The magnitude of future capital investment needs, the projected shortfalls in available capital funds, the impact of inflation, the rapid pace of technological change, and the growing intensity of competition from foreign industries— much of which is subsidized by their governments-pose a tremendous threat to our continued economic well-being.

In its report," the Staff of the Joint Committee on Taxation noted that in the United States most investments are undertaken by private business and individuals. Therefore, a necessary step in increasing the rate of capital accumulation is to make the private sector of the economy more willing to invest in plant, equipment and other types of capital.

Conclusion.-In order to meet the long range challenge thus posed, business must be permitted to develop the capability to more effectively modernize its productive capacity by assurance of the available of an adequate supply of capital funds. Financial Executives Institute agrees with the Staff of the Joint Committee on Taxation in their conclusion that federal tax policy can and does influence the level of capital investment. Financial Executives Institute believes that the most effective way to provide such funds is through realistic Federal income tax treatment of capital costs, from the standpoint both of allowances for capital recovery and of other sources of capital investment, such as reinvestment of earnings.

STATEMENT OF NORMAN B. TURE, PRESIDENT, NORMAN B. TURE, INC., WASHINGTON, D.C. AND B. KENNETH SANDEN, PARTNER, PRICE WATERHOUSE & Co., NEW YORK, N.Y.

The Financial Executives Research Foundation has just published a study on "The Effects of Tax Policy on Capital Formation". We were asked to undertake this study in order to stimulate further serious dialogue about the nature and extent of the capital formation problem. In the study we have attempted to delineate the problem, to establish base line saving and capital requirements for the decade 1976-1985, and to describe and discuss tax changes to meet our saving requirements.

As set forth in the study, without an adequate increase in the stock of private capital, the rate of growth of the nation's economy will falter-employment and real wages will grow more slowly, inflation will continue, and public policy goals will be more difficult to achieve. While labor will be hardest hit, there will be less for all of us to share. As a matter of public policy these results must be unacceptable to all Americans.

Whether we will add enough to our stock of capital over the next decade depends critically on whether we can increase the rate of private saving. What is earned is either spent for consumption or saved for the future. Private capital formation has no source other than saving.

Increasing the rate of private saving enough to meet these private and public goals will require substantial changes in our tax system. The present tax structure exerts a severe bias against saving and capital formation and in favor of consumption. Moderating that bias is essential if the economy is to realize the advances in living standards to which all Americans aspire.

IS THERE A CAPITAL SHORTAGE?

Economists, leaders, and public policy makers differ as to whether a capital shortage exists or is in prospect, and, if so, its magnitude. Maintaining the postwar trend rate of increase in employment, in productivity, and real wages, however, will require maintaining at least the postwar trend rate of increase in the capital-labor ratio.

When adjusted for inflation, profits at current and prospective rates cannot be expected to provide as large a portion as formerly of business saving to finance capital expenditures. Government mandated programs such as for pollution control, however desirable in the long run, add substantially to projected capital requirements, hence compete for the Nation's total saving. This is not to imply a collision course between environmentalists and businessmen but rather a recognition that the saving rate must be increased to encompass the aims of both. In many instances, because of underdepreciation of assets and distortion of inventory values, taxes are, in fact, being assessed on essential business capital. Increases in business saving from more adequate capital recovery allowances and 'Joint Committee on Taxation, op. cit., II, Determinants of investment, 1.

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lower effective tax rates on profits plus increases in personal saving from more nearly neutral tax treatment of saving uses of income are needed if total saving is to be adequate.

With the current slack in the economy and consequent idle plant capacity, some question whether current rates of saving and capital formation are, in fact, inadequate. At issue, however, is whether we will save enough to meet our capital requirements not merely today but over an extended period. Looking ahead 10 years, we should be concerned by the fact that much of the nation's stock of capital equipment is outdated and shopworn; among the industrialized countries, the United States has the highest percentage of obsolete production facilities. We should be concerned about the fact that the U.S. has the lowest ratio of capital investment to GNP and the lowest rate of productivity increase of any of the major industrial nations. Achieving the objectives of high employment and rising real wage rates without inflation, along with numerous other public policy goals, will require us to accelerate modernization and expansion of the stock of capital. Over the next decade, this requirement cannot be met if we pursue policies which encourage us to use ever-increasing shares of income and production capability to satisfy consumption demands.

