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In other words, in a period when liquid savings ran at the high rate of $3,000,000,000 quarterly, individuals added only $200,000,000 to their corporate securities holdings.
The evidence in recent years is even more startling. We find that in the 8-year period 1940–47, individuals actually reduced their holdings of corporate securities by 1.3 billion dollars net. In the same period, while individuals were cutting down their corporate security holdings, liquid savings increased in the astronomical amount of $182,000,000,000. If any proof is needed that current tax laws are preventing savings of the type which would be invested in equities, here it is.
This is the time of the year when corporations in large number publish their annual reports.
The CHAIRMAN. Mr. Hanes, is it not a fact that numerous companies in this country have wanted to float equity securities and have been unable to do so and have been driven to taking on indebtedness?
Mr. HANEs. That is an exact fact, Senator, and I understand that there have been a great many issues registered with the Securities and Exchange Commission for sale to the public that have been withdrawn.
I do not have the exact figure, but I think it would be interesting for the committee to have it.
The CHAIRMAN. We will have data on that later.
I wish that tax experts of the Treasury and others.would examine these reports, for they represent the raw material of American enterprise. Analysis of these annual reports reveal how a business actually functions and why an increase in profits tells only part of the story.
Concretely, in a period of business expansion and the problem is aggravated when the price level is rising-profits are rarely reflected in a corresponding increase in the ratio of cash to current liabilities. The amounts provided through undistributed earnings and depreciation fall far short of the amounts that have to be expended for increased accounts receivable, inventories and plant expansion. This means that funds have to be provided from outside sources, either bank loans or the sale of bonds or equity securities.
Since the banking authorities are concerned with the increase in bank loans and business itself hesitates to reduce the ratio of net worth to debt, the outlet through the stock market is of special importance. The deplorable state of the stock market explains in part why corporations have paid what seems to be a niggardly part of their earnings in dividends. As stated in the annual report of one large company-Burlington Mills annual report:
With the securities markets showing less and less absorption power at reasonable values, there will be no source of funds for renewals and modernization unless they are arbitrarily set aside from profits, and no prudent management could afford to plan otherwise.
Thus we have a vicious circle. Management is caught in a dilemma. When the demand for its products calls for plant expansion, it finds that the tax laws place obstacles in its way in attracting additional funds. On the other hand, if inability to expand results in unemployment, business is attacked for not furnishing adequate employment.
Here, Mr. Chairman, I would like to call your attention to the exhibit which is marked "Exhibit B” attached to my statement, which is an editorial from the New York Times, dated January 21, 1948, entitled “Capital, and Mr. Harriman.”
I call your attention especially to the last sentence of that editorial, because it clarifies this issue better than anything I have seen up to date.
With your permission, I would like to have that inserted in the record.
The CHAIRMAN. It will be inserted at this point. (The editorial is as follows:)
[Editorial from the New York Times, January 21, 1948]
CAPITAL, AND MR. HARRIMAN
Testifying before the House Ways and Means Committee in opposition to Republican tax-reduction plans, W. Averell Harriman, Secretary of Commerce, argued that it would be economically dangerous at present to divert capital into private investment at a rate higher than that now prevailing. To increase that rate, said he, would necessitate a “painful readjustment" later.
Now, it may well be true that industry can raise funds to cover the replacement and expansion needs regarded as desirable under present inflationary conditions. It is by no means as clear that it can raise such funds on terms which are consistent with the needs of a stable economy. In 1946 security issues floated in the investment market for purposes of raising new capital amounted to 3.5 billion dollars. The total included 2 billion dollars in bonds and notes. One and five tenths billion dollars in common and preferred shares. That is a fairly healthy ratio of debt to equity capital. But in the first 9 months of 1947, while the rate of financing was almost identical with that of 1946, the pattern showed a prononced change. In the latter period 2.5 billion dollars of the new issues took the form of borrowing and only 1 billion dollars equity financing. In other words, where corporations had found it necessary to raise but 57 percent of their new capital through borrowing, in the first 9 months of 1947 the percentage has risen to around 71 percent.
What do these figures suggest? They suggest, first, that in boom times, such as the present, corporations do not cease expanding because of a shortage of risk capital; they merely shift to less desirable methods-methods which, if long continued, would almost certainly make the "painful adjustment" of which Mr. Harriman speaks vastly more serious than otherwise. They suggest, second, that we have already reached the saturation point so far as financing through equity capital is concerned. Mr. Harriman, as a matter of fact, admits that the trend toward financing through credit is an unhealthy one, but observes that it has "not yet reached the danger point.”
