Fed Officials Warn Against Push for Tax Cuts Over Real Reform -- Update

The leaders of the Dallas and New York Federal Reserve banks warned Wednesday that any overhaul of the tax code that emphasizes deficit-boosting tax cuts over making the system more efficient could bring short-term gain but lead to long-term pain.

Robert Kaplan of the Dallas Fed and William Dudley of the New York Fed spoke at an event in New York about economic issues in their districts and the nation as a whole. The officials reiterated that they see a positive path for the economy, while staying relatively quiet about monetary policy.

"We are a long way from tax reform," Mr. Dudley said. "If we would be able to lower the corporate tax rate and broaden the base," as well as make the system more efficient, "that would be good for the United States" and help the economy over the long haul.

But tax cuts alone wouldn't be a good idea, the officials agreed.

"If it's a short-term stimulus, or basically a tax cut funded by growth in the deficit, I actually think that could be harmful," Mr. Kaplan said.

"We are either at full employment or are nearing full employment, and my concern is that if we do a tax cut financed by increasing the debt, the deficit, we'll get the short-term up and then come right back down to trend growth, and when it's over, we'll be more highly leveraged than we were before," he said.

Mr. Dudley agreed that government debt levels under a tax-cut-only shift likely would become harder for the government to pay for.

"I'm actually concerned people aren't talking about it more," Mr. Dudley said of what it costs to service the nation's debt. Today's low interest rates have made it less expensive, but that is likely to change as the Federal Reserve presses forward with rate increases.

Debt service costs "are going to start to ramp up as the Fed continues to raise short-term interest rates. Investors right now aren't focused on debt service burdens anywhere in the world...That could change quickly," Mr. Dudley said.

President Donald Trump and GOP leaders last month proposed sharply reducing tax rates on businesses and many individuals, kicking off a major legislative push to overhaul the nation's tax code this year.

Steve Rattner, a former Obama administration official and investor who was on the panel with the Fed leaders, reacted to the Fed officials' comments by saying: "On the tax side, what I think I heard both of you guys say is that you don't like the president's proposal."

Mr. Dudley denied that, while Mr. Kaplan said, "We didn't say that, but you can draw that conclusion."

In an interview after the event, Mr. Kaplan said his response to Mr. Rattner was in jest and that he wasn't criticizing the tax overhaul efforts taking place in Washington. "Tax reform, depending on how it's done, could be a positive thing for the country," he said.

Creating a more efficient tax code that promotes economic activity is "something I'm in favor of," and things are "enough in flux that I'm hopeful we will get tax reform," Mr. Kaplan said in the interview.

Critics say the Republican tax plan would boost the nation's deficit, but the Trump administration says the plan would generate enough economic growth to offset the cost.

While Fed officials have no official role in setting tax policy, the choices made by elected leaders can affect the economy's trajectory and how central bankers set interest-rate policy.

The officials' comments on the economic outlook and monetary policy were limited. Both were upbeat about growth and said they saw no reason why it shouldn't continue. Mr. Dudley expressed surprise at the weakness of inflation but added he still expects it to rise.

Speaking with reporters after the event, Mr. Kaplan said he needs to see data showing the potential for a rise in price pressures to support another rate increase.

Write to Michael S. Derby at michael.derby@wsj.com

(END) Dow Jones Newswires

October 18, 2017 16:15 ET (20:15 GMT)