Decreasing the supply of money is a time-tested and proven way to cure inflation. But it is also a long, painful process when the inflation rate is high; it stifles business activity, creates unemployment, and reduces the production of goods and services. It is something like trying to cure cancer with a very toxic drugthe medicine damages good cells as it destroys the bad. On the other hand, if you attack inflation by creating new goods faster than new money, the whole society would benefit. Unemployment diminishes, real income goes up, and Government revenues rise on the same-or even lower-tax rates. An increase in the volume and efficiency of production requires increased capital investment-money for newer, better products, machinery, and production techniques. The capital to invest must come from savings. Currently, neither business nor individuals are investing and saving enough because of the discouraging effects of high inflation and high taxes, The subjects of which you heard this morning. What are the specific elements of a good supply side-package? The Chamber of Commerce of the United States recommends a Federal tax cut of $25 billion in fiscal 1980, consisting of business investment incentives in the 10-5-3 Capital Cost Recovery Act, an immediate cut in the corporate income tax, and a reduction of taxes on savings and investment income; a cut in Federal spending to 21 percent of the gross national product for fiscal 1981 and 20 percent thereafter; a closer look at the need for regulations that decrease economic efficiency; further long-term tax reductions on labor and investment income; and continued restraint on the creation of new money. That's good advice, and it's all right to enjoy a tax cut fortunately that's not illegal, immoral, or fattening. My testimony was changed in the last few minutes, because many of the subjects were covered earlier by those that are experts in the field. Senator BAUCUS. Thank you very much, Terry, we appreciate your statement. Bob? STATEMENT OF ROBERT H. OAKLAND, CITY MOTOR CO., NADA DIRECTOR, HELENA, MONT. Mr. OAKLAND. My name is Bob Oakland. I am a Chevrolet dealer in Great Falls, Mont., and director of the National Automobile Dealers Association. I would like to thank you for the opportunity to testify on behalf of the new car and truck dealers of Montana. Capital formation to get started in the automobile business or probably most small business has always been a difficult task. The automobile business is probably one of the most difficult because of the high ticket items which we sell and the complexity of our business. To best serve our customers we are in the new and used car and truck business, the parts business, the mechanical and body shop business, the insurance business, the finance business and the lease business. All of these individual businesses have to be financed and each demands sizable amounts of money. With the rising inflation of the last several years the demands for cash have become so great that I feel the "great American dream" of getting started in business and owning your own business is almost gone, unless your family has wealth to help you or you inherit funds. The present laws of our country severely restrict both of these sources of funds, and you alluded to those yourself a little bit earlier. Most dealers I know who started without family help worked for a dealer and saved their money, which in today's inflationary environment is almost impossible. Most received some help from their employer and probably a loan from a commercial bank. If, however, one were able to get into the automobile business and adequately finance it at the start and were successful, it is my understanding that four out of five new small business starts fail in this country in the first year. But let us assume that we are successful, however, and get past the first year hurdle-the problems of retaining enough capital out of earnings to build and grow are enormous if not imposible. If you will excuse a personal reference, I would like to give you some of my own experience along these lines. We have operated what I feel reasonably sure is considered a successful small corporate business for over 19 years. It has never operated at a loss in that period of time. We have always operated with profits at least average in our industry. No dividends have been paid and all of the after tax profits have been used and are used in the business. After almost 20 years this business is still not capable of fully financing the inventories it needs to serve our customers and we must borrow funds. At today's unbelievable rates of over 20 percent for new car floor plan costs most automobile dealers are on the verge of financial disaster. I feel the reference I have given clearly shows that small business is being taxed too severely. I am aware that there have been some cuts in the corporate income tax and they are helpful, but they fall far short of allowing small business to retain the capital needed in the years ahead. Depreciation schedules for buildings and equipment are so low that it is impossible to replace worn out facilities and equipment with new, modern efficient ones at the inflated costs of today. As we look ahead and project our business needs to 1985 I would like to share with you some of my personal thoughts. Preparation to do business in 1985 in the retail automobile business involves three particular facets of any business capital, facilities, and people. I would at this time like to discuss one of these facets-capital. Based on current minimum net working capital standard determinants, my manufacturer estimates that by 