lead to recessions. This evidence has been sifted by many, including the Subcommittee on Domestic Monetary Policy of the House Committee on Banking, Finance, and Urban Affairs. It concluded, as others have, that there is a close link between changes in the monetary aggregates and changes in consumer prices and real output. Among their conclusions is the following:

"Both money supply and velocity play important parts in recessions and recoveries. Money supply expansion during and immediately after recession promotes recovery."

It then remains to establish whether the changes in the money supply that foreshadow movements in the economy can be controlled by the Federal monetary authorities. And most would agree that the Federal Reserve has the power to stabilize monetary growth. If they were to do so, I feel certain that business cycle movements would be moderated and therefore pose less of a deterrent to capital spending.

THE ROLE OF TAXES

The foregoing is simply meant to place the issue of how taxation effects capital investment in perspective by pointing out that changes in the tax law can't be expected to provide a magic solution to the problem posed by the current lag in capital spending. But I wish to emphasize that this does not mean that taxation has no effect on capital spending. On the contrary, it has important effects and a reduction in the heavy burden of taxes on the returns to investment would provide an important stimulus to investment, the economy, and further advances in the general living standards. This becomes even more important as capital investment begins to recover more rapidly, as it is likely to do, in the months ahead. This speedup of investment should not be permitted to discourage tax changes to improve capital formation over the long run.

In a fundamental sense, investment is made possible because people forego consuming some part of their current income which is then available to finance the production of capital goods. When these capital goods are introduced into production, the amount of goods and services available to the population is increased. Only by foregoing current consumption, in other words, can we create the means to enjoy higher future living standards.

In our society, the saving that makes investment possible in the private sector is the result of the voluntary decisions of individuals and business managements. Those decisions in turn are strongly influenced by the expected rate of return to prospective investments. People will save, in other words, if offered a sufficient bonus for foregoing current consumption. And the size of the bonus that can be offered depends on the expected return on use of those savings to finance productive investments.

Taxes insert a wedge between the return on the investment and the return to the individual or business investor. Thus, they discourage savings and investment. Lowering taxes on the returns to capital will increase the rate of return to potential investors and stimulate more saving and investing.

The fruits of that investment will benefit the entire society. In discussions of tax policy there is an unfortunate tendency to view corporations as if they were people as if they pay taxes or benefit from tax relief. In a real sense, only people can bear the burden of taxes. The tax paid by a corporation is borne by the employees, customers and shareholders of that corporation.

In the same vein, changing taxes in a way that increases the after-tax return to business investment will provide real benefits to people, not corporations. And those people won't just be shareholders. They will be the employees of corporations, both the existing ones and the additional ones that will be employed in constructing the investment goods and in operating the new plant capacity once it is installed. And they will also include the customers of those corporations who will be able to purchase products that are relatively less expensive and/or improved quality because of the improvements in productivity embodied in the additional investment. In short, adequate investment in plant and equipment is vital to the improvement of general living standards. And taxes help to determine whether investment will be adequate.

In this context, I would like to make two very general comments about some of the proposals that have been advanced for increasing incentives to capital investment. The first concerns the intriguing proposals for the so-called integration of individual and corporate income taxes. This has a lot of appeal just for the reason I noted earlier that corporations don't bear the real burden of taxes. Integrating corporate with individual income taxes would bring the form of the

law into conformity with the reality of the economics. And it might clear up some of the confusion over just how the burden of the corporate tax is distributed among individuals. Until we eliminate this confusion, we can't meaningfully come to grips with problems of tax equity.

In addition, the double taxation of corporate dividends inherent in our tax structure creates a bias towards the use of debt in corporate capital structures. This has, in the past, aggravated the problems corporations have experienced in obtaining capital for investment purposes at crucial times in the business cycle. It is important to keep in mind, however, that integration will only provide a significant spur to capital investment if it is part of an overall program that. lowers the tax burden to business investment. Designing a plan that allows, for example, a dividend deduction but then offsets the immediate revenue loss to the Treasury by repealing the investment tax credit or some similar existing provision would not provide sufficient incentive to promote additional capital investment.

Another proposal calls for indexing income taxes to adjust for increases in the price level. In the context of corporate income taxation, this involves adjusting depreciation allowances to take inflated replacement costs into account instead of lower historic costs. By failing to do this, we distort the computation of corporate net income in a way that causes the effective rate of tax on true profits to rise with inflation. In this context, we should not allow ourselves to be misled by focusing only on rates of return expressed in current dollars. Percentage returns that may compare favorably with past rates don't look good at all once we take today's much higher rates of inflation into account.

Also, the general indexing of both corporate and individual tax rates would do much to achieve an equitable distribution of the burdens of inflation among all elements in society. This in turn would help to restore business and consumer confidence a necessary prerequisite to an adequate level of capital investment. In conclusion, let me reiterate the view that the problem of sluggish growth of capital spending in the current recovery can't be fully understood without considering the depth of the recent recession. Significant factors bringing on this recession were the high rates of inflation and general instability fostered by monetary and fiscal policies of the federal government. Thus the government can contribute to a revival of capital investment by implementing stable, moderate, monetary and fiscal policies conducive to noninflationary growth.

Given such policies, tax policies have an important role to play in insuring that the return to investment is sufficient to provide the volume of saving and investment our economy needs to ensure a continued improvement in living standards.

Corporate profits

Still trying to catch up

percent change from cycle peak

'52 54 56 58 60 62 '64 '66 '68 '70 '72 '74 '76 '78

EXHIBIT 3

92-201 O 77-10

Senator BYRD. The next witnesses are Dr. Kenneth R. Biederman and Dr. Kenneth J. Thygerson, National Savings and Loan League and U.S. League of Savings Associations.

STATEMENT OF DR. KENNETH J. THYGERSON, CHIEF ECONOMIST AND DIRECTOR OF THE ECONOMICS DEPARTMENT, UNITED STATES LEAGUE OF SAVINGS ASSOCIATIONS

Mr. THYGERSON. Mr. Chairman, my name is Kenneth J. Thygerson, Chicago, Ill. I am chief economist and director of the Economics Department of the United States League of Savings Associations. The United States League of Savings Associations appreciates this opportunity to discuss with you the broad subject of capital formation and, in particular, incentives for economic growth.

The savings and loan business is concerned primarily with the business of mortgage finance and the ability of our country to adequately house its citizens. Thus, in my comments I would like to address specifically the types of incentives which are needed to encourage economic growth and at the same time assure an adequate supply of capital to house the American people.

As you know, during the recent Presidential and congressional campaigns and more recently in testimony by officials of the Carter administration, we have come to grasp the scope of the capital formation needs of our country. Five major national priorities have been outlined by the new administration-full employment, inflation abatement, environment, energy, and housing, particularly the problem of rebuilding the central cities.

On pages 2 through 16 of my prepared text I consider broadly the need for high-level capital formation to sustain an acceptable rate of economic growth.

To review, we consider in these pages the impact on economic growth and capital formation of first, the fiscal and monetary policy that is the balance of fiscal and monetary stimulus and restraints over the business cycle as we have seen it used over the last decade, in particular, its impact on housing.