poor fellows who met down at the Mayflower Hotel during the war when they had that 90 percent excess profits tax on. After a few rounds of drinks, one decided to break it up and go home. One fellow said, let me have the bill. He said, I'm in the 90 percent tax bracket; it won't cost me but 10 cents on the dollar. The other fellow said, no, let me have it. I'm on an expense account. It won't cost me anything. The other fellow said, let me have it. I have a cost-plus contract, I'll make a 10 percent profit.

A great number of these pension plans for executives started at that time. The companies were buying company aircraft just because they

needed a deduction.

One has to wonder if that 90 percent tax rate made us any money at that time. I do not think we made any money with a 90 percent tax bracket. I do not think we make any money with the 70 percent tax bracket. It would be my guess that if you reduce your top rate to 50 percent, you actually would make money with it because people, rather than just leaving money sit idle or wasting it on non-productive expenditures would put it into productive investments.

Apparently the Treasury method of estimating is, if a businessman does not put his money in this, he will put it someplace else. I do not think it works that way, from my own experience. My guess is that there is a tremendous amount of capital sitting idle because of a counterproductive tax rate. I can show situations, including my own situation, where I would be paying more taxes-making more money and paying more taxes-with such resources as I have available, if the tax were not so high.

As it is, it serves the purpose to create some good will, to have people pay me less and make money on me, by making money on funds in a savings account or checking account, by lending those funds out to others, and we end up with less tax ultimately paid to the Treasury.

Those things tend to add up, on balance, to a real loss of money at a 70 percent tax rate, where a lower rate would bring more money to the Treasury.

I would like your reaction to that.

Mr. FROMM. Of course the maximum tax rate on earned income is 50 percent, not 70 percent.

Senator LONG. Investment income.

Mr. FROMM. Senator Byrd asked some questions about capital gains. Under current law, the maximum tax on capital gains, given an individual in the top 50 percent bracket for earner income, the 70 percent bracket for total income, and minimum tax provisions, would be 49 percent. This is just about the same, of course, as the maximum rate on earned income of 50 percent, so the differential between capital gains and earned income is not very large.

You are not going to gain very much by raising the tax on capital gains, and it would probably cost a great deal in terms of savings and investment incentives.

Senator LONG. When you have a tax on capital gains of 49 percent, a lot of people are going to freeze up their assets and not move them, just sit there with them.

Mr. FROMM. That is correct. There is a locking in effect that would cause people not to shift, just for tax reasons, into other investments.

Senator LONG. It irritates me, everytime I pass by a large piece of property, virtually in the center of my hometown. Baton Rouge, La., that was use for a cow pasture until recently. I am not sure what they are using it for now. There is 1,000 acres in the middle of a town of approximately 300,000 people.

You ask the people, why don't you develop it? They say, the tax would be prohibitive. They would loose too much taxwise if they

did it.

When our tax law becomes counterproductive, it seems to me that we ought to do something about it. We are defeating our own purpose. The purpose is to make money for the Government, to do it in the way that does the least harm to the economy and, hopefully, the most good for the economy.

I wonder if you could give us any suggestions as to how we might find some way to have Treasury more correctly give us feedback.

Mr. FROMм. In the economics profession, we have been constructing various kinds of models to evaluate economic impacts. The investment impact estimates I have presented here are based on econometric models. Much additional research is needed to refine these estimates. But, it is extremely difficult to obtain research funds, at times, to conduct this type of research.

For example, I think it was unwitting, but the House HUDIndependent Agencies Appropriations Subcommittee, which also has jurisdiction over the NSF budget, took a large chunk out of a particular activity within the National Science Foundation Research Applied to National Needs RANN) program, because there had been some criticism of the way that program had been administered.

The House committee, I believe, was not aware, when it was making those cuts, of the full range of research being funded within that activity. They were concentrating on selective administrative practices of a few research projects.

It turns out some of the needed research to which you are referring is being funded under the RANN programs. This includes the work of Joe Pechman, for example, on tax policy, and that of Arthur Okun. It also includes research that I am conducting with James Tobin and William Brainard of Yale University.

