Not only do corporations, in general, have more cash flow than they are spending for new plant and equipment, but they are very tight on capacity. Our organization conducts a survey of capacity utilization in each quarter of the year. When we initiated that survey in the Fall of 1974, manufacturing industry was operating at 92 percent of capacity, and there were many industries operating at rates above 90 percent of capacity. According to our most recent survey of capacity utilization, for the month of April 1977, manufacturing was operating at 89 percent of capacity and many industries were operating at rates near or above 90 percent. There is little room left for economic expansion (see Appendix D, Rinfret Associates staff memorandum from Barry Molefsky to Pierre A. Rinfret, entitled "Capacity Utilization", dated June 9, 1977).

For the past three years we have asked ourselves this simple but fundamental question: "If American industry has the cash for new plant and equipment expenditures and they are, at the same time, very tight on capacity, why don't they spend more than they are spending?" What is holding them back?

The paradox is this: industry has the money and the need for more plant and equipment, but the new investment in plant and equipment is not being made. Why not?

Our research reveals some surprising answers to this basic question.

5. FINDINGS

The following are the three most important findings we have made in our research effort to identify those proposals which we "consider as the key to providing for greater business growth and higher employment."

1. Uncertainty

It is axiomatic that the greater the degree of certainty about the future, the greater the willingness to invest, and the greater the degree of uncertainty, the less the willingness to invest.

Business today is based on two major kinds of uncertainty. We may call one the normal, everyday, run-of-the-mill uncertainty and risk of the business world. This is the kind of uncertainty which business is used to and can understand. More importantly, however, business can evaluate this uncertainty with a relatively high degree of certainty.

In the past five years or so, however, a new kind of uncertainty has emerged. I call this the legislative uncertainty. From one day to the next, business does not know nor can it project what new legislation will pass in the Congress and what new requirements will be imposed upon business. Legislation is a shifting sand which is never static, it changes in strange and mysterious ways and, frequently, utterly destroys all earlier calculations of the viability of investments. Here are quotations from our survey respondents regarding the impact of legislative uncertainty on capital investment:

"The most important deterrent to investment in our industry is the absence of stable, realistic regulations. From one year to the next, we don't know what type of product we will be allowed to build-because of the changing safety, emissions and fuel economy regulations, many of them conflicting, and many imposed so late that waste in investment is the inevitable result. The combination of regulatory uncertainty and normal market uncertainty has led us to defer all but the most urgent investments."

"The problem today is one of uncertainty, particularly over energy. If a company wants to build a plant today it doesn't know how it will be heated. The company cannot get long-term commitments for electricity."

"In 1976 the company was interested in a vital nonferrous mineral which is used in nuclear power plants. This would have been a multimillion-dollar project. The company was very interested in this project and a great deal of management time was spent on it. The project was dropped principally because of uncertainties over the outlook for nuclear energy."

"The environment for investment is becoming increasingly uncertain. The future looks scary. Contributing to this uncertainty are Government regulations. The Tris case is a good example of this. First the Government required that Tris be used in children's sleepwear; then it ruled that Tris was unsafe."

"Delays caused by Government regulations and litigation are inhibiting new product development and investment. The time it takes to bring our new products to market has been stretched from three to eight years. The Government's approval process should be accelerated."

"Uncertainty about future tax laws is inhibiting investment now. People won't invest because they are uncertain about what future 'tax reform' will do to the

capital gains tax. They fear even further limitations and reductions. The assumption of worsening tax provisions makes new business formation and growth of innovative scientific companies difficult. For investors it is now more attractive to invest in tax-exempt securities or conservative growth companies than in venturesome new small companies."

These comments about uncertainty, the legislative uncertainty, permeated each and every meeting we held with our survey respondents, Here are the major uncertainties facing American industry today, the uncertainties which reduce new capital formation, reduce venture capital and reduce new expenditures for plant and equipment:

The energy uncertainty.-Energy is a major cost of production. There is no energy policy in the United States. No one, but no one, knows what is going to happen to petroleum prices, to natural gas prices, to nuclear energy, to pollution laws covering the mining of coal, to regulations concerning the flow of intrastate natural gas, to electric power in the Northwest and the Southeast. Business cannot plan because with energy uncertainty there is no base upon which to plan.

