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Senator BYRD. A person, whether it be a man, widow, or whomever it might be, who owns shares of stock in that corporation, would be paying a tax on 100 percent, yet would be receiving a dividend of only 30 percent.

Mr. BRILL. As I say, one of the deficiencies in that approach is that an individual would be paying taxes on income accrued, but not necessarily paid to him.

Senator BYRD. In your judgment, is that a sound approach?

Mr. BRILL. No. You asked whether it was logical. I said that there is a logic to it. I am not saying that it is equitable or fair.

Senator BYRD. I gather from what you say that you personally do not regard it as a sound approach?

Mr. BRILL. Under that criteria, requiring people to pay taxes on income they have not received, no, I do not regard it as a fair approach. Senator BYRD. The Americans for Democratic Action, Senator Long tells me, have advocated that approach. I agree with you. I do not think it is fair or reasonable at all.

Mr. BRILL. I find it rather difficult myself to be in that position. Senator BYRD. If a person, whoever it might be, owns a share of stock, you tax him on 100 percent of the profit of that corporation, yet they receive only a 30-percent dividend. I do not know how you will get people to buy stock on that basis.

What other approach would there be?

Mr. BRILL. There is the possibility of allowing corporations to deduct, to treat dividends the same as interest.

Senator BYRD. What do you think of that?

Mr. BRILL. It answers one objective. It makes it equally advantageous for a corporation to finance through equity as against debt. That has been a problem.

I think I indicated in my paper one of the problems of financing through debt. We have created a debt-heavy financial structure that inhibits the kind of venture capital approach that we need in our society.

We are not accustomed to debt-equity ratios of the kind you find in some other societies, like Japan, where, for entirely different reasons, they are able to finance in a 25 or 30 to 1 debt-equity ratio. That is not acceptable here.

We find it has resulted in a tilt of the tax structure toward debt financing, and is indeed an inhibiting factor on the formation of capital. Therefore, an action that would move payment of dividends and interest into closer consonance would be favorable from the viewpoint of aiding the corporate balance sheet.

Senator BYRD. How else can you integrate?

Mr. BRILL. There are a number of variations where, instead of requiring or instead of permitting the dividend payment to be deducted by the corporation and treat it simply as you would interest expense. There is the approach of allowing the individual to receive the dividend, but then have a tax credit for the amount of the tax that the corporation has paid.

Both of these approaches have technical problems. Both of them have some advantages. I am not technically proficient enough to indicate which is preferable, but I think that the basic objective of both.

approaches is to make the payment of interest and payment of dividends a more equal choice by corporations under the tax code.

Senator BYRD. One final question.

What three steps in the tax field do you think Congress should take to be the most effective in encouraging capital formation?

Mr. BRILL. When our proposals are submitted to the Congress, I would hope they will be given very thorough examination. But I think the general approach that we are taking should be encouraged. That is the desire to develop a tax structure which will be conducive to capital formation.

Senator BYRD. That is broad. Could you not give us two or three concrete suggestions that you think would be the most concrete ways that we could achieve that?

Mr. BRILL. Yes. I really think that hearings such as those you are conducting right now are very important to get all the views-and there are contrary views.

I alluded earlier to the fact that economists are not in agreement. That is not unusual; economists generally are not in agreement, but there are many people who have different views, not only economists, businessmen, labor leaders, agricultural leaders. All of them have their views on what is best, not only for their own group but their views on what is needed for the country.

I think we should be getting these views, getting them on the table and getting an assessment of how various alternatives can meet the objectives, keeping in mind that there are multiple objectives; the objective of simplification and equity have to be balanced with economic effectiveness.

Senator BYRD. I think so. That is the objective of these hearings, to be helpful-helpful to the committee and to the administration and the Congress in formulating new programs and policies in the tax field.

I might point out that I have found my talk with you in my office tremendously interesting. You devote a great deal of attention and time to your mail. As a result, you realize that there is a great diversity of viewpoints throughout this great country of ours.

I just want to commend you for the many hours and the tremendous amount of time that you do put on your mail. I spend much time on my mail. It encourages me to know that you, in your position as Assistant Secretary of the Treasury, find it helpful.

Mr. BRILL. It does, sir.

Senator BYRD. Thank you very much, Mr. Secretary. [The prepared statement of Mr. Brill follows:]

STATEMENT OF THE HONORABLE DANIEL H. BRILL, ASSISTANT SECRETARY OF THE TREASURY FOR ECONOMIC POLICY

Mr. Chairman and Members of this distinguished committee: It is indeed a privilege to appear before this Committee today to lead off a discussion of the problems of incentives for economic growth, particularly incentives to increase the rate of capital formation so essential for sustaining economic growth.

In addressing these issues, we all recognize, of course, that we are not invading virgin territory. The problem has been the subject of intensive examination by economists, lawyers, business and labor leaders and by officials in the Executive and Legislative Branches of government over an extended period.

