Mr. SMITH. You would be very hard-pressed in Fairfax County today to find a lot that would be less than $20,000. It is extremely difficult to find that. Mr. SUMICHRAST. You cannot find any lot, unless you go way out to Frederick. Senator BYRD. I was in Williamsburg over the weekend. While I did not go to the new development outside of Williamsburg, some of my friends did. They told me the lots were selling there for about $50,000. Mr. SUMICHRAST. That does not make sense. Senator BYRD. Senator Curtis? Senator CURTIS. I was interested in what you said about subsidized housing. What types of subsidized housing? Mr. SUMICHRAST. Section 8. Senator CURTIS. What is the other? Mr. SUMICHRAST. Section 235. Senator CURTIS. What is the difference between 235 and 236? Senator CURTIS. Have you written any 235's? Mr. SUMICHRAST. There are no 235's being built now. Less than 1,000 last year. At the peak, there were as many as 330,000 built in a 3-year period, a little over 100,000 a year. Mr. SMITH. We have never built any. Senator CURTIS. The program had a lot of problems. There could be, on one side of the street, someone paying for their house in a conventional way with a neighbor with a 235 house with similar income, very similar and the purchaser of the 235 house had a very substantial subsidy. Mr. SUMICHRAST. That was one of the problems. The biggest problem with 235, was actually, in the existing houses not in new, where a lot of speculation was done. Detroit was one area where a lot of people made a lot of money and a lot of people were actually put in jail as a result of it. In the new housing, 235 was a fairly successful program. The problem you mentioned was one of the major problems. Senator CURTIS. What made it successful? Did poor people actually get them? Mr. SUMICHRAST. No, not poor. The typical buyer of 235 had an income of about $7.500. The typical public housing income was about $2.200. The typical-203 being nonsubsidized income was about $14,000. It was about one-half or two-thirds what the typical unsubsidized FHA housing was, only one-half of what the typical family income today for new homes is $21,000. People with medium or average incomes do not buy new homes. The people have typically double incomes and make more money than the average family makes. The average family income is about $14,750. The people who buy houses do have about $7,000-$8,000 more income. Senator CURTIS. I was very critical of that subsidizing. It was very expensive for the Government. It was a good bargain for the person who got it, but terribly unfair to their neighbors who had to pay for it in taxes. Mr. SUMICHRAST. The 235 program was a cheap program compared to 236. Senator CURTIS. It may have been, but it gave a portion of our people treatment that they did not give to the great number of people who do not buy a house. Mr. SMITH. Another problem with these particular programs is that they tend to be funded in the down cycle. By the time they work their way through the legislative process and become funded and HUD finally gives the OK on them, we are probably coming out of the cycle and they are used as a stimulus to the economy. They are placed on the industry while the industry has already recovered. Probably they should be initiated in the legislative process when the industry is at its very peak. When we are at the peak, we know we are going to come to a valley. By the timelag of delay, getting our program involved, it will be a year and a half. That is when you need it the most. Mr. SUMICHRAST. We expect a decline in production next year. We should be working on to help us do something next year when the interest rates will go up, when the mortgage money will dry up and the construction will start declining. Senator CURTIS. Thank you, Mr. Chairman. Senator BYRD. Thank you very much, gentlemen. You have pointed out to us that the housing industry is very important to the economic growth of the country. Our next witness is Edward I. O'Brien, president of the Securities Industry Association. He is accompanied by Stephen Small, assistant vice president and legislative counsel for legislation. Please proceed, Mr. O'Brien. STATEMENT OF EDWARD I. O'BRIEN, PRESIDENT, SECURITIES INDUSTRY ASSOCIATION, ACCOMPANIED BY STEPHEN SMALL, ASSISTANT VICE PRESIDENT AND LEGISLATIVE COUNSEL FOR LEGISLATION Mr. O'BRIEN. Mr. Chairman, my name is Edward I. O'Brien; I am president of the Securities Industry Association. Accompanying me today is Stephan K. Small, assistant vice president and legislative counsel for taxation. SIA represents approximately 550 leading investment banking and brokerage firms headquartered throughout the United States which, collectively, account for approximately 90 percent of the Nation's securities transactions conducted in this country. The business of our members includes retail brokerage conducted on behalf of 25 million shareholders, institutional brokerage, over-the-counter market making, various exchange floor functions, and underwriting and other investment banking activities conducted on behalf of corporations and governmental units at all levels. I wish to commend the