ownership, which seems at least to shy away from tax incentives for individual shareholders as preferential for a segment of our society. In fact, there are about 25 million human beings who own shares of stock and most of them have made these investments for the long term, for retirement, for the education of their children, or to share in the growth of the country. These 25 million people are, in many respects, in the forefront of our economic system in that they are investing in that system, and they should be encouraged. Certainly, they should not be discriminated against. Unfortunately, many of the studies of capital formation have practically ignored the investors' role in this process. For example, the report entitled Tax Policy and Capital Formation prepared by the staff of the Joint Committee on Internal Revenue Taxation, restricts its discussion of capital investment to physical capital-plants, equipment, housing even though it acknowledges a relationship between financial and physical capital. While it is important to focus on plants and equipment, we believe it is equally important to focus on people, who, as investors, are needed to provide the dollars for capital investment. There are three fundamental reasons for our urging this special emphasis on the individual investor: Individual investing on a nationwide scale provides broad public support for the system of private enterprise in this country. More, not fewer, Americans should have a direct ownership stake in the success of that economic system. This goal is fully consistent with the economic as well as the democratic political traditions of this Nation. Individual investing on a wide scale provides a sound means, perhaps the best means, for improving the mobility of capital. Incentives at the corporate level help existing businesses regardless of their needs whereas providing incentives directly to individuals permits their savings to flow wherever the needs and opportunities are most attractive. It is noteworthy that major industrialized countries enjoying greater growth than the United States all provide more favorable capital gains tax treatment than does this country. Individual ownership, if encouraged, will slow the steady, inexorable trend toward institutional ownership. If ownership of our corporations continues to concentrate in a relatively small handful of giant institutions, our system will become more like that of Japan or Germany and will have lost one of its unique attributes. Economic concentration of this type will have a further negative impact on the ability of credit-worthy but smaller companies to meet their capital needs. A tax system which imposes a greater burden on individual investors than on institutions exacerbates this problem. Regrettably, a look at the current American shareholder census reveals that the ranks of the individual supplier of equity capital are shrinking. During the first half of this decade, there has been nearly a 20-percent reduction in the number of shareholders. Approximately 6 million individuals have left the equity markets. Today there are only 25 million shareholders compared with 31 million in 1970. Several factors contributed to this phenomenon. Soaring inflation rates were a severe blow to equity investment, and concern about possible recurrence continues to inhibit investors. Economic policies compounded uncertainty by veering from stimulus to controls and back again. During the early 1970's, the level of personal savings dropped severely. Harsh changes in tax policy accelerated the flight of equity investors and inhibits their return. I shall elaborate on the latter point. Tax Policy and Capital Formation cites studies showing that "an individual's choice between various assets is quite sensitive to the after-tax yields he expects to receive on the assets" and that "tax incentives for personal saving do not significantly affect the amount of such saving, but do affect its composition." The recent recovery in the level of personal saving has not prompted a return to equity investment. We believe one must look to the treatment accorded equity investment by the tax code for an explanation of this situation. The erosion of capital gains provisions and the continuation of double taxation of dividends have served to discourage equity invest ment. The willingness of millions of Americans to invest depends on a favorable risk/reward relationship. By their mass desertion of the equity markets, millions of Americans have signaled a consensus that the relationship is seriously imbalanced. There are many factors involved on both sides of this equationmany of which are not solved by legislation. But a singularly important factor, affecting both risk and reward, is amenable to legislative remedy. That factor is the tax treatment of capital gains. In the past, the United States and other industralized countries have taxed capital gains differently than income. We believe this distinction is sound and economically justifiable. During the last 8 years, however, this distinction has been dramatically eroded. In 1969 the Congress increased the tax rate on capital gains from 25 percent to 35 percent and added capital gains as a tax preference item subject to the minimum tax to raise even higher than