Having followed the course of these discussions over the years, from several different perspectives, I am encouraged by the growing coalescence of views on

some key aspects of the problem. I think it fair to say that there is today, much wider acceptance of the theses that:

(a) there is a need to accelerate the rate of growth of our capital stock; (b) government policies-not only the general tools of economic stabilization, such as monetary and fiscal policies, but also regulatory and tax policies-play a key role in determining the rate of capital growth;

(c) encouraging the rate of capital growth involves, importantly, the removal of impediments in the saving/investment process as well as the development of new inducements to higher levels of saving and investment. Before turning to aspects of the problems on which there is less agreement, let me address what I think are the principal factors underlying these three generally accepted theses.

Recognition of the need to accelerate the rate of capital formation has been spurred, in recent years, by increasing evidence that productivity in the U.S. economy has deviated significantly below the earlier long-term growth trend. Ultimately, the increase in real returns to the factors of production, that is, the possibility of raising everyone's living standards, depends on the growth of output per unit of input. This sets the limit for our society as a whole. Disturbingly, in the past decade, the rate of gain in productivity has slowed significantly, limiting the possible growth in living standards and contributing to upward pressure on prices.

A substantial growth in productivity, averaging 2.9 percent annually in the nonfarm business sector, was a major contribution to the low inflation rate of the 1956-66 period. The data for the last decade, however, indicate that productivity increased at an average of only 1.5 percent per year. For the private sector as a whole, labor productivity growth was slightly more rapid because of a continued shift of employment out of agriculture into the nonfarm sector, where labor productivity is higher. However, a significant decline is equally evident for the private sector as a whole.

Of course, the decade of the mid-1950's through the mid-1960's was a period of rapid economic growth, terminating in a year of exceptionally high resource utilization. In contrast, the latest decade includes two severe recessions, and terminates in a year of low resource utilization. But even after adjustment for cyclical influences, it appears that the secular rate of productivity growth slowed perceptibly after 1969.

This slowdown in productivity growth has been attributed to a variety of causes-reduction in the workweek, slower growth in productive capital per worker, shifts in the composition of output to low productivity sectors, shifts in the composition of the workforce toward workers with less experience and fewer skills, and to a miscellany of other causes. For the most recent years, the drop in productivity after 1973 can be explained by the impact of the energy crisis, and the subsequent rebound in productivity in the past two years to the normal cyclical effects aocompanying the economic recovery that began in early 1975. But these fluctuations have occurred around a level far below the longterm trend growth rate extrapolated from the experience of the 1950's and 1960's.

It is clear that no one factor satisfactorily explains the slowdown in productivity gains. But I am persuaded that the slower growth in the capital stock per worker has been one of the most important factors. I should hasten to emphasize that this has not been so much the result of a slowing in the rate of growth in the capital stock per se. There is some evidence that in recent years, the capital stock has grown at a somewhat slower pace than earlier, but the principal factor in the declining capital/labor ratio since 1969 has been the sharp acceleration in the growth of the labor force. In other words, we haven't been creating the tools of production as rapidly as we have been creating workers willing to use them. The amount of capital per member of the labor force grew by 3 percent per annum in the first two postwar decades. So far in the 1970's, the amount of capital per worker has grown at only half that rate.

The implications of such a trend are disturbing, not only for the effect on inflation of reduced productivity but also for the substainability over the longer term of an adequate growth rate for the economy as a whole. The benchmark study of the capital requirements of the U.S. economy, undertaken by the Department of Commerce two years ago, concluded that to assure a 1980 capital stock sufficient to meet the needs of a full employment economy, business fixed capital investment would have to absorb some 12 percent of real GNP in the second half of this decade. So far into the period, that is, in 1975 and 1976, fixed

investment has been less than 10 percent of real GNP, so the gap to be filled in the remaining years would require an even faster rate of growth in additions to our capital stock than was postulated in the study.

In summary, then, we need more capital formation, both to restore productivity to the growth track of the 1950's and 1960's and also to provide the tools of production for a full employment economy in the 1980's.

What private and public policies can facilitate the needed growth in capital formation? The answer was best put, in my judgment, in a report issued last October by the Fifty-first American Assembly, when a distinguished group of academic, business, labor and government leaders met to consider the capital needs of the United States. The final report of the Assembly noted: "The single most important means of encouraging investment expenditures is to combat economic instability and inflation."

Wide fluctuation in economic activity induce excessive caution in investment decisions. After all, whatever else may be done to increase the cost effectiveness of new investments, entrepreneurs have to have confidence that a market will be there for the products that will be produced in the plants in which they are investing. Instability in the economy breeds uncertainty, and uncertainty diminishes investment propensities.

Inflation and expectations of inflation are also adverse to investment. Businessmen no longer rush to accelerate expansion plans to "beat the price rise"; the experience of recent years has taught that by the time a new facility launched in the feverish atmosphere of inflationary momentum is likely to come on a stream, a post-inflation recession will probably have dried up the intended market. And consumers have long displayed the wisdom of reducing major outlays when inflationary forces gather momentum.