committee and its chairman for their decisions to hold hearings on incentives for economic growth. These hearings provide a timely and welcome opportunity to reexamine the effect of the Nation's tax policies on the process of capital formation. Moreover, the hearings permit public comment on various proposals before specific legislation is introduced. In the thousands of miles that I travel throughout this country each year, I have the opportunity to speak with many investors, large and small, as well as the heads of corporations, institutions, securities firms and salesmen. I am very much impressed with the tremendous interest on the part of citizens of all types on the overall subject of our economy, the need for prudent fiscal budgetary management of the Nation's resources, and the recognition that we need to build our capital and our well-being in the future. There is also a strong tide in favor of providing equity or fairness for the average shareholder who is, by and large, not a person of substantial means. This desire for fairness is, in great measure, reflected in the area of dividend taxation and incentives for investment. People tell me from across the country that they wish to see some material steps taken to relieve the double taxation of dividends as well as to enable them to share in the country's growth through stock ownership. We believe that strong and stable growth of the Nation's economy is a prerequisite to the expansion of job opportunities for a growing work force, to the resumption of world leadership in the standard of living enjoyed by Americans and to the availability of a sound tax base for revenues to support needed government services and national defense. We are gratified to note the growing consensus that such essential economic growth is best achieved through greater capital investment in the private sector. And many regard a major revision of the tax code as it applies to capital formation as the best way to spur the stable economic growth we need. National leaders in both the public and private sector have called attention to the need for Government action to encourage capital investment. Consider the following: Tax stimulus legislation presently pending in the Congress contains incentives for business to expand hiring. The Joint Economic Committee published a staff study last year which focused on the need to broaden stock ownership. Senator Humphrey and Congressman Rostenkowski have introduced legislation (S. 1055, H.R. 5359) which would establish a national policy "to provide sufficient incentives to assure meeting the investment needs of private enterprise." Treasury Secretary Blumenthal in several speeches has stated that one of the administration's goals will be to encourage increased investment in order to provide jobs and higher productivity. The House Ways and Means Committee published a Task Force on Capital Formation which recently published a paper, Tax Policy and Capital Formation, discussing a number of approaches to increase investment. The Americans for Democratic Action have called for elimination of the corporate income tax. The previous administration published Blueprints for Basic Tax Reform which included as part of one sweeping proposal the integration of individual and corporate income taxes. Importance of the individual investor. Effective solutions to capital formation must recognize the importance of the individual investor as a source of new capital. I must tell you in candor that I believe that there is a false notion prevalent with respect to shareholders and stock ownership, which seems at least to shy away from tax incentives for individual shareholders as preferential for a segment of our society. In fact, there are about 25 million human beings who own shares of stock and most of them have made these investments for the long term, for retirement, for the education of their children, or to share in the growth of the country. These 25 million people are, in many respects, in the forefront of our economic system in that they are investing in that system, and they should be encouraged. Certainly, they should not be discriminated against. Unfortunately, many of the studies of capital formation have practically ignored the investors' role in this process. For example, the report entitled Tax Policy and Capital Formation prepared by the staff of the Joint Committee on Internal Revenue Taxation, restricts its discussion of capital investment to physical capital-plants, equipment, housing even though it acknowledges a relationship between financial and physical capital. While it is important to focus on plants and equipment, we believe it is equally important to focus on people, who, as investors, are needed to provide the dollars for capital investment. There are three fundamental reasons for our urging this special emphasis on the individual investor : Individual investing on a nationwide scale provides broad public support for the system of private enterprise in this country. More, not fewer, Americans should have a direct ownership stake in the success of that economic system. This goal is fully consistent with the