some key aspects of the problem. I think it fair to say that there is today, much wider acceptance of the theses that:

(a) there is a need to accelerate the rate of growth of our capital stock; (b) government policies-not only the general tools of economic stabilization, such as monetary and fiscal policies, but also regulatory and tax policies-play a key role in determining the rate of capital growth;

(c) encouraging the rate of capital growth involves, importantly, the removal of impediments in the saving/investment process as well as the development of new inducements to higher levels of saving and investment. Before turning to aspects of the problems on which there is less agreement, let me address what I think are the principal factors underlying these three generally accepted theses.

Recognition of the need to accelerate the rate of capital formation has been spurred, in recent years, by increasing evidence that productivity in the U.S. economy has deviated significantly below the earlier long-term growth trend. Ultimately, the increase in real returns to the factors of production, that is, the possibility of raising everyone's living standards, depends on the growth of output per unit of input. This sets the limit for our society as a whole. Disturbingly, in the past decade, the rate of gain in productivity has slowed significantly, limiting the possible growth in living standards and contributing to upward pressure on prices.

A substantial growth in productivity, averaging 2.9 percent annually in the nonfarm business sector, was a major contribution to the low inflation rate of the 1956-66 period. The data for the last decade, however, indicate that productivity increased at an average of only 1.5 percent per year. For the private sector as a whole, labor productivity growth was slightly more rapid because of a continued shift of employment out of agriculture into the nonfarm sector, where labor productivity is higher. However, a significant decline is equally evident for the private sector as a whole.

Of course, the decade of the mid-1950's through the mid-1960's was a period of rapid economic growth, terminating in a year of exceptionally high resource utilization. In contrast, the latest decade includes two severe recessions, and terminates in a year of low resource utilization. But even after adjustment for cyclical influences, it appears that the secular rate of productivity growth slowed perceptibly after 1969.

This slowdown in productivity growth has been attributed to a variety of causes-reduction in the workweek, slower growth in productive capital per worker, shifts in the composition of output to low productivity sectors, shifts in the composition of the workforce toward workers with less experience and fewer skills, and to a miscellany of other causes. For the most recent years, the drop in productivity after 1973 can be explained by the impact of the energy crisis, and the subsequent rebound in productivity in the past two years to the normal cyclical effects aocompanying the economic recovery that began in early 1975. But these fluctuations have occurred around a level far below the longterm trend growth rate extrapolated from the experience of the 1950's and 1960's.

It is clear that no one factor satisfactorily explains the slowdown in productivity gains. But I am persuaded that the slower growth in the capital stock per worker has been one of the most important factors. I should hasten to emphasize that this has not been so much the result of a slowing in the rate of growth in the capital stock per se. There is some evidence that in recent years, the capital stock has grown at a somewhat slower pace than earlier, but the principal factor in the declining capital/labor ratio since 1969 has been the sharp acceleration in the growth of the labor force. In other words, we haven't been creating the tools of production as rapidly as we have been creating workers willing to use them. The amount of capital per member of the labor force grew by 3 percent per annum in the first two postwar decades. So far in the 1970's, the amount of capital per worker has grown at only half that rate.

The implications of such a trend are disturbing, not only for the effect on inflation of reduced productivity but also for the substainability over the longer term of an adequate growth rate for the economy as a whole. The benchmark study of the capital requirements of the U.S. economy, undertaken by the Department of Commerce two years ago, concluded that to assure a 1980 capital stock sufficient to meet the needs of a full employment economy, business fixed capital investment would have to absorb some 12 percent of real GNP in the second half of this decade. So far into the period, that is, in 1975 and 1976, fixed

investment has been less than 10 percent of real GNP, so the gap to be filled in the remaining years would require an even faster rate of growth in additions to our capital stock than was postulated in the study.

In summary, then, we need more capital formation, both to restore productivity to the growth track of the 1950's and 1960's and also to provide the tools of production for a full employment economy in the 1980's.

What private and public policies can facilitate the needed growth in capital formation? The answer was best put, in my judgment, in a report issued last October by the Fifty-first American Assembly, when a distinguished group of academic, business, labor and government leaders met to consider the capital needs of the United States. The final report of the Assembly noted: "The single most important means of encouraging investment expenditures is to combat economic instability and inflation.”

Wide fluctuation in economic activity induce excessive caution in investment decisions. After all, whatever else may be done to increase the cost effectiveness of new investments, entrepreneurs have to have confidence that a market will be there for the products that will be produced in the plants in which they are investing. Instability in the economy breeds uncertainty, and uncertainty diminishes investment propensities.

Inflation and expectations of inflation are also adverse to investment. Businessmen no longer rush to accelerate expansion plans to "beat the price rise"; the experience of recent years has taught that by the time a new facility launched in the feverish atmosphere of inflationary momentum is likely to come on a stream, a post-inflation recession will probably have dried up the intended market. And consumers have long displayed the wisdom of reducing major outlays when inflationary forces gather momentum.