The major contribution of public policy to capital formation, then, is the creation of a stable and noninflationary economic environment. The Carter Administration has expressed its dedication to this objective. The actions taken by the President to date to insure noninflationary growth, and the President's commitment to pursue this course into the ftuure, should provide confidence to businessmen and consumers that the economic environment will be propitious for capital formation.

There are, in addition to the pursuit of macroeconomic policies conducive to investment, specific policy areas addressing the capital formation problem. Principal among these is the tax structure. As this Committee knows, the Treasury has under way a major reexamination of our tax system, with the view to proposing to the Congress significant revisions. That study is not yet comlete. However, it will be submitted sometime this summer or early fall; every effort is being made to reach conclusions as soon as possible.

Over the years, there have been many proposals for modifying the tax structure to enhance incentives for adding to our capital stock. The excellent study prepared by the Joint Committee on Taxation, released last month, classifies these proposals under six broad headings: proposals for the integration of corporate and individual income taxes, investment tax credits, modification of depreciation allowances, changes in the corporate tax rate, deduction of losses, and indexing for inflation. Each of these approaches, individually and in various combinations, is being carefully assessed.

The criteria that are being applied in the Treasury's evaluation of all revision options relate to three general considerations: simplification, equity and economic effectiveness, particularly in enhancing capital formation. The need for simplification is self-evident to anyone who has struggled through the preparation of an income tax return. It is only about a month since many of us have had to suffer through this annual exercise in frustration. But the complexity of the return is a function of the complexity of the law; simplification of the law will permit the design of a form more easily comprehended by the bulk of taxpayers. The need for equity is also self-evident. Our tax system is unique in the extent to which it depends, successfully, on the voluntary participation of those subject to the system. That success can be maintained only if all taxpayers are convinced that the burden is being shared on an equitable basis. Equity considerations require correction of imbalances in the present tax structure that may be penalizing one form of income-generating income as against another, individual taxpayers as against businesses, small enterprises as against larger firms.

The need for an economically effective system, particularly one that facilitates capital formation, is evident from the analysis advanced earlier as to the

economy's need for an accelerated rate of investment. One aspect of the tax structure with particular relevance to the problems of adding to our capital stock is the impact of taxes on the form of financing new investment. Our financial system is justifiably renowned for its capacity, scope, richness of form and resiliency. It functions with remarkable efficiency in gathering the savings of the public and transforming these into the means of financing private investment. Nevertheless, there is concern that the availability of financing-in both appropriate amount and form-is, or could become, an impediment to the necessary growth in our capital stock.

One fundamental problem is the tilt of the system toward financing through debt instruments. Savers appear, in general, to prefer acquiring financial assets of fixed nominal value and fixed income return-a preference that persists despite the postwar erosion in the purchasing power of fixed-value claims. Moreover, our present tax system encourages the financing of investment through debt instruments.

Over the longer run, this is not the ideal arrangement; there are limits to which it is prudent or even feasible to pile increasing amounts of debt on a very slowly growing equity base. A debt-heavy financial structure increases the vulnerability of the business enterprise to cyclical fluctuations in income. It limits the venturesomeness of investment, for lenders cannot in good conscience underwrite the risks appropriate to an equity participant. And it inhibits economic growth because growth depends very much on willingness to risk investment in new products and new processes.

Moreover, the emphasis on debt financing raises particular problems for smaller and newer enterprises, which often lack the track record necessary to attract adequate amounts of financing from lenders, and must therefore fight for access to pools of equity financing.

Many proposals have been advanced to modify the tax structure in order to achieve more even-handed treatment of alternative means of financing investment. These proposals are all under active study.

As the Committee can well imagine, such a comprehensive assessment of the tax structure as is now under way is no mean task. Within each broad category of tax modification proposals mentioned earlier there are many variants to be pursued. There is a decided lack of unanimity among economists as to the economic "pay-off" of the various alternatives, and reasons for these differences in view must be explored. Foreign experience with some of the alternative approaches must be evaluated in terms of their possible relevance to U.S. problems. The relationship of the various alternatives to the tax measures and innovations incorporated in the National Energy Plan must be assessed.

Finally, the consistency of various alternatives must be established with the Administration's goals of reduced unemployment, reduced inflation and a balanced Budget by fiscal year 1981. I might note, in concluding, that achievement of these goals depends importantly on maintaining a high rate of growth in investment over the balance of the decade. The Committee can be assured, therefore, that the tax revisions recommended will contribute to this objective.

Senator BYRD. The next witness is one who has been before this committee many times, one in whom the committee has a high regard, and one in whom the committee has great confidence, and the committee is most pleased to welcome back Mr. Alan Greenspan, the former Chairman of the Council of Economic Advisers.

I want to welcome you, Mr. Greenspan, both on behalf of the committee and on behalf of myself. I am personally very pleased to see you again. I appreciate your coming here today. You may proceed as you wish.

STATEMENT OF ALAN GREENSPAN, FORMER CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS

Mr. GREENSPAN. Thank you very much, Mr. Chairman, especially for those kind words.

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