First of all, in suggesting tools, if I may use that term very loosely, for the improvement of our situation the only one that you have suggested, I believe, is the money supply should be permitted to grow at a 6-percent rate. At least that is one of the clear suggestions you have made.

Do you have any other tools to suggest?

And in that regard let me be the devil's advocate for a minute. In our attempts to redirect the use of our financial resources, what about using our tax policy, such as, setting a limit on the deductibility of interest based either on rate or amount?

We acknowledge today that commercial enterprises, industry, and so on, can afford to pay 10, 11 percent for their money, because they are doing the very thing you have said. They are getting a deduction plus they are by inflation reaping a gain there. So in effect the money is costing them very little.

What about the idea of putting a limitation upon the deductibility of interest?

Mr. EISNER. Yes; I think something of this kind would be a step very much in the right direction. Of course, when one makes a drastic change in the system, one has to try to think through the various consequences.

If one merely said that interest were no longer deductible, this would involve a substantial loss for very many people.

Now, one thing to do perhaps-and I am saying this without any study-one thing to do would be to substitute for the interest deductibility on homes some kind of a flat subsidy. I mean, one can figure on the average how much tax saving there is in a person investing in a home. It is not only actually the interest deductibility on what he borrows but the fact that by putting money into a house he really gains income from living there which is not taxable. It is not even reported as income, which would be taxable if he kept his money that he put into the house in a bond, for example.

What one might do is end deductibility of interest payments but then substitute some kind of a flat subsidy based on the value of a house so that the average homeowners would not suffer. If you simply ended interest deductibility, unless you had some kind of particular bonds you have in mind in limiting it, you might generally penalize homeownership, which would not be my purpose.

Mr. BROWN. No, I am suggesting that you set a rate limit for interest and any amount paid in excess of this rate would not be deductible. In other words, on the outstanding indebtedness, you would be entitled to deduct interest at the rate of 7 percent, regardless of the rate paid in excess of 7 percent. If business wants to pay 11, they do not get the advantage of the deductibility of the extra 4 percent of interest they pay. This would lessen the attractiveness for the commercial enterprises to engage in such borrowing.

It seems to me that through our tax policy rather than through controls we can have a much greater impact without the psychologically or emotionally disturbing things that come with controls. We can do much through use of incentives, even through use of a negative incentive proposal. We have done it with the investment tax credit to try to increase and expand activity.

I think some of you who are testifying before the committee, may have suggestions regarding such tools which we as members of the committee and of the Congress would find very valuable.

Let me turn to another aspect of your statement that I just don't understand. You have said, and I am quoting, "That well over 70 percent of every dollar will continue to be devoted to the military."

Now, I confess that I have not had an opportunity to date to even reasonably familiarize myself with the President's budget, but I do recall him being quoted some place as saying this is the first time in many years that a greater proportion of the Federal dollar will be devoted to nonmilitary usage than to military usage.

Mr. EISNER. Yes. I appreciate the chance to clarify that, Mr. Brown. The point is that my statement refers to the projected Federal expenditures for goods and services, and indeed I think this is a most significant thing on which to focus.

There is a good bit of confusion sometimes compounded by referring merely to the total budget of some $200 billion, because a lot of that is simply what we call transfer payments, taking from one hand and giving that to the other. So, for example, a major element of that is merely the social security payments and then the social security receipts which in a sense cancel each other out and involve some redistribution, if you wish, from the young to the old but do not have any overall impact on the economy. The economy would be the same if people insured for their old age by going through private companies. It would not change the allocation of resources.

So the major direct impact on the economy on the part of the Federal Government, comes from its purchases of goods and services. And if we look at that we see that the Federal Government in 1969 was estimated to have purchased $102 billion of goods and services, of which $79.3 billion, about 77, 78 percent went to national defense.

Now, the budget reductions, or implied reductions for this calendar year are in the area of perhaps $79 billion to maybe $74, $75 billion at most as far as I can make out and total Federal expenditures would still be in the area of a hundred billion. So I would say roughly about 75 percent of Federal expenditures for goods and services would be for the military.

Now, if you want to look at the whole budget picture, the whole $200 billion, you might add in, for example, the veterans payments. You might add in the payment of interest on the debt which is almost exclusively from wars. And then you might recognize that a large part of the rest is money which is simply coming in in social security payments and going out, and coming in in medicare and going out. So I would stand by that "over 70 cents of every dollar," and that is your real problem.