The major contribution of public policy to capital formation, then, is the creation of a stable and noninflationary economic environment. The Carter Administration has expressed its dedication to this objective. The actions taken by the President to date to insure noninflationary growth, and the President's commitment to pursue this course into the ftuure, should provide confidence to businessmen and consumers that the economic environment will be propitious for capital formation.

There are, in addition to the pursuit of macroeconomic policies conducive to investment, specific policy areas addressing the capital formation problem. Principal among these is the tax structure. As this Committee knows, the Treasury has under way a major reexamination of our tax system, with the view to proposing to the Congress significant revisions. That study is not yet comlete. However, it will be submitted sometime this summer or early fall; every effort is being made to reach conclusions as soon as possible.

Over the years, there have been many proposals for modifying the tax structure to enhance incentives for adding to our capital stock. The excellent study prepared by the Joint Committee on Taxation, released last month, classifies these proposals under six broad headings: proposals for the integration of corporate and individual income taxes, investment tax credits, modification of depreciation allowances, changes in the corporate tax rate, deduction of losses, and indexing for inflation. Each of these approaches, individually and in various combinations, is being carefully assessed.

The criteria that are being applied in the Treasury's evaluation of all revision options relate to three general considerations: simplification, equity and economic effectiveness, particularly in enhancing capital formation. The need for simplification is self-evident to anyone who has struggled through the preparation of an income tax return. It is only about a month since many of us have had to suffer through this annual exercise in frustration. But the complexity of the return is a function of the complexity of the law; simplification of the law will permit the design of a form more easily comprehended by the bulk of taxpayers. The need for equity is also self-evident. Our tax system is unique in the extent to which it depends, successfully, on the voluntary participation of those subject to the system. That success can be maintained only if all taxpayers are convinced that the burden is being shared on an equitable basis. Equity considerations require correction of imbalances in the present tax structure that may be penalizing one form of income-generating income as against another, individual taxpayers as against businesses, small enterprises as against larger firms.

The need for an economically effective system, particularly one that facilitates capital formation, is evident from the analysis advanced earlier as to the

economy's need for an accelerated rate of investment. One aspect of the tax structure with particular relevance to the problems of adding to our capital stock is the impact of taxes on the form of financing new investment. Our financial system is justifiably renowned for its capacity, scope, richness of form and resiliency. It functions with remarkable efficiency in gathering the savings of the public and transforming these into the means of financing private investment. Nevertheless, there is concern that the availability of financing-in both appropriate amount and form-is, or could become, an impediment to the necessary growth in our capital stock.

One fundamental problem is the tilt of the system toward financing through debt instruments. Savers appear, in general, to prefer acquiring financial assets of fixed nominal value and fixed income return-a preference that persists despite the postwar erosion in the purchasing power of fixed-value claims. Moreover, our present tax system encourages the financing of investment through debt instruments.

Over the longer run, this is not the ideal arrangement; there are limits to which it is prudent or even feasible to pile increasing amounts of debt on a very slowly growing equity base. A debt-heavy financial structure increases the vulnerability of the business enterprise to cyclical fluctuations in income. It limits the venturesomeness of investment, for lenders cannot in good conscience underwrite the risks appropriate to an equity participant. And it inhibits economic growth because growth depends very much on willingness to risk investment in new products and new processes.

Moreover, the emphasis on debt financing raises particular problems for smaller and newer enterprises, which often lack the track record necessary to attract adequate amounts of financing from lenders, and must therefore fight for access to pools of equity financing.

Many proposals have been advanced to modify the tax structure in order to achieve more even-handed treatment of alternative means of financing investment. These proposals are all under active study.

As the Committee can well imagine, such a comprehensive assessment of the tax structure as is now under way is no mean task. Within each broad category of tax modification proposals mentioned earlier there are many variants to be pursued. There is a decided lack of unanimity among economists as to the economic "pay-off" of the various alternatives, and reasons for these differences in view must be explored. Foreign experience with some of the alternative approaches must be evaluated in terms of their possible relevance to U.S. problems. The relationship of the various alternatives to the tax measures and innovations incorporated in the National Energy Plan must be assessed.

Finally, the consistency of various alternatives must be established with the Administration's goals of reduced unemployment, reduced inflation and a balanced Budget by fiscal year 1981. I might note, in concluding, that achievement of these goals depends importantly on maintaining a high rate of growth in investment over the balance of the decade. The Committee can be assured, therefore, that the tax revisions recommended will contribute to this objective.

Senator BYRD. The next witness is one who has been before this committee many times, one in whom the committee has a high regard, and one in whom the committee has great confidence, and the committee is most pleased to welcome back Mr. Alan Greenspan, the former Chairman of the Council of Economic Advisers.