If the House appropriation action sticks on the Senate side and through conference, and is passed into law, there will be a substantial reduction in support for economic research and, thus, in the amount of work that can be done and the quality of expert advice that can be given.

Senator LONG. Thank you very much.

Senator BYRD. Dr. Fromm, do you think that the Congress made a mistake in increasing the capital gains tax in 1969?

Mr. FROMM. Well, I am not sure about going back to 1969. The capital gains tax, of course, has been increased now, as I indicated, for people in all top brackets to 49 percent; for people in lower brackets, subject to the minimum tax, the maximum tax on capital gains is 40 percent.

This probably has had some detrimental effect on investment. On the other hand, there is a trade-off here, to some extent, in terms of equity across individuals in our society. One has to weigh those trade-offs.

Senator BYRD. It seems to me, overall, Congress made a mistake in changing the capital gains rate.

Mr. FROMM. On questions of equity, it is up to the Congress and the President to decide, or at least are the best to evaluate, social welfare questions. You are the right person to make such judgments.

Senator BYRD. What effect do reductions in business taxes have upon interest rates? Do they have any effect on interest rates?

Mr. FROMM. There may be some effect on interest rates through the medium of stimulating investment demand. Clearly, there is another side to this pair of scissors-what the Fed does in respect to monetary policy. That has a great deal of influence on interest rates.

It is difficult to say where, on net balance, it would come out. With no change in monetary policy, it is likely that interest rates would rise somewhat. I think, given the magnitude of likely business tax reductions, it would be to a modest degree.

Senator BYRD. Thank you very much, Dr. Fromm.

The next witnesses will be Dr. Thomas Reese and Dr. Gerard Brannon, representing Taxation with Representation.

I might ask a question before we start. Which is worse, taxation without representation, or taxation with no representation?

STATEMENTS OF THOMAS REESE AND GERARD BRANNON, TAXATION WITH REPRESENTATION

Mr. REESE. My name is Thomas Reese, I am legislative director of Taxation With Representation, a public taxpayers' lobby. We are a national organization based in Arlington, Va., and, for my presentation, I have distributed to the members of our committee a copy of our Taxation with Representation newsletter that I ask to be put into the record.

Senator BYRD. It will be put into the record.

Mr. REESE. I also have with us today Dr. Gerard Brannon who is a person who is well-known to this committee. Dr. Brannon was the director of the Office of Tax Analysis in the Treasury and has done research and work in tax policy for many years.

I would like to have the remainder of all of our time given to Dr. Brannon.

Senator BYRD. You may proceed.

Mr. BRANNON. Thank you, sir.

I hope that I can suggest some different ways of looking at this tax problem in front of us. I want to look at it from a political standpoint.

It seems to me that the politics of taxation in the United States has been a war between what I call facetiously the "redistributors" and the "growthpeople." Redistributors think that America will go to hell in a limousine unless we do things to stop the rich from getting richer while the poor get poorer. Growthpeople think that America. will go to hell on foot unless we do things to increase the reward for thrift and initiative.

Redistributors win most of the big battles, like progressive income tax rates, high rates on corporations, and taxes on property. Growthpeople win most-but not all of the skirmishes, like rapid depreciation, tax exempt interest, and investment credit.

On the face of this, it seems like a compromise. Some think we should be satisfied with the compromise. We have some redistribution of income, but not very much, and we have some growth, but the U.S. growth experience has not been very good either.

I think that this has not been a good compromise. I think we have managed to select the worst from each side and snatch defeat from the jaws of victory.

The way I would describe this compromise is starting with this highly redistributive tax system, we provide incentives in the way of exceptions from tax for people who do good things, like invest. The structure of this is the people who would otherwise pay most tax get the most advantage from the exemption.

Basically, we are creating a system which on the face of it seems to tax rich people very heavily and then says specifically, rich people, since we do this through a tax exemption, "we will cut your tax if you do things that we want you to do, like buy State and local bonds, drill oil wells, build machines, things like that."