ESTIMATES OF SAVING SHORTFALL

The critical question is whether the required amount of gross private saving will be forthcoming. Business in the aggregate cannot invest more than people— households and businesses-save. The most optimistic study ("Capital Needs in the Seventies", Bosworth, Dusenberry, Carron-The Brookings Institution, 1975) indicates "... that we can afford the future, but just barely." Given the underlying assumptions of employment, inflation and government expenditure policies, this prophecy requires more faith than most of us would be willing to rely on for guaranteeing the fruitful lives of future generations. Alternatively, more is involved than adding together what business and other groups indicate they would like to have and arrive at a shortfall of several trillion dol ars. In any event, whatever the approach, there is basic agreement that no capital surplus exists and accordingly we are in danger of rapidly becoming underachievers in growth, research and development, new industries and technologies so vital to our economic health.

The analysis presented in this study shows that the accumulated saving shortfall, assuming no change in the price level, will be $816 billion for the decade. At a 3-%-a-year inflation rate, the shortfall would increase to $983 billion and at a 5-percent rate, it would increase to $1,113 trillion.

Capital market adjustments and changes in government deficits or surpluses will not be sufficient to eliminate the saving shortfall in prospect. The primary difference to be taken into account is the capital-labor ratio in the United States which exceeds that of most other countries. This means we must try harder to stimulate capital formation or fall faster if we do not.

TAX POLICY-WORLDWIDE

There has been increasing worldwide recognition that tax policy plays an important role in meeting the challenge of capital formation. Many countries have recently removed impediments in their tax laws or instituted other forms to stimulate saving and consequently capital expenditures. Of all the industria'ized countries, it appears that the United States taxes saving far more heavily than consumption, as follows:

Capital recovery.—Even with the temporary increase in investment credit we are just about tied for last place.

Capital gains.-With few exceptions we tax capital gains far more harshly and, with losses limited and gains taxable, treat investors somewhat as professional gamblers.

Corporate income.-A double tax is imposed on earnings distributed-and even undistributed when capital gains taxes are involved while all other major industrialized countries have some form of relief.

Foreign income.-Constant whittling away from economic neutrality concept while other countries exempt entirely or allow tax credit for foreign levies. Benefits to saving.-No saving benefits while others exclude income from taxation or grant special writeoffs or allowances.

Reliance on income tax.-We rely more heavily on income tax with its bias against saving and investment while other countries are using more nearly neutral taxes such as VAT.

CAPITAL FORMATION AND RELATED TAX POLICY

Adjustment to the U.S. tax system in the foregoing areas would not call for special incentives or loophole parity but rather the elimination of disincentives restricting saving and capital formation.

The time is ripe to begin consideration of a bold new policy which would result in drastic changes in the tax structure of the United States. Included among these changes should be repeal of the corporation income tax and individual income tax revisions to achieve neutrality with respect to saving and consumption. This neutrality can be accomplished by excluding from the base of the tax either the amount of net saving in the taxable year or the returns on saving realized in that year. As a practical matter, a deduction of saving from gross income with inclusion of all the returns on saving in the tax base is more feasible than taxing current saving and exempting the returns thereto.