I want to welcome you, Mr. Greenspan, both on behalf of the committee and on behalf of myself. I am personally very pleased to see you again. I appreciate your coming here today. You may proceed as you wish.

STATEMENT OF ALAN GREENSPAN, FORMER CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS

Mr. GREENSPAN. Thank you very much, Mr. Chairman, especially for those kind words.

To save the committee time, I would like, if I may, to briefly outline the content of my formal statement and request that the full document be submitted for the record.

The issue which I think is critical to these hearings-and perhaps to national economic policy more than most of us are aware, is the need to create improved incentives for capital investment in this country.

If one looks across the spectrum of the major industrial countries of the world, what strikes you most is the extraordinary shortfalls that now exist with respect to real investment, not only in the United States, but also in virtually every industrialized country in the world.

We are increasing our investment rates at the moment, but even as we are doing that, they are still far less than what we would normally expect, granted the levels of economic activity, granted the levels of capacity utilization, granted the levels of profitability.

Clearly, something is wrong. My suspicion is that this deficiency in investment, and therefore, in real income growth, is caused by a massive increase in uncertainty.

Senator BYRD. A massive increase?

Mr. GREENSPAN. A massive increase in uncertainty, a shortfall, a failure, deterioration in business willingness to invest, particularly in longer lived capital assets. The reasons for this, Mr. Chairman, are, I think, fairly obvious but the solutions are not.

First, it is clear that inflation and the great instability that it has generated, both in this country and around the world, has increased the risk premiums employed in evaluating projections of future profitability. Most business investors, and most corporate planning committees have a sense of instability and frenetic activity about the future that, requires that they increase the prospective rate of return on any new facility in which they will invest.

In a sense, the required rate of return has obviously risen, and risen quite signficantly, which means that any particular project that is evaluated for investment must look a lot better than it used to before business will invest in it.

Second, we have had a dramatic increase in regulatory change. There are two ways of looking at this question. One is, to look at the costs of the new regulations as they embody themselves in the costs of production. This is a calculable number and one which I do not believe very greatly inhibits capital investment. It does in part, but not greatly.

What does, is the rapid changes in regulation and the uncertainly that most businessmen feel about what new regulations will be put in place.

The most recent example, in my view, is the proposal put forth by the current administration with respect to energy regulation. It is stated, I think in many respects probably correctly by the administration, that the incentives built in to their recommendations with respect to the expansion of crude oil supply are probably quite significant; they say that there will be, in a sense, free market prices for a number of types of so-called new oil.

It you read the regulations, that is what it says.

The problem, however, is that most everyone has become sufficiently

sophisticated to know that if you have a regulatory apparatus in place whose legislative requirement is to make regulations, it is also in the business of making them and changing them and making new ones. It is indeed the rare, regulatory apparatus which creates a whole series of regulations and then self-destructs.

Therefore, even though it is true at the moment that we are looking at a proposed set of regulations that creates large incentives for a number of various types of oil projects, the risk that those regulations will change before the investments were put in place, certainly before the returns have been derived from those investments, is perceived as very large.

Parenthetically, I find it rather odd, if the administration is willing to bite the major bullet on the oil issue, namely proposing oil product prices go to world market levels through taxation, why it does not argue for full decontrol.

If you eliminate the regulatory apparatus through decontrol, then you remove the latent uncertainly that these regulations will be easily changed.

This is a very major issue which I do not believe has been sufficiently focused on. This energy proposal has in it essentially world oil prices for consumers, and very substantial taxation to do so. Even though I would not necessarily approve of this, but if the administration had recommended complete decontrol and 100-percent taxation on old oil, they would get the same tax revenues, the same prices for consumers, and very substantially increase the incentives, merely because the regulatory apparatus would be disengaged in the process of decontrol.

I choose this particular example, Mr. Chairman, because we do not realize, I believe, that we are moving toward more and more uncertainly creation within the Federal Government, through continuously changing regulation. I fear that rather than resolve the major energy problem in this country we will impede it. Increasing rather than decreasing regulation is the wrong way to go.

It may well turn out that there is in fact-very little in the way of crude oil reserves still to be discovered.

But granted our problems, we cannot afford not to turn every single knob that we can find to enhance our capacity to achieve these additional reserves.

The concern we have of oil companies' profits is an issue I do not think we can afford. Energy policy in this country should be largely, if not wholly, focused on what is good for this country, what is good for our economy, what is good for the American people, not what is good or bad for the oil companies.

Assailing oil companies and oil company profits, it is a luxury that I think we, as a people, cannot afford. There is too much at stake here to be concerned whether something is good or bad for the oil companies. The criteria should be whether it is good or bad for the American economy and the American people.

Senator BYRD. I think so. If you broaden the scope beyond the energy question, beyond the oil company problem, let me ask you, what two or three steps in the tax bill do you think the Congress could take which would be the most effective in encouraging capital formation?