Very well. Let us agree, for purposes of argument, with Mr. Harriman's diagnosis that although the patient is sick its condition is not yet critical. What is to be said, then, for Mr. Harriman's going beyond the point of defending the present tax structure and supporting the President's proposal to add 3.2 billion dollars to the corporate tax burden?
On the face of figures which he himself presented your Ways and Means Committee, this is a preposterous suggestion. Those figures are an analysis of the methods by which corporations financed their expenditures in 1947. The expenditures included 14.5 billion dollars for plant and equipment, 7 billion dollars for inventory enlargement, and 5 billion dollars for added trade receivables, a total of 26.5 billion dollars. Of this 26.5 billion dollars no less than 15 billion dollars was met out of retained profits. Of the remainder 4 billion dollars was raised through new issues, 3.5 billion dollars through bank loans and 3 billion through trade and other "payables.” In other words, the chief source of financing—and almost the only source of legitimate risk capital-was retained profits. Yet while he himself admits that too much risk investment is already being financed through the medium of nonrisk securities and other forms of borrowing, the Secretary of Commerce blandly approves the President's plan to “soak corporate profits,” and thus deal a crippling blow to what is today almost the sole source of business capital. It simply doesn't make sense.
The CHAIRMAN. Is the sentence to which you refer the one starting with the word "yet" ?
Mr. HANEs. It starts with "in other words" and reads:
In other words, the chief source of financing—and almost the only source of legitimate risk capital-was retained profits. Yet, while he himself admits that too much risk investment is already being financed through the medium of nonrisk securities and other forms of borrowing, the Secretary of Commerce blandly approves the President's plan to “soak corporate profits,” and thus deal a crippling blow to what is today almost the sole source of business capital. It simply doesn't make sense.
Mr, Chairman, the time has come when it is the plain duty of every patriotic American to throw aside the superficial thinking that is destroying that way of life which created this vast productive machine of ours. Tax laws which steal from the individual the fruits of his labor will produce stagnation in this country just as it has done in England, France, Italy, and elsewhere. Socialism and capitalism cannot live together, and our obligations are so great that we cannot afford any further experiments in socialism. There is no country to which we can turn for loans when these experiments fail.
As I understand it, the position of the administration is that tax receipts over-all should not be reduced at this time. If a change is made in the tax structure, the Treasury argues, relief should be concentrated in the lower income groups and offset by a corresponding increase in corporate taxes.
The CHAIRMAN. Mr. Hanes, I might suggest that that is hardly the effect of the administration proposal. The compensatory excess-profits tax will not commence to compensate for a year or two after the effectiveness of any bill of that kind.
Mr. Hanes. That is right.
The CHAIRMAN. So there is no compensatory effect at the time when under the arguments by the administration there should be such an effect?
Mr. HANES. That is exactly right. In fact, tax from corporations is in some cases 15 months away from
payments. The CHAIRMAN. That is right.
Mr. HANES. The President, in his message on the state of the Union, in harmony with these conclusions, requested Congress to reduce individual incomes taxes by $40 for each member of the family and to lift corporate taxes by $3,200,000,000 to compensate for this reduction.
The doctrine is fallacious. In my opinion, substantial tax reduction would revitalize risk capital, it will help maintain employment, and through increased production it will lower the cost of goods and services to the consumer. It is utterly inconsistent, in my judgment, to ask for higher production and at the same time discourage business expenditure.
A lower scale of Government spending and the application of the resulting savings and a portion of the current surpluses to tax reduction can be our best insurance against a downward deflationary spiral or a
a depression. Lower taxes will create savings with which to invest and assume business risks, which, in turn, will encourage labor and management to expand and to increase production. Both in the near future and in the long run, greater production is our strongest bulwark of defense against inflationary pressure on the one hand, and against deflation and a lower standard of living on the other.
The House Ways and Means Committee has made an excellent statement on H. R. 4790, and I would like to quote one paragraph from their report:
In the opinion of your committee production must be the ultimate answer both to the immediate inflationary problem and the long run goal of achieving a higher standard of living. Increased production requires the wholehearted cooperation of all segments of our economy. To accomplish this goal the productivity of labor must be increased, the initiative of our business managers must be stimulated, and profits after taxes must be of sufficient size to attract investors into risk-taking enterprise.. Your committee believes that the present high, wartimetax rates represent one of the chief obstructions to the achievement of this higher level of production.