the effective capital gains tax rate. Again, in 1976, both the increase in the minimum tax rate plus the reduction in the credit for other regular taxes paid further diminished the positive effects of the capital gains tax. Moreover, in addition to practically doubling the capital gains tax rate-reducing the reward the Congress has also doubled the element of risk. As a result of the Tax Reform Act of 1976 extending the holding period, by next year an investor will have to remain at risk 1 year before qualifying for capital gains treatment. In addition to these tax increases or disincentives-which in themselves could scare off already reluctant investors, current tax policies result in double taxation of corporate earnings paid out to investors as dividends. This situation not only is inequitable to the investor and the corporation, but also has created a dangerous bias in favor of debt over equity financing. Debt now accounts for 55 percent of the total capitalization of all nonfinancial corporations. Indeed, the double taxation problem is the major focal point of Tax Policy and Capital Formation, which notes that current law "encourages that use of debt finance relative to new stock issues, since interest payments are deductible and dividends are not. More debt increases the risk associated with corporate financial structures because firms must meet higher fixed charges for interest and face greater risk of bankruptcy." In recent months proposals to address double dividend taxation have attracted considerable attention and support from both the past and present administrations, from members of this Committee and the House Ways and Means Committee, from economists, and from the business community. The Securities Industry Association has long supported elimination of the double taxation of dividends because we are convinced that simple fairness to those who own American companies demands that, but also, because in our professional judgment, there should not be a bias in favor of one type of security over another when we are advising clients seeking to raise capital. The selection of a specific method of achieving this end, however, is not a simple process and we recognize it cannot be considered apart from other changes in the tax code. Nonetheless, we are deeply concerned by those proposals which tie the elimination of double dividend taxation to redefining capital gains as ordinary income. Such a proposal reduces one inequity in the tax code by increasing another. If it is inequitable to impose a double tax on corporate earnings paid out in dividends, it must also be inequitable to impose a double tax on corporate earnings retained and reflected in capital gains. Moreover, such proposals could shut off sources of new capital, imposing the harshest penalties on companies which are new, small or engaging in major expansion vital to employment and long term economic recovery. Tax policy can be a powerful tool to stimulate the investment necessary to promote long-term economic growth and to achieve public policy objectives. There is little doubt that these goals require increased capital investment. Current tax policy has served to retard investment. Therefore, this Nation needs a new tax policy. A tax policy which is based on the simple and equitable principle that corporate earnings should only be taxed once. Yet we know that efforts to alter the code will be resisted because it is asserted that the benefits of such changes will go only to a limited number of very wealthy people. We reject the notion that tax policy which fosters investment is merely "welfare for the rich." Even with the exodus of equity investors the median stockholder has a family income of just under $19,000. Millions of lower- and middle-class Americans participate in private and public pension funds which are also major stockholders. All Americans have an interest in, and will benefit from, the creation of jobs and improved standard of living which can only occur through increased capital investment. The tax code should not be biased to discourage investment and increase the concentration of equity ownership. We believe that public policy can be furthered by changes in the tax code which will promote investment. We believe that those changes must focus on people-investors as well as on plants and equipment. In determining what specific changes in the code are needed, we believe it is necessary to assess the effects of any contemplated change either in the capital gains tax or on the taxation of corporate earnings on the following factors: 92-201 O 77-9 Impact on individual investors; Impact on corporations, especially those which are expanding and those which are new or small; and Impact on Federal revenues taking into account the "ripple" effect. The answers to these very important questions can be derived only after the most careful analysis and study. I hope you will believe me when I tell you that people are looking to you to help solve these twin problems of providing incentives for investment and eliminating the inequity of the double taxation of their dividends. Most people realize it is difficult to devise the precise balance and in fairness, they rely on experts in and out of government to design the solution. But they do want