By Edward Krudy

NEW YORK, Sept 15 (Reuters) - Former Federal Reserve chief
Alan Greenspan said 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)