certain source of all. The former system of taxing only half of any gain realized was designed to reflect the uncertainty of gain.

Although many companies, as a result of the 1976 tax amendments and new proposals for still higher taxes on capital gains, may be totally unable to sell any new equity, for other companies the market mechanism will adjust stock prices downward to offset higher capital gains taxes upon individuals. If the selling price of new equity is below book value, the original holders will suffer dilution of their investments, a consequence not conducive to further equity sales. In any event, there will be continued flight of capital from the equity markets, lower stock prices for many corporations and a reduced level of jobcreating equity capital investment. Investment strategists at banks and investment bankers report that this trend is underway.

I recommend two courses to Congress and the Administration:

First, just as the capital gains tax on a home may be deferrable, I suggest that the tax on the gain from sale of equity securities be deferred if the individual, within ninety days of receiving the proceeds of sale but within the same tax year, reinvests those proceeds in other equities. Individuals presently achieve the same result through their tax-exempt pension funds. Why protect saving in one from and penalize it in another?

Second, repeal the punitive taxes on capital gains which consume up to 49,125 percent of gains and erode our base of "seed corn available for replanting" and, instead, institute a capital gains tax having a maximum effective rate of 35 percent upon a one-year holding period, reducing to 25 percent upon a five-year holding period. Proportionate tax reductions should be made for lesser amounts of capital gains based on the same timetable.

If we don't reduce the present penalties upon capital gains, we shall all be losers; but the greatest losers will be those trying to enter the labor force over the next several years and finding jobs unavailable.

Senator HARRY F. BYRD. Jr,

THE BUSINESS ROUNDTABLE,
New York, N.Y., July 19, 1977.

Chairman, Subcommittee on Taxation and Debt Management, Senate Committee on Finance, Washington, D.C.

DEAR MR. CHAIRMAN: I am pleased to enclose a set of the tax papers prepared under the auspices of The Business Roundtable and respectfully request that they be included in the printed record of the hearings recently conducted by your subcommittee on the impact of taxation on the economy

As you probably know, Mr. Irving Shapiro, Chairman of The Business Roundtable, is also Chairman and Chief Executive Officer of duPont, and Reginald Jones, Co-Chairman of The Business Roundtable is also Chairman and Chief Executive Officer of General Electric and Chairman of The Roundtable's Task Force on Taxation.

Sincerely yours,

Enclosures.

JOHN POST.

CAPITAL FORMATION

A NATIONAL REQUIREMENT

Over the long-term, increased productivity is essential to sustained economic growth, the battle against inflation and continued improvement in the standard of living of the nation's citizens. Productivity improvements, in turn, are dependent upon and are a function of the level of investment in productive capacity. Although a higher rate of capital investment does not guarantee lower rates of inflation, there is a close correlation between the rate of capital investment and increases in a nation's productivity and its standard of living.

U.S. private investment and economic and productivity growth rates lag

A study released April 1, 1975, by the Office of Financial Analysis, United States Treasury Department, provides compelling evidence that the United States needs more favorable tax treatment of capital investment to improve its competitive position vis-a-vis its principal international competitors The study, which covered the years 1960-73, showed that among the principal industrialized countries of the world the United States ranked at or close to the bottom in all

of the following: Investment as percent of real national output; economic growth rate; and productivity growth rate.

The Treasury data compare each country's nonresidential fixed investment rates, expressed as a percent of Gross Domestic Product, and real growth rates, during 1960-73, and rank each accordingly:

NONRESIDENTIAL FIXED INVESTMENT RATIOS AND GROWTH RATES OF REAL OUTPUT, 1960-731

Data apply to 1961-73 and are not strictly comparable to data presented for other countries.

As the foregoing data indicate, there is a strong correlation between high investment ratios and high growth rates.

