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In recent months proposals to address double dividend taxation have attracted considerable attention and support from both the past and present administrations, from members of this Committee and the House Ways and Means Committee, from economists, and from the business community.

The Securities Industry Association has long supported elimination of the double taxation of dividends because we are convinced that simple fairness to those who own American companies demands that, but also, because in our professional judgment, there should not be a bias in favor of one type of security over another when we are advising clients seeking to raise capital.

The selection of a specific method of achieving this end, however, is not a simple process and we recognize it cannot be considered apart from other changes in the tax code.

Nonetheless, we are deeply concerned by those proposals which tie the elimination of double dividend taxation to redefining capital gains as ordinary income. Such a proposal reduces one inequity in the tax code by increasing another. If it is inequitable to impose a double tax on corporate earnings paid out in dividends, it must also be inequitable to impose a double tax on corporate earnings retained and reflected in capital gains. Moreover, such proposals could shut off sources of new capital, imposing the harshest penalties on companies which are new, small or engaging in major expansion vital to employment and long term economic recovery.

Tax policy can be a powerful tool to stimulate the investment necessary to promote long-term economic growth and to achieve public policy objectives. There is little doubt that these goals require increased capital investment. Current tax policy has served to retard investment. Therefore, this Nation needs a new tax policy. A tax policy which is based on the simple and equitable principle that corporate earnings should only be taxed once.

Yet we know that efforts to alter the code will be resisted because it is asserted that the benefits of such changes will go only to a limited number of very wealthy people.

We reject the notion that tax policy which fosters investment is merely "welfare for the rich.”

Even with the exodus of equity investors the median stockholder has a family income of just under $19,000.

Millions of lower- and middle-class Americans participate in private and public pension funds which are also major stockholders.

All Americans have an interest in, and will benefit from, the creation of jobs and improved standard of living which can only occur through increased capital investment.

The tax code should not be biased to discourage investment and increase the concentration of equity ownership. We believe that public policy can be furthered by changes in the tax code which will promote investment. We believe that those changes must focus on people-investors as well as on plants and equipment.

In determining what specific changes in the code are needed, we believe it is necessary to assess the effects of any contemplated change either in the capital gains tax or on the taxation of corporate earnings on the following factors:

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Impact on individual investors;
Impact on securities markets;
Impact on mobility of capital;

Impact on corporations, especially those which are expanding and those which are new or small; and

Impact on Federal revenues taking into account the "ripple" effect. The answers to these very important questions can be derived only after the most careful analysis and study.

I hope you will believe me when I tell you that people are looking to you to help solve these twin problems of providing incentives for investment and eliminating the inequity of the double taxation of their dividends. Most people realize it is difficult to devise the precise balance and in fairness, they rely on experts in and out of government to design the solution. But they do want a chance to build for the future and to be treated fairly with respect to their dividend income. Finally, then, the Board of Directors of the SIA is committed to provide its collective best judgment in providing answers to the abovementioned questions. On behalf of our member firms and in the interest of the 25 million individual investors they serve, SIA has undertaken a study of a number of specific proposals which are intended to stimulate investment and promote economic growth. We will be happy to share our conclusions with this committee and the Congress at the earliest possible moment.

Senator BYRD. Thank you. You made a good statement.

The question of double taxation, of course, is a vitally important one. I do not believe you indicated how you would solve that problem, or what recommendation you have in that field.

Mr. O'BRIEN. What I indicated, Mr. Chairman, is that we have studied the three proposals which are set forth in the task force paper and we have not reached a conclusion yet for the reason that the matter is under active study. It is a highly complicated one. I have spent hours studying it myself. I do not pretend to know the answers.

We lean toward one that is a partial integration system rather than a full integration system, but that is the very point, that we have begun work and which we would like to furnish to your committee.

Senator BYRD. The committee would be glad to get your view when you have completed your study. I thought in testifying today that you had a recommendation that you wanted to make.

Mr. O'BRIEN. We have a recommendation with respect to the general principle.

Senator BYRD. As a general principle you favor the elimination of double taxation. That is the general principle?

Mr. O'BRIEN. That is correct.

Senator BYRD. I certainly agree with that but we cannot legislate. on the general principle. We have to have specifics.