1985, not considering inflation, the minimum requirement for working capital could be 78 percent higher than today. By applying a very conservative 8-percent inflation rate per year for 6 years ahead it appears to me my minimum net working capital requirement could be approximately 21/2 times what it is today. At the time I made these calculations in the middle of 1979 I exceeded the then required minimum standard by over 50 percent. Using my best profit year out of 19 years in after tax dollars as a goal for 6 years and leaving every dime of that profit in the business I will not be able to meet the projected minimum capital requirement of my manufacturer in 1985. Again I must say that excessive taxes and inflation are making its impossible to retain enough capital to progress even in a good economic climate. I feel it is only fair to point out that most dealers have been in business for a much shorter time and very few of them would exceed the minimum capital requirement at this time, and probably very many of them would not even meet it all. The situation we find ourselves in at this moment is so near a crisis stage in our business that many Montana dealers are on the verge of insolvency. The unbelievably high floor plan interest rate of 20 percent plus which we are all paying will cause the highest rate of small business failures in our history. Senator BAUCUS. Haven't a couple of dealers already gone under? Mr. OAKLAND. Yes, they have. Senator BAUCUs. Is Billings one of them? Mr. AADSEN. One in Ronan. [Laughter.] In addition we have a statutory ceiling on the interest we can charge the retail customer in Montana. Maximum interest is set by State law at 12.83 percent on a 36-month contract for new cars and trucks. With the prime rate at 20 percent it is becoming almost impossible to finance the needs of our customers as the source of this capital is disappearing. We need immediate relief from the high interest costs. We agree that inflation must be controlled but feel that high interest is itself most inflationary and does not really get at the true causes of inflation. The administration's present fiscal policy will do irreparable damage to the small businesses of this country unless there are immediate changes. Most new car and truck dealers in Montana have record high inventories with extremely depressed sales and many are, in fact, facing inevitable bankruptcy. Some are already there, and you mentioned a few. Senator BAUCUS. Thank you very much, Bob. Mr. Abramson? STATEMENT OF C. E. ABRAMSON, REAL ESTATE BROKER, MISSOULA, MONT. Mr. ABRAMSON. I am C. E. Abramson. I am a commercial-investment real estate broker here in Missoula, and in my capacity as a broker I get involved in a lot of different kinds of business activity in the area, including the startup of new businesses and transactions that involve the change in ownership of businesses. I will limit my remarks this morning, and look forward to the opportunity to answer some questions and make some specific comments on "subchapter S" corporations and other specific issues after lunch. No one has really mentioned yet that the term "small business" has come to being like "capital" itself, a relative term, just as we have recently learned that "high interest rate" is a relative term. In the largest sense, the formation of capital for the start of new, smaller, businesses and for the sale or other transfer of existing businesses is desirable; a lot of incentives with that goal in mind are essential but don't presently exist. One of those incentives would be the elimination of some of the disincentives that exist under current law. That brings us to the transaction cost, chiefly taxes, involved for a person who has started one business, is getting out of that enterprise and starting another business. That is just one example of where there may be an opportunity to provide for either credits upon reinvestment or the rolling over or the carrying over of a basis without taxation, or of a lot of other highly technical possibilities there, but the issue is the same. It is a large one. How does inflation impact on this process, which is our panel's topic here? If I might limit myself to a real estate perspective, I will just suggest that "if there ain't no long term take-out financing, there ain't no venture." It's that simple. We've already heard it suggested that what would be ideal would be equity financing for new ventures, and for the expansion of existing ventures, and not new debt or an expansion of existing debt. What we are already seeing in real estate development, and it hasn't come from within my brokerage industry, but rather from the financers, is a combination of equity and debt financing, or participatory debt financing, and although that looked like it was going to be a good thing for a while allowing people to lend money with the prospect of participating in any profit-I would like to read one paragraph from a letter that I received from a large national venture company within the last month. DEAR ABE: For the past month, our firm has been in the process of re-evaluating our investment strategy as a response to the uncertainty which exists in the money market today. Today's cost for interim financing, coupled with the scarcity of reasonable take-out financing has caused us to decide not to enter into any new projects in which construction must begin during this spring and summer. We have decided to wait on the sidelines for the money market to come under control, rather than starting new projects under such uncertain conditions. In some of the pro forma projections that I see for new businesses and for