The extent to which the United States trails in productive growth is illustrated by the following chart (which is based upon Treasury Department data and represents an updating of the data included in the April 1975 study):

The Treasury study acknowledges that factors other than fixed capital formation also contribute to productivity and real economic growth. However, the study notes that even after allowing for these other factors, there would still remain large benefits to productivity resulting from larger growth in the stock of fixed capital.

The study concludes that the falling share of United States resources allocated to investment has:

Lowered rates of advance in living standards of the average consumer in the United States.

Created shortages in basic materials industries during periods of economic expansion.

Added substantially to the inflationary pressures in recent years.

Limited job opportunities because had the growth of plant and equipment exceeded that of the labor force, more jobs would have been required to utilize that increased capacity.

The study also concluded that the policy implications for the United States to attain greater productivity growth from this source would require some alteration in the nation's consumption and saving patterns and point towards encouragement of capital formation by minimizing tax disincentives, use of accounting methods which adjust earnings for replacement cost of capital and elimination of tax barriers to the flow of capital into productive uses.

Need for capital formation

The report on "Tax Policy and Capital Formation", prepared for the use of the House Ways and Means Committee Task Force on Capital Formation by the Staff of the Joint Committee on Taxation (April 1977) commented on the critical importance of capital formation as a source of economic growth as follows:

"When a society accumulates capital, it foregoes current consumption in order to provide a higher standard of living in the future-through construction of plant, equipment and housing, accumulation of inventories, discovery and development of mineral deposits, research and development of new products and processes and improvements in the skills and health of workers."

The report identified several reasons to be concerned about whether the United States will have an adequate amount of capital accumulation, including:

There are several national goals whose fulfillment would require high levels of investment. These include: Housing; environmental standards; energy independence; occupational health and safety standards; and rebuilding many parts of the large cities.

In the past decade, there has been a significant increase in the rate of growth of the labor force which has not been matched by a corresponding increase in the rate of growth of the amount of plant and equipment. As a result, the growth rate of the amount of plant and equipment available for each employee has declined significantly. This has reduced the growth of labor productivity and the decline in the growth rate of productivity has reduced the growth rate of real wages.

The report, citing a recent study by the Congressional Budget Office, measures these disturbing trends in investment and productivity as follows:

The growth rate in the amount of private plant and equipment (excluding pollution control investments) declined from 4.3 percent per year in the period 1965-70 to 3.3 percent per year in 1970-75 and can be expected to decline further to 2.5 percent per year in the period 1975-77.

The growth rate in the amount of such plant and equipment per worker fell from 2.6 percent in 1965-70 to 1.6 percent in 1970-75 and is expected to decline further to only 1 percent in 1975-77.

The growth rate in worker productivity fell from 2.4 percent in 1965-70 to 1 percent in 1970-75. (To some extent, this resulted from unusually low productivity in the recession year of 1975, but inadequate investment in plant and equipment was also a major factor.)

The estimated contribution of increased plant and equipment to the increase in labor productivity fell from 0.9 percent per year in 1965-70 to 0.4 percent per year in 1970-75 and is estimated to be only 0.2 percent per year in 1975-77.

Noting that, without major structural changes in the economy, the growth rate of real wages over the long run is determined primarily by the growth rate of productivity, the study concludes that:

"The recent slowdown in the growth rate of the amount of plant and equipment per worker and the resultant slowdown in the growth rate of labor productivity, therefore, have contributed to the extremely sluggish growth in real wages in recent years. (Since 1969, real hourly wages in private nonfarm employment have grown by only 5.2 percent, less than 1 percent per year.) To the extent that workers have responded to what they perceive to be an inadequate growth in real wages by demanding higher money wage rates, the rate of inflation has increased. More capital accumulation would raise real wage rates and could also reduce the rate of inflation."

Need to create more jobs

Another major reason for capital formation is the need to equip a rapidly expanding labor force. The ability of the country to create jobs and reduce unemployment depends on its ability to equip its workers with the tools of production; the dimensions of the problem are as follows:

The civilan labor force is expected to rise from 93 million in 1975 to 103 million in 1980 and to 110 million in 1985.