I am always rather perplexed by, on the one hand, the admirable congressional insistence on keeping Federal expenditures down and the failure to face the fact that the great bulk of Federal expenditures for goods and services are in the military. I am delighted that this administration is finally making some beginning in cutting military expenditures, but expert opinion has indicated that they can be cut

much more. And I call your attention to the article of Mr. Carl Kaysen of the Institute for Advanced Study at Princeton, a former assistant National Security adviser, who has pointed out that the military budget could well be cut to $50 billion some time in the 1970's if one merely decides what programs are desirable in the national interest and then goes about doing it with no less whatsoever to national security and, in the opinion of many, some increase in security.

Mr. BROWN. Mr. Eisner, just one further question.

In your statement you have expressed "general sympathy," with the apparent objectives of H.R. 11. I am not sure what you mean by "general sympathy." Certainly I don't believe you mean that you would favor making the Federal Reserve Board subservient to any President, do you?

Mr. EISNER. Well, this is a ticklish one. As a matter of principle, I find it hard as an economist to defend a situation where the Government can be going in two directions at once. We might decide the Government should have virtually nothing to do with the economy, should do nothing in the way of monetary or fiscal policy, and, of course, some people advocate that. I am not one of those, although I recognize many imperfections.

But if you grant the Government should act, then it seems rather foolish to say that the Treasury will do one thing and the Federal Reserve can do something else.

Now, I grant you that occasionally you are better off that way. If one is clearly doing something wrong and the other refuses to go along, you might on occasion find you are better off with this canceling each other out, but it is a hard thing to defend in principle. So I said in principle I am in agreement with the coordinating of the two and in principle, also, I am in agreement with removing or reducing the influence of private banks or the banking system on the Fed, and that again this is something in the public interest.

I do not think the Nation's bankers have any unique right to influence the economy, and therefore this should be publicly controlled, and I understood-I read provisions of the bill directed toward that purpose. I think in large part, of course, the Fed is publicly controlled as it stands, but to the extent this will serve to accentuate that it seems to me to be a step in the right direction.

Mr. BROWN. I like your analogy of the tight money policy being like squeezing the balloon.

If we are going to do something in the way of restricting, I mean tightening monetary policy at all, don't we have to do something like I have very casually suggested, for example, a limitation upon deductibility of interest payments, so that we don't through our tight money policy force the money into those channels that we are trying to restrict?

Now, don't we have to take two things into account? In other words, don't monetary policy and fiscal policy-I am speaking of fiscal policy in the way of taxation and expenditure policy-don't they go hand in hand and don't we have to combine these activities rather than using one and not effectively using the other tool?

Mr. EISNER. Yes, I would agree. But I would emphasize that we should ease the tight money in general.

Mr. BROWN. Thank you very much.

Thank you, Mr. Chairman.

Chairman PATMAN. Mr. Chappell?

Mr. CHAPPELL. I have no questions, Mr. Chairman.
Chairman PATMAN. All right, sir.

Well, thank you, gentlemen, very much. Your testimony was very fine. It will be very helpful to the committee.

Mr. CUMMINGS. Mr. Chairman, I raise one issue which did not come up. I think one of the factors that adds to the cost of low- to moderateincome housing is the building codes in effect in many communities. And I might suggest that this is something this group might want to look into.

Chairman PATMAN. Would you be willing to extend your remarks on this and give us the benefit of your views about it in addition to what you have said?

Mr. CUMMINGS. In writing, sir?

Chairman PATMAN. Just attach it to your transcript when you look it over for approval.

Mr. CUMMINGS. All right, sir.

Chairman PATMAN. And if you desire to elaborate on questions that you did not elaborate on, why you may do so in your testimony when you approve it for printing. You may do the same thing, Mr. Eisner. Mr. CUMMINGS. Thank you, Mr. Chairman. (The information requested follows:)

REPLY RECEIVED FROM MR. CUMMINGS

The present housing crises is compounded by the inability of developers and builders to be able to produce housing in the $15,000 to $16,000 range as previously stated. The high cost of labor, materials and financing precludes the possibility of economically building houses in this price range. It is becoming increasingly apparent that if we are to address ourselves to the problem of furnishing housing for low and moderate income people, we will have to look for sources other than the custom-built home. These sources will be principally in the areas of pre-engineered and factory-built houses which will be shipped in sections over the roads to the individual house lots. This type of construction will have the capacity to produce housing at a lower cost than the custom-built house. One of the existing problems which has considerably slowed progress in these areas are existing stringent building codes in effect in many communities. These building codes, which to a large degree have been fostered and supported by the various trade unions, prevent any significant sales of the factory-built home. In the next few years the Congress and the home building industry including the manufacturers, the trade unions as well as municipalities will have to reach some accommodation with each other. When this is done and many of the existing codes are relaxed and the manufactured homes industry is expanded, the possibility of mass producing homes to be sold in the $15,000 to $18,000 range will be greatly enhanced.