The pollution uncertainty.-Pollution laws have had a major impact on the private capital expenditures of American industry. We estimate that about 6 percent of all capital expenditures in the United States are for pollution control. Pollution laws are in a constant state of flux and change. From one day to the next the laws change, and as the laws change the investments to keep pace with those laws also change. It is not possible at this date to build a plant which can anticipate the pollution laws of two to three years hence. The businessman cannot plan on pollution laws because they are constanty changing.

The tax uncertainty.-The investment tax credit was established in 1962. It was suspended in 1966. It was reinstated in 1967. It was repealed in 1969. It was reinstituted in 1971, retroactively. Its suspension was called for in 1972 and 1973 by the Chairman of the Federal Reserve Board. It has been debated endlessly, since 1975. Tax laws are the quicksand of the financial world. They change in every session of Congress. There is no permanency. There is total fluidity. It is impossible to make any rational decisions based upon present tax laws or assumptions about future tax laws.

Why is capital formation inadequate? Why are capital expenditures lower than they should be relative to cash flow? Why has venture capital dried up? There are many answers to these questions but I suggest that a major reason, perhaps the major reason, is that Congress has created a nightmare for American industry in legislative uncertainty. If there is a certainty about laws passed by Congress, it is this certainty: you can be sure they will be changed in the subsequent session of Congress if the laws are in the national domain. 2. Inflation

The tax laws in the United States contain a vital but unstated assumption. This assumption is that there is little or no inflaion to worry about and that economic and financial planning may be based upon the concept of price stability. The tax laws assume price stability and are totally and completely incapable of dealing with inflation.

Inflation has a particularly damaging impact on invested capital. The depreciation laws permit the recapture of historical costs but do nothing about replacement costs. In an inflationary period such as we are in now this guarantees the businessman that at some time in the future he will have to raise substantially more capital than the depreciation allowed on his assets.

"The corporate tax burden has been increasing over the years because inflation has cut deeply into depreciation allowances, which are, of course, based on historical costs. It is essential, we believe, to eliminate this inflation 'surtax' by means of indexing capital goods to reflect replacement costs. We also would strongly support further acceleration of depreciation allowances. This is one of the measures widely utilized abroad, and we believe it helps account for higher investment as a percent of GNP in such countries as Germany, Japan and France."

"We don't have enough depreciation. All non-producing costs should be expensed and immediately tax-deductible."

"*** it would seem that corporate tax relief should not focus on making it more desirable to pay dividends, for example, a tax deduction for dividends paid, but rather stress encouragement to companies. . . to improve [their] capital base. For example, we believe it is imperative that percentage depletion for hard minerals be retained and that the present depreciation provisions be replaced by more realistic, flexible capital recovery allowances for plant euipment akin

to the approach presently following by Canada. We also strongly believe that industry should be allowed current write-offs of non-productive pollution control facilities unreduced by the minimum tax and without affecting percentage depletion deductions."

"A change in depreciation rules should be considered. Either shortening the depreciation period or indexing depreciation to the rate of inflation."

"More specifically, what we are talking about is an accelerated five-year write-off for all tangible personal property and an accelerated ten-year writeoff for all other eligible tangible property, including buildings and structural components. . . . Under a Capital Cost Recovery system, the impact of inflation would be substantially reduced due to the shorter recovery periods. Capital intensive companies, with their ongoing requirements for efficient productive facilities, are those most damaged by inflation as they seek to recover capital expenditures through depreciation deductions taken over the extended useful life of the assets."

Inflation does many things to a corporation. One of the most evil effects of inflation is that industry eats up, lives off, its capital. Inflation results, ultimately, in the destruction of capital because capital is consumed instead of being replaced and increased.

I said earlier that "The tax laws assume price stability and are totally and completely incapable of dealing with inflation." It is worse than that:

Because taxes are paid on an upward-sliding scale, the Federal Government benefits from inflationary increases in income.

Because deductions are based on historical costs, the Federal Government takes in revenue which is the result of the destruction of capital.

Taxes rise as income rises as a result of inflation, but historical cost deductions during the same period become less and less realistic. The tax laws favor the destruction of capital in an inflationary environment.