Mr. O'BRIEN. We also made one other point in that testimony today. We lean toward the emphasis on the stockholder relief; namely, the elimination of double taxation and the capital gains question as distinguished from the physical side, which is the investment tax credit and things of that nature.

Senator BYRD. How does the investment tax credit fit in?

Mr. O'BRIEN. I think they are different problems. They are meant to have different incentives.

The only point we wish to make is in the former area.

Senator BYRD. Maybe I missed the point. I do not see what the investment tax credit has to do with the question of double taxation. Mr. O'BRIEN. I think they are different. I agree with you; they are different. I think each one provides a measure of capital accumulation. I agree with that.

All I am saying, in terms of emphasis, I would like to see that emphasis placed on the elimination of the double taxation of dividends. That is my point.

Senator BYRD. I understand now.

As I understand it, then, while you have not completed your study, you lean toward a tax credit for the stockholder.

Mr. O'BRIEN. In a way it is in the nature of a partial integration of the corporate tax and the individual tax which we would call alternative 1 in the task force study rather than one which would take into consideration taxation of both the dividend as well as the retained earnings on the grounds that it is conceivable that the stockholder, under that latter approach for integration may end up you used the example yourself with one of the earlier witnesses, he could end up being taxed for a substantially greater amount of dividends than he actually received.

Senator BYRD. Do you advocate that?

Mr. O'BRIEN. I am saying I am leaning toward the former system which is partial integration rather than full integration of the two taxes on the individual and on the corporation. I said what I intend to do is once our study is completed to furnish you with the information on those points.

Senator BYRD. Thank you, sir.

Thank you, gentlemen.

The next witness is Mr. Leif H. Olsen, chairman, Economic Advisory Committee, American Bankers Association.

Mr. Olsen, you may proceed in any way that you wish.

STATEMENT OF LEIF H. OLSEN, CHAIRMAN, ECONOMICS ADVISORY COMMITTEE, AMERICAN BANKERS ASSOCIATION

Mr. OLSEN. Thank you, Mr. Chairman. I have a brief statement. I am going to summarize the statement.

I am Leif Olsen, senior vice president and economist at Citibank in New York and I am chairman of the economic advisory committee of the American Bankers Association, a trade association whose membership includes approximately 93 percent of the Nation's commercial banks. We appreciate this opportunity to testify before your subcommittee on the effect of tax policy on the growth of the private sector of our economy. This is an important issue which has serious implications for the maintenance of the standard of living of all of our citizens. It is also closely tied to the issue of tax reform, and the need to develop an equitable tax system for all of our citizens.

Today, I will make a few brief remarks about monetary and fiscal policy, the effect of tax policy on economic growth in the private sector, and discuss in a general way a few of the key proposed tax changes from the standpoint of this issue only. The American Bankers Association is currently forming a special task force to consider the

multitude of issues involved in various proposals for tax reform. This group will consider the specifics of various proposed tax changes, and help the association form positions on them.

I would ask your permission, Mr. Chairman, to submit for the record the recommendations of this task force.

Senator BYRD. We will be very happy to receive them for the record. [The following was subsequently supplied for the record:] AMERICAN BANKERS ASSOCIATION, Washington, D.C., June 30, 1977.

HON. HARRY F. BYRD, JR.,

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

DEAR SENATOR BYRD: This letter is being written as a followup to the testimony of Leif Olsen on behalf of the American Bankers Association before the Subcommittee on Taxation and Debt Management of the Committee on Finance of the United States Senate on May 17, 1977.

At that time you requested our views on the integration of corporate and personal income taxes. This subject was considered very carefully by a special task force on tax reform that has been assembled by our Association. This task force includes members of our Association's Economic Advisory Committee, Bank Taxation Committee, and the Executive Committee of the Trust Division.

We discussed three methods of integration. First, full integration through the elimination of the corporate income tax, and the treatment of all corporate income as if it were earned income of the shareholders. This proposal has too many problems and should not be considered at this time.

