Feb. 18 (Bloomberg) -- Federal Reserve Chairman Alan Greenspan says rising U.S. deficits may have to be addressed with a move he hasn't favored in the past: tax increases.

Greenspan, in testimony before the House Financial Services Committee yesterday, said he didn't rule out raising taxes to rein in a deficit the Bush administration says will reach $427 billion in the fiscal year ending Sept. 30, topping a record $412 billion last year.

``You're going to have to increase taxes or reduce spending somewhere if we're going to keep the deficit under control,'' Greenspan said.

In past appearances before congressional panels, Greenspan has expressed a preference for spending cuts to balance the budget. His willingness to consider tax increases indicates a growing uneasiness with President George W. Bush's fiscal policies, said Barry Bosworth, senior fellow at the Brookings Institution, a Washington-based policy research group.

``Since Bush has come in there is just a complete breakdown in the budget process,'' Bosworth said. Greenspan has ``got to be getting alarmed.''

Bush's plan to set up private Social Security accounts by borrowing as much as $2 trillion is adding to the chairman's concern, Bosworth said. ``What I think has really got Greenspan nervous is that you will just borrow the money to make up for the privatization of Social Security,'' he said.

Cautioning

In testimony yesterday and Wednesday before House and Senate panels, Greenspan praised private accounts while cautioning they should be phased in gradually to gauge the reaction of financial markets to the increased borrowing that would be required.

Greenspan's libertarian roots orient him toward spending cuts and smaller government, said Mickey Levy, chief economist at Bank of America Corp.

``He is saying, `If you have to adjust the tax structure somewhat to get the necessary adjustments, then, OK, do it now,''' Levy said. ``But when push comes to shove, he would avoid relying heavily on tax hikes.''

Greenspan aired his views on tax increases in discussing Bush's proposal to extend the $1.85 trillion in tax cuts that were approved in 2001 and 2003. Greenspan said yesterday that he would support making the 10-year cuts permanent on a ``pay-go'' basis, which requires Congress to offset spending increases or tax cuts with new revenue. He previously stressed a preference for spending cuts.

``I argued a year ago that my support for the tax cuts is in the context of a pay-go rule,'' Greenspan said during his semiannual testimony to the House committee. ``Looking out beyond, say 2008, the problems we have with the budget deficit are huge, and therefore, we need very significant changes to come to grips with those issues.''

Prepare for Retirement

Greenspan said the U.S. needs to cut the deficit to prepare for the anticipated retirement of 30 million baby boomers who will receive Social Security and Medicare benefits.

Cutting the deficit would help boost national savings, or the total savings of individuals, companies and the government. That money can be used in turn for capital investment to help a smaller workforce provide for the growing number of retirees.

Democrats on the committee unsuccessfully pressured Greenspan to oppose the tax cuts because the Bush administration and congressional Republican leaders have resisted the pay-go rules.

``I would think that you as a fiscal conservative would be sounding the alarm,'' said Representative Maxine Waters of California.

Fiscal Restraint

Democrats criticized Greenspan, who was appointed Fed chairman in 1987 and whose non-renewable term expires in January 2006, for backing the 2001 and 2003 tax cuts after advocating fiscal restraint throughout the 1990s.

In March 2001, after the U.S. reported a budget surplus of $236.9 billion for fiscal 2000, Greenspan told Congress that ``it is far better'' that ``surpluses be lowered by tax reductions than by spending increases.'' That, analysts say, gave political momentum to the 2001 Bush tax cuts, which were signed into law in June of that year.

Greenspan, 78, said those reductions helped lift the economy out of the recession that began in March 2001 and ended in November of that year. He didn't say the economy now needed a similar boost.

``The evidence does indicate that the economy was significantly supported by the tax cuts in their initial form,'' he said. ``But that, of course, has nothing to do with tax cuts going forward in any material way.''

The cuts Bush wants to make permanent include lower income tax rates, a reduction in the dividend tax to 15 percent from 30 percent and breaks for parents and married couples. The reductions are scheduled to begin expiring in 2008.

Republican Opposition

Republican senators including John McCain of Arizona and George Voinovich of Ohio said they want to offset Bush's tax cuts with spending reductions or tax increases.

Voinovich said he told White House Deputy Chief of Staff Karl Rove recently that he wouldn't support making Bush's tax cuts permanent because of the rising U.S. budget deficit. He said he would also like any tax cuts considered this year to be offset.

``I made it clear that if they try to go permanent on these things that I would not support the budget,'' he said.

The Senate last year approved a Democratic plan that would have mandated offsets for new spending or cuts over the next five years. Only measures that cleared the Senate with 60 votes would be exempted. The legislation died in negotiations with the House when it ran into objections from Republican congressional leadership.

To contact the reporter on this story: Jeff Bliss in Washington at jbliss@Bloomberg.net.

Last Updated: February 18, 2005 00:04 EST