One reason to say that this is obviously counterproductive is to notice that we are concentrating this investment very much on a small segment of the society. We are basically encouraging rich people to invest. It is rather like an education policy which decided we will give full college scholarships to all high school students who have an IQ of over 130. Pick out the ones who are going to college, and give them the scholarships. Obviously, this is not going to change our college education system very much.

I think that there is an alternative to this way of starting out with a very progressive system and trying to encourage investment by exceptions from that. Basically, it would be an effort to think specifically about devices that encouraged savings and investment by ordinary people.

I think there are a lot of things that one can do in this direction. I will simply describe a couple of them in order to emphasize that this is an approach rather than a highly specific prescription.

One approach is to adopt a sales tax or a value-added tax that is specifically a tax on consumption. Most people react to this kind of a suggestion by saying immediately a sales tax, or value-added tax is regressive, it hurts the poor. This is rubbish.

You can make the sales tax or value-added tax impact on anybody you want it to impact on.

For example, to construct a sales tax, or value-added tax that did not change the progressivity of the present tax system one bit, you could do the following: provide a refund of the value-added tax paid on some basic amount of income, such as the income that you would exempt from income tax.

Above that level, provide that the income tax would be reduced in each bracket just as much as the sales tax was increased, so that you still have the same amount of income being paid in each income bracket, but in every bracket you are telling people that if they save more, their tax is lower; if they consume more, their tax is higher.

I imagine there are some people in the world who want a sales tax because it is regressive. I am not addressing that. I am accepting the fact that in the politics of our current society we want a system that corresponds to ability to pay.

I am simply pointing out to you that you can accomplish this ability to pay objective and still be concerned with the savings and investment. Another part of this approach has to do with the corporation income tax. Many other prior witnesses have talked about the double taxation on dividends. This, to my mind, is an utterly secondary aspect of the problem of the corporate income tax.

By and large our present corporate income tax is structured so that it under taxes the investment of rich people and over taxes the investment of poor people. This comes about because the corporate tax rate itself, and that is the rate on retained earnings, is lower than the top bracket rate for individuals.

This is why people organize a corporation in order to save taxes. This is why you once had subchapter R in the code that permits a partnership to pay tax like a corporation without having to pay the 70-percent returns that would be applicable to earned income.

Notice for a low-income person who would have a marginal tax rate of 20 percent or even 0, you say, if you put money into the corporation, if you buy stock, the return on that money is going to be taxed at 48 percent. That is just a tax at the corporate level and it is going to apply to the retained earnings of the corporation. The double taxation of dividends is an aspect of the whole thing that imposes a penalty on this tax relief, that the investors get through retained earnings. The proper approach to this is one of the proposals that would look to complete integration of the corporate such as the Carter Commission proposal in Canada in the mid-sixty's and not simply one that eliminates the tax on dividends. If you only eliminate the double tax on dividends, you will still have the situation where you are undertaxing high income investors that are enjoying the retained earnings that would increase the value of the stock, and you are overtaxing low income investors.

I think if you really looked at this clearly you would find areas outside of the tax law where our system is presently in a very irrational way penalizing ordinary low-income people who invest.

It should be obvious that, for low-income people, an important component of their savings is deposited in the savings bank and, for heavens sake, we have a law that says you have to limit the return on savings. We make it miserable for ordinary people to save and some say turn around separately and see what we can do to make dividends more attractive.

We offer low-income people a miserable rate of return on Series E savings bonds and spend all kinds of money telling them to buy this lousy deal.

We could, in this way, deal with this very serious problem that this society does want to grow more rapidly. The last portion of my paper offers some arguments as to why I think we should grow more rapidly. I gather from the previous discussion that you are already convinced on this and that there is no need for me to read that part of the argument, but notice the typical pattern of testimony that you get here. It gets rather mixed up, with people who are telling you at the same time that we want to grow more rapidly, I want you to cut my taxes.

After all, we are not in the situation where any one of us can write the U.S. law precisely the way we want it. We are dealing with a coun