3. Small business

Large businesses are increasingly concerned that the laws of the U.S. overwhelmingly favor large business to the detriment of small business. Large business wants, desires and advocates a healthy and dynamic small business community. Large business believes that small business should have immediate financial and legislative help for the good of the country.

"We need to encourage the young fellows who are the entrepreneurs, starting businesses as we did in 1939, so they will take risks, borrow money, innovate and start new ventures."

"The young scientists and entrepreneurs who would have started small innovative companies now find it more attractive and secure to seek affiliation with big, mature companies."

"It is important to revert to the earlier tradition-and tax code—that permits entrepreneurs to make money and keep it. Otherwise we will inhibit the growth of small business, of innovative business and curb the vitality of the free enterprise system."

6. CONCLUSIONS AND RECOMMENDATIONS

There could be hundreds of conclusions and recomendations, but I will confine myself to just three. I believe that these three recommendations, if enacted by the Congress, would materially and favorably impact the formation and utilization of capital in the United States today and in the future:

1. The grandfather clause

The Grandfather clause would permit a company to invest or accumulate capital, and the laws that would apply thereafter would be the laws in effect at the time of investment. Consider the utilization of the Grandfather clause in legislation affecting private industry. This would replace uncertainty with certainty. The Grandfather clause would permit industry to invest with known parameters.

2. Capital recapture

Liberalize the tax laws regarding capital recapture. Ways to do it are innumerable, but it should be done and done as soon as possible. The current depreciation and depletion laws should not only be kept but liberalized as well. 3. Small business

This sector of the American economy needs to receive special attention and assistance. Laws tend to favor large corporations. The time has come to give small business preferential treatment.

In conclusion, I believe that our problems of capital formation and capital investment are the direct result of sweeping changes which have taken place in the past five years in the relation of Government to the private sector.

As Congress has closed one so-called "loophole" after another, it has destroyed one capital and investment incentive after another. The legislative uncertainty grows and grows, and in growing it delays the capital investments so desperately needed.

The U.S. Government needs to replace uncertainty with certainty and to create incentives to growth by restoring the capital and investment incentives to taxpayers who now have virtually none. As the "loopholes" have been eliminated, so has the risk-taking, the creation of new capital, the drive to grow.

APPENDIX A

APPENDIX B-1 THROUGH B-3

RINFRET ASSOCIATES, INC.

Short-term Business Study "Resurvey-Capital Expenditures" March 15, 1977 1. On January 31, 1977 we began our resurvey of 1977 capital expenditure plans of private industry. We did the first survey of 1977 capital expenditure plans of private industry in the Fall of 1976 so that this survey is a follow-up of that one. Not only is it a follow-up but it is an update as well.

At this writing we have responses from firms representing about 41 percent of all private capital expenditures in 1976. We will obtain more responses but the current level of responses approaches the significant level. The results we present in this Study are meaningful results but they will change somewhat as more responses come in. The changes, however, are not likely to materially or significantly alter the results we present here.

Herewith the results of this resurvey.

2. Comparison.—In the following tabulation we compare the percentage changes in 1977 capital expenditures as originally indicated by private industry in the Fall of 1976 and as indicated currently (for the Fall of 1976 see our short term business study subtitled 1977 Capital Expenditures dated October 18, 1976). We use the percentage change figures only because there have been changes in the 1976 base figures of the U.S. Department of Commerce.

Point number one.-Industry has raised upwards rather materially capital expenditure plans for 1977.

In the following tabulation we compare the actual dollar figures for capital expenditures in 1976 as reported by the U.S. Department of Commerce in the Fall of 1976 and as reported currently:

Point number two.-Industry fell short of its plans as late as the Fall of 1976 for the year 1976. There has been, in recent years, a tendency for industry to undershoot, to fall short of, its capital expenditure plans. Put that another way: industry tends to plan more than it actually spends. This raises an interesting question: are capital expenditure plans hypersensitive to the state of the business cycle?

Why do we make this point? For the reason that almost everyone tends to forget: capital expenditure plans are not fixed in concrete (no pun intended), they change and are modified. The outlook for capital expenditures in 1977 is better at the moment than it has been but if history is any guide, the year could end up at lesser gains than those now being indicated. That's not pessimism, it's