These basic revisions are so sweeping that there is little prospect for their early enactment. Nevertheless, these concepts provide guides for the consideration of far more limited tax changes which could be enacted in the near term to reduce the bias against saving and capital formation. One or more of the following alternatives are worthy of consideration for early enactment:

1. Provide a capital recovery allowance system for plant and equipment which is not related to useful life of the asset.

2. Make the Investment Tax Credit permanent and increase the rate.

3. Provide inflation adjustments for fixed assets as well as for inventories.

4. Reduce corporate and individual income tax rates.

5. Remove the double tax on corporate profits by providing a deduction for dividend payments.

6. Eliminate the minimum tax on corporations and individuals.

7. Extend the maximum tax rate limitation on individuals to cover income from investments and saving.

8. Substitute a Value Added Tax for part or all of the Income Tax on business income.

9. Permit a limited deduction or credit against income tax for net saving by individuals.

10. Revise the treatment of capital gains and losses to provide a lesser burden relative to the tax on income.

Even within the present tax structure, tax changes considered politically unthinkable a decade ago have become economically indispensable. It is hoped that the analysis presented and the recommendations made in this study will be a positive contribution toward the ultimate solution of this important problem.

STATEMENT OF THE NATIONAL ASSOCIATION OF MANUFACTURERS

The National Association of Manufacturers represents 13,000 members primarily engaged in manufacturing and employing a majority of the industrial labor force in the United States. Approximately 75 percent of our members are small businesses which employ 500 or fewer persons.

The Association is pleased to provide industry's views on the relationship between federal tax policy and economic growth in the United States. Recognizing that the Subcommittee hearings are concerned primarily with significant longterm tax policy issues, this statement will discuss only three major proposals for tax reform-an end to double taxation of dividends, capital recovery allowances, and rate reductions. A number of other changes supported by the Association are listed in testimony submitted to the Committee on Finance during the consideration of the 1976 Tax Reform Act.

I. CAPITAL FORMATION AND ECONOMIC GROWTH

During recent years, capital formation in our economy has become a critical concern. There has been an increased awareness within the business community, within the Federal government, and by the public of the importance of capital formation as the seed corn for future self-generating economic growth which provides new jobs for a growing labor force, higher productivity, and increased real wage rates. An even more important factor of immediate interest is the heightened awareness that we must fuel the production process with increased amounts of net new investment just to stay even in terms of real per capita living standards and to further reduce the level of unemployment.

One factor probably contributing to this increased understanding has been a comparison of savings and growth rates among various industrialized countries. As is noted in the following table, the economies of Japan, West Germany, Canada, and France have devoted significantly more gross domestic product to savings and investment than have the U.K. and United States, and these same economies have grown at a faster rate than those of the U.K. and United States. While there can be other circumstances influencing such relationships, the message should be clear-there is a direct relationship between the level of investment and the rate of economic growth.

INVESTMENT AND ECONOMIC GROWTH: INTERNATIONAL COMPARISON (1960–74)

As concern has grown over the rate of capital formation, various studies have provided quantitative estimates of capital needs for the next decade. The New York Stock Exchange, the General Electric Company, and Chase Econometric Associates have reported results of studies suggesting that there will be a significant gap between the level of investment the economy will need to achieve certain objectives and the level of total savings which can fund that investment. Forecasting such developments over a period of years is not a simple matter, and perhaps too much has been made of some attempts to provide specific dollar estimates. But the basic point remains that the known forecasts indicate there will be very substantial capital requirements in the coming decade not only to keep up some semblance of economic growth, but to account for mandated environmental and personal safety standards and at least to get a start on energy self-sufficiency-and it is unlikely that those requirements can be met unless the general climate for capital formation is improved.

II. TAX POLICY AND CAPITAL FORMATION

Tax policy is a key factor affecting the level of capital formation in the private sector. While not the only factor, it can be critical at the margin and may well determine the success or failure of regaining a better productivity performance and achieving more satisfactory increases in real income for workers.

This critical impact results from the effects tax policy has on available sources of capital. For industry, three sources are: (1) retained earnings, which are affected by the tax rates and depreciation system; (2) equity, which is impacted by the double taxation of dividends and the imposition of capital gains taxes; and (3) debt, which is also affected by the double taxation of dividends.