a chance to build for the future and to be treated fairly with respect to their dividend income. Finally, then, the Board of Directors of the SIA is committed to provide its collective best judgment in providing answers to the abovementioned questions. On behalf of our member firms and in the interest of the 25 million individual investors they serve, SIA has undertaken a study of a number of specific proposals which are intended to stimulate investment and promote economic growth. We will be happy to share our conclusions with this committee and the Congress at the earliest possible moment. Senator BYRD. Thank you. You made a good statement. The question of double taxation, of course, is a vitally important one. I do not believe you indicated how you would solve that problem, or what recommendation you have in that field. Mr. O'BRIEN. What I indicated, Mr. Chairman, is that we have studied the three proposals which are set forth in the task force paper and we have not reached a conclusion yet for the reason that the matter is under active study. It is a highly complicated one. I have spent hours studying it myself. I do not pretend to know the answers. We lean toward one that is a partial integration system rather than a full integration system, but that is the very point, that we have begun work and which we would like to furnish to your committee. Senator BYRD. The committee would be glad to get your view when you have completed your study. I thought in testifying today that you had a recommendation that you wanted to make. Mr. O'BRIEN. We have a recommendation with respect to the general principle. Senator BYRD. As a general principle you favor the elimination of double taxation. That is the general principle? Mr. O'BRIEN. That is correct. Senator BYRD. I certainly agree with that but we cannot legislate on the general principle. We have to have specifics. Mr. O'BRIEN. We also made one other point in that testimony today. We lean toward the emphasis on the stockholder relief; namely, the elimination of double taxation and the capital gains question as distinguished from the physical side, which is the investment tax credit and things of that nature. Senator BYRD. How does the investment tax credit fit in? Mr. O'BRIEN. I think they are different problems. They are meant to have different incentives. The only point we wish to make is in the former area. Senator BYRD. Maybe I missed the point. I do not see what the investment tax credit has to do with the question of double taxation. Mr. O'BRIEN. I think they are different. I agree with you; they are different. I think each one provides a measure of capital accumulation. I agree with that. All I am saying, in terms of emphasis, I would like to see that emphasis placed on the elimination of the double taxation of dividends. That is my point. Senator BYRD. I understand now. As I understand it, then, while you have not completed your study, you lean toward a tax credit for the stockholder. Mr. O'BRIEN. In a way it is in the nature of a partial integration of the corporate tax and the individual tax which we would call alternative 1 in the task force study rather than one which would take into consideration taxation of both the dividend as well as the retained earnings on the grounds that it is conceivable that the stockholder, under that latter approach for integration may end up you used the example yourself with one of the earlier witnesses, he could end up being taxed for a substantially greater amount of dividends than he actually received. Senator BYRD. Do you advocate that? Mr. O'BRIEN. I am saying I am leaning toward the former system which is partial integration rather than full integration of the two taxes on the individual and on the corporation. I said what I intend to do is once our study is completed to furnish you with the information on those points. Senator BYRD. Thank you, sir. Thank you, gentlemen. The next witness is Mr. Leif H. Olsen, chairman, Economic Advisory Committee, American Bankers Association. Mr. Olsen, you may proceed in any way that you wish. STATEMENT OF LEIF H. OLSEN, CHAIRMAN, ECONOMICS ADVISORY COMMITTEE, AMERICAN BANKERS ASSOCIATION Mr. OLSEN. Thank you, Mr. Chairman. I have a brief statement. I am going to summarize the statement. I am Leif Olsen, senior vice president and economist at Citibank in New York and I am chairman of the economic advisory committee of the American Bankers Association, a trade association whose membership includes approximately 93 percent of the Nation's commercial banks. We appreciate this opportunity to testify before your subcommittee on the effect of tax policy on the growth of the private sector of our economy. This is an important issue which has serious implications for the maintenance of the standard of living of all of our citizens. It is also closely tied to the issue of tax reform, and the need to develop an equitable tax system for all of our citizens. Today, I will make a few brief remarks about monetary and fiscal policy, the effect of tax policy on economic growth in the private sector, and discuss in a general way a few of the key proposed tax changes from the standpoint of this issue only. The American Bankers Association is currently forming a special task force to consider the |