This is an average annual increase of more than 1.5 million workers to be equipped.

The total investment required to equip these new workers, as business attempts to continue providing higher quality, more energy efficient equipment (at higher prices) in order to increase productivity, will require huge amounts of capital spending.

A comprehensive Commerce Department study (December 1975) concluded that the U.S. needs to devote 12 percent of its real GNP to business fixed investment during the period 1975-80 to achieve the following minimum economic and employment goals by 1980: Create enough jobs to reduce unemployment to 5 percent; Improve productivity and real wage gains; Meet the requirements of environmental legislation currently on the books; Keep the 1980 share of imported oil from rising above the 1973-74 proportion.

However, between 1965 and 1974 business fixed investment averaged only 10.5 percent of GNP and during 1975 and 1976 it averaged only 9.3 percent. Based on this record, it should be obvious to even the most casual observer that the required levels of investment needed to attain these minimum economic and employment goals cannot be achieved without new and effective investment incentives.

Impact of capital spending on employment

Some critics argue that increased capital spending will aggravate rather than alleviate unemployment. They reason that increased capital spending means increased investment in labor-saving equipment and this in turn will lead to further unemployment. This view was responsible, at least in part, for the jobs credit provisions of the Tax Reduction and Simplifications Act of 1977.

Although this view may have superficial appeal, those that argue this case are ignoring the facts; historically, increased capital spending consistently has led to increased levels of employment in the private sector. The close correlation between capital spending and private sector employment is clearly illustrated by the following:

Capital
Spending

Percent

20

Capital Spending versus Private Employment
(percent change from prior year)

1950-1976

Private
Employment

Percent

15

10

5

0

5

10

5

4

3

2

1

1

2

3

1976

Source: U.S. Department of Commerce and Labor.

Furthermore, increased capital spending permits industry to manufacture goods at prices which will be lower relative to increased income. This will leave the consumer with more income after purchasing manufactured goods to purchase services which, in turn, will create more jobs in service related industries. Plant capacity and unemployment

Another way to view the effect of capital spending, or lack thereof, on employment is to examine the relationship between idle plant capacity and unemployment.

92-201 O-77 - 31

*Forecast based on assumption that capacity grows at same rate as in 1971-76 and real GNP grows 6 percent per year from 1976:4 to 1978:1.

Source: Federal Reserve Board and Bureau of Labor Statistics (Historical Data).

In considering the implications of the above chart, one might be tempted to describe the current stock of plant and equipment as adequate. However, it is important to keep in mind that, although indicated idle capacity in 1968 and 1973 was 13.2 percent and 12.3 percent, respectively, the economy was operating during both periods at close to full effective capacity. Much, if not most, of the idle capacity in those years was comprised of over-aged and inefficient equipment and facilities which were maintained for standby use only in emergencies or to meet other special situations. As a result, and particularly in 1973, as the nation's utilization of its plant capacity approached 90 percent, inflationary bottlenecks and shortages, as noted previously, occurred in a number of key industries.

However, in both 1968 and 1973, the nation's stock of plant and equipment was such that as the capacity utilization rate approached 90 percent, or effective capacity levels, the jobless rate declined to 3.4 percent in 1968 and 4.8 percent in 1973. This picture has now changed. As a result of the lag in capital investment in recent years, it now appears that the country will run out of capacity before it runs out of unemployment. This may be as early as the end of 1978 when, according to some forecasts, the economy will again hit "full" capacity (utilization rate approaching 90 percent) and "bottleneck" situations may again occur. However, the unemployment rate then is expected to be still above 6 percent. This means that it can no longer be assumed that an economy operating at full capacity will result in full employment.

Present economic recovery

The lag in capital spending has continued during the present economic recovery and represents the principal weak spot in the present economic outlook.