Chairman PATMAN. The committee will stand in recess until 10 o'clock tomorrow morning.

(The following article was submitted for the record by Professor Eisner :)

[From the American Economic Review, December 1969]

FISCAL AND MONETARY POLICY RECONSIDERED

(By Robert Eisner1)

Does the 1968-69 period of continued inflation in the U.S. economy in the face of higher tax rates and a huge swing from budget deficit to surplus prove that fiscal policy is impotent? One-third of a century after Keynes' General Theory are we to return to the policy prescriptions of a crude or sophisticated-quantity theory of money? Is salvation yet to be found in a restrictive monetary policy which has sharply reduced the rate of growth of the money supply to some 3 percent per annum, seen bank prime rates rise to 8 percent, rates on top corporate bonds to over 8 percent, and average mortgage yields to 7 percent?? All this coincides with relatively full employment-a seasonally adjusted unemployment rate of 3.6 percent in June 1969 and, after over a year of the 10 percent income tax surcharge and perhaps nine months of tight money, accelerating price inflation now approaching an annual rate of 6 or 7 percent.

We shall argue in this paper that contemporary economic theory implies severe limitations in the effectiveness of both tax policy and monetary policy in curbing an inflation brought about by high government expenditures, such as are typically related to war. In so doing, we shall review the balanced budget theorem in light of the permanent income hypothesis. We shall also review monetary theory in terms of interaction of wealth and liquidity factors in current demand.

1. WEAKNESS OF COMPENSATORY TAX POLICY

The balanced budget theorem indicated that, with appropriate ceteris paribus assumptions, an increase in government expenditures for goods and services matched by a corresponding increase in tax revenues will under certain circumstances imply an increase in the new equilibrium level of national income equal to the increase in government expenditures (and taxes). A ready implication of the theorem is that an increase in government expenditures at full employment would have to be matched by a somewhat greater than equivalent increase in tax revenues, or a tightening of monetary policy, if inflation is to be avoided. Conversely, of course, to maintain full employment in the face of a fall in government demand for goods and services, there must be a greater than equivalent reduction in tax revenues and/or an easing of monetary policy. Applying a very simple example of the balanced budget relation to the problem of maintaining aggregate demand constant, since the multiplier effect of an increase in government expenditures for goods and services is 1/1-b while that of an increase in taxes is -b/1-b, the increase in taxes necessary to counterbalance a one dollar increase in government expenditures must be 1/b, where b is, of course, the marginal propensity to consume.

Inflationary ills of the last several years in the U.S. economy are, consistent with the analysis above, frequently traced to the major escalation of Vietnam war expenditures beginning in 1965, unmatched by a reasonably prompt tax rise. Over the years from 1965 to 1968, indeed, Federal expenditures for national defense rose from $50.1 billion to $60.6 billion to $72.4 billion to $78.9 billion, or from 8.6 percent of 1965 Gross National Product (GNP) to 9.2 percent of an already inflated 1968 GNP. The surcharge of 1968 is estimated to have amounted to somewhat more than $6 billion in personal income taxes and probably came to another $4 billion in increased corporate income taxes plus a few billion more in the accompanying extension of certain excise rates. Operating on the apparent assumption that much of the increase in defense expenditures had already been absorbed in the real and inflationary growth of the economy, some observers ascribed the failure of the tax increases of 1968 to curb further inflation to a

3

Professor of economics, Northwestern University, and research associate, National Bureau of Economic Research. The author is most grateful for comments by the Editor, Frank Brechling. Otto Eckstein, Walter D. Fisher, Milton Friedman, Sherman J. Maisel, and Charles L. Schultze on an earlier draft of this paper. They are, of course, all absolved of responsibility for any of the current version with which they are in disagreement. 2 The Federal Reserve Bank of New York reported in August 1969, While there are suggestions of slowing in some sectors of the economy, there is little evidence that financial restraint has as yet sufficiently dampened the excessive pace of economic activity." [11, p. 155.]

[10, p. 463.]