Congress obviously faces difficult choices in reducing tax obstacles to capital formation, given the context of multibillion dollar federal budget deficits and the concern such deficits raise as inflationary potentials in the economy. The justification for reducing any taxes in periods of such substantial budget deficits is simply the fact that estimated direct revenue impacts do not reflect changes in economic activity which would follow basic tax changes. When a new investment is made and people are put back to work, or new jobs created, as a result of the tax changes recommended, the federal income tax base will grow. The revenue losses are then substantially or fully offset due to the feedback effects of the original tax reductions.

In addition to the particular effects of specific tax policies, the general stability of tax law is a major concern. Uncertainty as to the favorable nature of the general tax climate can affect both the timing of new investments and even the

decisions to make such investments at all. The investment tax credit is virtually the only tax provision enacted in the last twenty years which favorably affects the capital formation process. And it has been suspended, reinstated, repealed, reenacted, raised, and extended six times since its creation. If it were viewed as the capital recovery mechanism that it is, rather than as a fine-tuning device which can be turned on and off at will, its long-term impact probably would be even more favorable than has been the case.

The planning of investment decisions, whether by corporations or individuals, would not be aided by recurring upheavals in tax policy, such as would occur, for example, if various so-called "tax expenditures" were to expire every five years. Such proposals are being discussed, and they pose a significant new threat to investment planning.

III. PROPOSED TAX REFORMS

There are a number of possible tax changes which would, to varying degrees, improve the climate for capital formation. Three are of particular interest, and the NAM strongly favors adoption of any of these proposals either alone or in combination.

Tax Treatment of Dividends

The economy has long endured the double taxation of dividends, first at the corporate level through the corporate income tax on earnings and then again at the shareholder level through the individual income tax on earnings paid out as dividends. Because of this long history, some claim it just doesn't matter. In fact, most efforts to enact relief from such double taxation have fallen largely on deaf ears. Even the very limited 4 percent credit for dividends received by individuals was repealed as part of the 1964 general tax reduction legislation.

Industry believes that it does matter-that the apparent indifference has been a case of growing accustomed to a chronic pain. Perhaps this pain didn't become really noticeable until the equity and new issues markets collapsed in the 1970's. Nevertheless, the problem has been with us right along. One result of such double taxation has been to enhance the appeal of debt financing relative to equity because of the tax penalty imposed on dividends but not on interest. Another has been the diversion of some funds to other forms of investments where the pre-tax rates of return need not be so high as that necessary in industry which generally utilizes the corporate form.

Industry's position with respect to double taxation should be clearly understood-double taxation of dividends is inequitable and economically undesirable, and it should be ended. There are collateral issues which are discussed below, but this general statement represents the policy position of the NAM.

While an end to double taxation is desirab'e, Congress should be wary of packaged proposals which would result in a climate for capital formation worse than that which already exists. "Tradeoffs" for an end to double taxation have become the number-one topic of discussion, and herein lies the concern of the business community. The end to double taxation would be an equitable tax relief action and, taken alone, would be a net benefit to the capital formation process. But, when combined with repeal or restriction of existing provisions which mitigate the adverse effects of tax law on capital formation, the end of double taxation could produce an overall adverse impact. This would not be desirable.

For example, if shareholders were allowed to take a tax credit for the corporate taxes already paid on their dividends but were taxable on 100 percent of the capital gains on sale of the stock, the impact might well be to discourage investment by individuals. From a different perspective, a shareholder credit having an estimated revenue loss of $10 billion, offset by a $5 billion revenue gain from other capital-related provisions, would produce a net benefit only if shareholders reinvested more than $5 billion of their tax savings.

The NAM does not have a preference as to the method used to end double taxation. A shareholder credit attached to dividends or a corporate deduction for dividends paid are the two methods generally discussed, and either could produce desirable results. Whatever alternative is adopted, the fair and equitable ending of double taxation is the primary objective.

Capital Recovery Allowances

While double taxation impacts the creation of capital and the level and form of new investment, existing depreciation policy has a substantial adverse impact on maintaining the real value and usefulness of previously invested capital. When any business asset is purchased, capital is expended. In order to prevent