economic as well as the democratic political traditions of this Nation. Individual investing on a wide scale provides a sound means, perhaps the best means, for improving the mobility of capital. Incentives at the corporate level help existing businesses regardless of their needs whereas providing incentives directly to individuals permits their savings to flow wherever the needs and opportunities are most attractive. It is noteworthy that major industrialized countries enjoying greater growth than the United States all provide more favorable capital gains tax treatment than does this country. Individual ownership, if encouraged, will slow the steady, inexorable trend toward institutional ownership. If ownership of our corporations continues to concentrate in a relatively small handful of giant institutions, our system will become more like that of Japan or Germany and will have lost one of its unique attributes. Economic concentration of this type will have a further negative impact on the ability of credit-worthy but smaller companies to meet their capital needs. A tax system which imposes a greater burden on individual investors than on institutions exacerbates this problem. Regrettably, a look at the current American shareholder census reveals that the ranks of the individual supplier of equity capital are shrinking. During the first half of this decade, there has been nearly a 20-percent reduction in the number of shareholders. Approximately 6 million individuals have left the equity markets. Today there are only 25 million shareholders compared with 31 million in 1970. Several factors contributed to this phenomenon. Soaring inflation rates were a severe blow to equity investment, and concern about possible recurrence continues to inhibit investors. Economic policies compounded uncertainty by veering from stimulus to controls and back again. During the early 1970's, the level of personal savings dropped severely. Harsh changes in tax policy accelerated the flight of equity investors and inhibits their return. I shall elaborate on the latter point. Tax Policy and Capital Formation cites studies showing that "an individual's choice between various assets is quite sensitive to the after-tax yields he expects to receive on the assets" and that "tax incentives for personal saving do not significantly affect the amount of such saving, but do affect its composition." The recent recovery in the level of personal saving has not prompted a return to equity investment. We believe one must look to the treatment accorded equity investment by the tax code for an explanation of this situation. The erosion of capital gains provisions and the continuation of double taxation of dividends have served to discourage equity invest ment. The willingness of millions of Americans to invest depends on a favorable risk/reward relationship. By their mass desertion of the equity markets, millions of Americans have signaled a consensus that the relationship is seriously imbalanced. There are many factors involved on both sides of this equationmany of which are not solved by legislation. But a singularly important factor, affecting both risk and reward, is amenable to legislative remedy. That factor is the tax treatment of capital gains. In the past, the United States and other industralized countries have taxed capital gains differently than income. We believe this distinction is sound and economically justifiable. During the last 8 years, however, this distinction has been dramatically eroded. In 1969 the Congress increased the tax rate on capital gains from 25 percent to 35 percent and added capital gains as a tax preference item subject to the minimum tax to raise even higher than the effective capital gains tax rate. Again, in 1976, both the increase in the minimum tax rate plus the reduction in the credit for other regular taxes paid further diminished the positive effects of the capital gains tax. Moreover, in addition to practically doubling the capital gains tax rate-reducing the reward the Congress has also doubled the element of risk. As a result of the Tax Reform Act of 1976 extending the holding period, by next year an investor will have to remain at risk 1 year before qualifying for capital gains treatment. In addition to these tax increases or disincentives-which in themselves could scare off already reluctant investors, current tax policies result in double taxation of corporate earnings paid out to investors as dividends. This situation not only is inequitable to the investor and the corporation, but also has created a dangerous bias in favor of debt over equity financing. Debt now accounts for 55 percent of the total capitalization of all nonfinancial corporations. Indeed, the double taxation problem is the major focal point of Tax Policy and Capital Formation, which notes that current law "encourages that use of debt finance relative to new stock issues, since interest payments are deductible and dividends are not. More debt increases the risk associated with corporate financial structures because firms must meet higher fixed charges for interest and face greater risk of bankruptcy." |