House can achieve anything," said Jeremy Gluck, a Mitsubishi Bank economist.

According to the CBO's analysis, the slow growth likely to be experienced next year is largely due to "an unusual coincidence of structural problems" that the economy is encountering and that can be worked out only over time.

Mr. Reischauer offere little encouragement that Congress would be able to do anything to correct one of the major structural problems -- that overbuilding of real estate and the resulting housing deflation that has caused the asset values of banks, businesses, and individuals to plunge in many areas.

"No amount of tinkering with the tax laws will fill empty buildings," he said.

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