the expansion of existing businesses--and I am talking about really small businesses in most cases the question that the accountant has to ask for the person who has requested a pro forma statement is, "Can you raise your prices and sales above what would be expected in your industry to pay for your capital goods, including real property and improvements, but also equipment, including replacements?" That really frames the issue. We are going to talk later again, I guess, about depreciation and the possibilities of adjusting capital recovery rates. I don't think that adjusting depreciation rates is an answer to inflation, and it certainly wouldn't counteract in any meaningful way the negative impact that inflation has on the provision of capital-assuming it's already been formed somewhere else, which is what we have to look for in a market like Missoula to new ventures and for the expansion of existing ventures. Back to our topic of inflation per se, the issue isn't really whether some small business person would be able otherwise to service their debt, because under most of the projections that I see, under existing assumptions, they could not, on a separate debt basis, service the startup even with zero inflation. Senator BAUCUS. Thank you all very much. We have a luncheon meeting that we have to get to, so we should probably recess right now. I guess we are not reconvening until 2; but at 2 sharp, we will begin with this panel and begin questions then. [Whereupon, the hearing recessed at 12 noon, and reconvened at 2 p.m., when the same panel resumed its testimony.] AFTERNOON SESSION Senator BAUCUS. Let's get started here. The first question I have really goes to the point you made, Earl, in regard to the multitier interest rate policy. It is an idea that on the face of it seems to make sense to me. Others have talked to me about it as you did this morning, and I guess my question is, how do we go about enacting some kind of multitier policy? Does there have to be any legislative change, or is it change that the Federal Reserve system can or each individual banker can do; or how do we go about it to the degree that it makes overall sense? Mr. JOHNSON. I think the situation perhaps could take care of itself somewhat if the banking community, and in particularly the more rural banks, would understand that this ought to be a way of life. And one of the things that we can do to help control this inflation, for instance, we have competitive forces working within our community, just in the agriculture sector alone, which has a tendency, because of the competition of the PCA, the Federal Land Bank, that type of thing, which will pull rates downward to the farmers just so that we can continue to service our agricultural customers and not have them go over to one of the other financial units to take care of their needs. When it comes in to, like, mortgage money for housing and that type of thing, it would seem to me that as a banking community, we could do something to accommodate that sector, say, in our area, rather than maybe going into a lot of support programs, FHA, VA, that type of thing. It seems like we could make it profitable by handling that within our own community or in Montana in general. I would not like to see the legislation there that says we have got two tiers, three tiers, or this kind of industry; but I think we have made it work in our own areas where we can level and price the loan so that it is profitable, the bank can still serve the various sectors without going to the maximum interest rates that might be allowable. Senator BAUCUs. How do you do it, because I assume that it costs you a certain amount to buy money? Mr. JOHNSON. Right. Senator BAUCUs. I am sure you are generous and altruistic and want to help, but you have to pay a certain amount of expenses. Are you talking about averaging it together? Mr. JOHNSON. We have had to work on a blended rate of our cost of money, and obviously our blended rate is not the prime rate. So, because of the blended rate, I think we could structure and have a various stratus that might take care of these various elements in the community to be served. I don't have any firm thing that you could put in place right now, but it seems it is worth investigating, and we could try it on a voluntary basis to begin with. Senator BAUCUs. My problem really is I believe that at one extreme, specific legislation doesn't make sense, because it is too rigid. The other extreme is say, to let the banking industry do this on its own. My worry is that some bankers will and some won't. In the meantime, some small businessmen are caught. So, what is the middle ground? Mr. JOHNSON. I don't know whether I can really tell you Senator whether there's really a way to do it other than we are getting much more sophisticated in our industry, and our costs of money at the various levels and our various earnings and a lot of this has come through, obviously, computer capabilities. I think that we can, through our various costs of money, the various elements of costs of money, to the checking account, to the highest cost, large C.D.'s. It seems that there is some way we could structure our costs so that we could price our dollars so that the various elements in the community can be taken care of. Our main problem now is that we have competitors on the outside that are intermediating the bank. They are taking the money out of our community, going elsewhere for more attractive rates. Senator BAUCUS. Treasury bills for one? Mr. JOHNSON. Yes; and we are plagued with the money market mutual funds, and I think we are late in getting them under some type |