Partial integration was discussed in terms of two other proposals. The first would be to allow corporations to deduct dividends paid from their gross income in their determination of taxable income. This deduction would be allowed for dividends paid to domestic tax exempt organizations, but not for these paid to foreign shareholders unless reciprocal treatment were afforded by treaty. The second method would be to allow shareholders to use corporate tax payments on income paid out as dividends as a tax credit against their personal tax liability, after these tax payments have been included or "grossed up" in their personal income. At the current time, our Association cannot take an official position on any of these methods because we do not know what other proposals will be involved in tax reform legislation. Subject to this qualification, our task force reached a tentative consensus in favor of the dividend deduction method for the following reasons:

1. Simplicity of Administration.-There would be no need to estimate taxes at the time dividends are paid. Shareholders would not have to be re-educated to include the gross-up in income and take the credit. No problems arise from audit adjustments for past years, partial-year share-holders, or the variations between current and deferred taxes. There would be no necessity of elaborate record keeping to ensure the correct treatment of the credit. The records on foreign shareholders are substantially the same as those that must now be kept for withholding tax purposes.

2. Incentive to Increase Dividends.—The dividend deduction approach would provide managers and shareholders with an incentive to increase dividends, thus passing on the tax savings to the shareholders for reinvestment. With a shareholder credit approach, in order for the dividend paying corporation to retain any benefit directly the dividend must be cut, although the shareholder may still receive a higher gross dividend than formerly.

3. Ease of Phase-In.-Under a dividend deduction alternative the phase-in is simple, with the burden of keeping up with the phase-in changes falling on professional managers rather than individual shareholders. It would also provide time for a corporation to change its business mix as necessary to accommodate the increasing deduction.

4. Preservation of Existing Incentives.-Congress has provided a variety of tax incentives to corporations for purposes seen to be of economic or social benefit to the national interest. With a dividend deduction, these incentives are more likely to be preserved than with a shareholder credit, which might be structured in such a way as to destroy the efficacy of present or future incentives to the extent of dividend payouts.

5. Enhancement of Capital Formation.-The dividend deduction approach would generate more capital formation for two reasons. First, the deduction

guarantees a tax savings at the marginal or statutory rate, rather than at some lesser gross-up factor, as might be the case under some forms of shareholder credit. Second, the capital thus formed is automatically reinvested unless dividends are increased; it is likely that somewhat more earnings would be retained than under a shareholder credit system, and thus less would be lost by any propensity of shareholders to spend rather than reinvest dividend income.

In general, we see many advantages to a dividend deduction system although we would not be opposed to a carefully constructed shareholder credit system which took account of the reservations listed above.

We share the concern expressed by many observers about the effects of these proposals on Treasury revenues. Indeed, economic stability will be a crucial element in any program to enhance capital formation. On balance however, capital formation will only be enhanced if the net tax burden on the corporate sector is lightened, and tax incentives are altered to favor capital investment. To accomplish this we urge the Committee to also consider other forms of tax incentives. Areas for consideration might be the investment tax credit, accelerated depreciation, lowering corporate tax rates, and indexing tax rates to account for inflation.

Sincerely,

GERALD M. LOWRIE,

Executive Director, Government Relations.

Mr. OLSEN. The growth and renovation of the capital stock represented by the Nation's industrial plant and equipment, utilities, transportation system and commercial enterprises, is essential to a growing economy. Yet in the first 2 years of the current economic recovery, capital investment has lagged badly.

Part of the reason for the lagging recovery is, of course, the depth of the recession itself. The 18 percent drop in capital spending, like the declines in numerous other sectors of the economy, was the deepest since World War II. The traumas of such a deep recession and the relatively high inflation have caused excess capacity to exist and have bred caution among managers and investors.

The highly cyclical nature of business fixed investment is shown in exhibit III. in which investment is related both to the actual gross national product and potential GNP or the effective capacity of the economy. During this recovery period, only about 8.5 percent of the economy's potential output has been devoted to replenishing and expanding the Nation's capital stock-the lowest proportion since the 1958-62 period.

Another factor inhibiting greater capital investment at this time is the large amounts of unutilized or underutilized capacity in many lines. The average utilization rate in American industry during the first quarter was 81 percent of capacity, up substantially from the recession low of 71 percent but still below the level of utilization which would normally trigger a new wave of capital expansion. In fact, because of increased uncertainties today, including environmental considerations, pollution requirements, safety regulations, et cetera, the trigger point may have moved higher than the 82 to 84 percent level which has normally set off waves of capital expansion in the past.

The basic uncertainty to be resolved before making an investment. decision, is, of course, the rate of return that can be earned on that investment. Today's uncertainties over both costs and prices are amplified by uncertainties over regulatory and tax matters. In addition,

1 See p. 141.

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