This is a statement which deserves wholehearted endorsement on a nonpartisan basis.
The CHAIRMAN. Mr. Hanes, with the exception of the editorial to which
you refer, I assume you do not now care to go over the rest of the attached material?
Mr. HANES. I believe it is self-explanatory, except for the editorial from the New York Herald Tribune which I also attach there as exhibit C.
That was an editorial entitled “Venture Capital,” which appeared on March 1, 1948.
I would like to have that incorporated in the record if you would, because I think it is very pertinent to this question so uppermost in my mind at the moment, which is venture capital. The CHAIRMAN. It will be put in the record. (The editorial is as follows:)
Financial markets are troubled by a peculiar problem which appears to have a decided bearing upon our national economic progress. The problem is an inadequate supply of venture or risk capital. New issues of debt securities can be marketed readily enough with institutions, such as insurance companies and savings banks the principal buyers. But common and preferred stocks, which the institutions usually are not permitted by State boards to buy, are not in demand. The market for outstanding stocks, which are the venture securities indicating ownership of enterprises, drags along despite dividend returns which are higher than average and corporate earnings which in many instances are at record levels.
As financial leaders and corporate managers are proclaiming with increasing emphasis, it is venture capital—the willingness to take risks—that fostered the inception and growth of our giant industries. The return on such capital is statistically adequate just now, and yet it does not venture. This makes it necessary for many companies to borrow for the development of improved processes and new products, when corporate financial structures suggest that a greater use of equity money, which shares in the risks and profits of an enterprise, would be advisable.
Many competent observers have concluded that this situation is due to the incidence of Federal taxes, which fall with exceptional severity upon those with large incomes who normally are the buyers of stocks. Emil Schram, president of the New York Stock Exchange, warns that the task of financing business may have to be taken over by the Federal Government under the current tax schedules. He calls, accordingly, for such drastic changes as a reduction of individual income surtaxes to a maximum rate of 50 percent and a reduction of the maximum tax on long-term capital gains to 10 percent from 25 percent.
Although the point may be raised that those who make these analyses and recommendations have a tax ax to grind, the contentions seem reasonable and cannot be dismissed lightly. They do run up against some stubborn facts, however, which suggest additional inquiry. Just 2 years ago, for instance, a booming market for new stock issues flourished under at least equally adverse taxation. Moreover, money available today for investment and other purposes adds up to many times the total of credit and ready funds, which financed the bubble that burst in 1929. Perhaps a survey by competent economists could clarify these matters.
Individual income-tax liability, income years 1939–46 and under H. R. 7490
MARRIED PERSON-TWO DEPENDENTS
1 Includes defense tax.
8 Includes net Victory tax. Computed by assuming that deductions are 10 percent of Victory tax net Income: i. e., that Victory tax net income is ten-ninths of selected net income.
Assumes entire income earned by one spouse. Source: 1939–46, Treasury Department, Treasury Bulletin, February 1947, p. A-10. H. R. 4790, House of Representatives, 80th Cong., 2d sess., Report No. 1274 to accompany H. R. 4790.
The CHAIRMAN. Are there any questions?
Senator MARTIN. Mr. Hanes, from your experience, how large can the tax take be so that men will still invest in what we call risk capital?
Mr. HANES. Senator, that is a pretty hard question to answer categorically.
I would say this: In the first place, the tax rates have got to be of such a level that it will first of all permit savings.
I think we are all agreed that at this particular moment and at the present rate of taxes for the higher income groups, it is almost impossible to have any savings left, or any surplus, after meeting your tax bill. It just does not exist.
Take, for instance, a man with what we used to think was a high income of $25,000 a year. Your 50 percent bracket begins at $18,000.
When you subtract the loss of purchasing power of the dollar compared with the 1939 dollar, you are really taxing that man 80 percent of his earnings and not 50 percent because you have subtracted from him the purchasing power to such an extent that it leaves him with no savings.
The CHAIRMAN. Mr. Hanes, might I interrupt to say, would it not be correct that the $25,000 man of 1939 would have to have an equivalent, because of tax rates, of take-home income return today of several times that amount?
Mr. HANES. That is right.
The CHAIRMAN. I later on will put the exact figures in the record, but, as I recall, it is several times that amount and that does not také into account the decreasing value of the dollar.
Is that correct?
Mr. HANEs. That is correct. We have taken no account of that since the tax rise began in 1939.