IBM grew through investment, by institutional investments, at a time when it was a relatively small company. Xerox, the same way. Control Data the same way. Today none of those companies could have gotten up into the top 100 under the prudent man rule under ERISA.

I just make an urgent plea to you to study the testimony and try to keep this one further factor from concentrating all of the money of the power in this country in some 200 corporate hands. I know you do not want that.

Senator BYRD. I certainly do not. I am certainly in agreement with your objective. I think you make a strong case.

As I said, this is a matter for careful consideration. I have some hesitancy in saying on the spur of the moment that the prudent man rule should be set aside, but I think that something needs to be done to accomplish the purpose that you have in mind.

Mr. KRASNOW. If I could add one word. The major problems today in our world society are concentration of power, concentration of assets and resources in fewer and fewer hands. Walter Stults talked about one piece of legislation designed to create safeguards which inadvertently is acting to concentrate these assets.

There are numbers in all the reports that indicate just how fast that concentration is moving. In just 15 years, in the banking structure, the 10 biggest banks have moved from 20 to 30 percent of the deposits within their confines.

I think that there is nothing more antidemocratic than this trend toward concentration of assets in fewer and fewer hands, and it is in small and large acts, not a single act that this trend can and should be arrested.

Senator BYRD. I think you are so right. Government has tended to encourage that. Government laws and government regulation have tended to encourage the concentration of power, economic power, yet the antitrust laws are supposed to be going in the opposite direction. Mr. KRASNOW. They have not been as effective as they should be. Senator BYRD. Beyond the antitrust laws not being as effective as they should be, other laws, particularly tax laws, are forcing more and more concentration.

Thank you gentlemen very much. It has been an interesting and helpful testimony.

[The prepared statement of Mr. Krasnow follows. Oral testimony continues on p. 72.]

STATEMENT OF HERBERT KRASNOW, PRESIDENT, NATIONAL ASSOCIATION OF SMALL BUSINESS INVESTMENT COMPANIES

Mr. Chairman and members of the subcommittee: I am Herbert Krasnow, President of the National Association of Small Business Investment Companies whose more than 300 members represent over two-thirds of all the licensed SBICS and minority enterprise SBICS (MESBICs) and about 90 percent of the assets committed to the industry. For the past 15 years, I have served as the founder and President of Intercoastal Capital Corporation, a medium-sized SBIC located in New York.

On behalf of the SBIC industry, I wish to thank this Subcommittee for turning the spotlight on a little-understood economic problem which threatens to

hobble the vaunted American free enterprise system: an inadequate rate of capital formation. Unless this trend can be reversed, prices and unemployment will both rise; our productive plant will come increasingly obsolete; independent businesses will not be able to expand or to compete effectively; and new businesses will not be formed.

My testimony will cover two broad but integrally related areas. First, I shall discuss the capital formation problem as it affects small business directly. In this subject area I would like to discuss small business's need for additional internally generated funds as well as its need for more long-term debt and equity capital. Second, I shall briefly discuss the SBIC industry and the role we play in captal formation for small business. In both discussions I have included suggestions for legislation which will, if enacted, help to dramatically improve the economic viability and competitive position of all small business in general and serve to significantly increase the amount of capital flowing into the SBIC industry. The latter is desperately needed in order to provide the capital needed to finance venture and equity needs in the small business sector of the economy.

THE SMALL BUSINESS CAPITAL GAP-INCREASED INTERNAL CAPITAL NEEDS

A small business relies on both internal and external funds for financing and expansion capital. Unfortunately, when scarce debt and equity capital is doled out via the traditional financial markets, small business is always at the bottom of the ladder. For that reason, small business has to rely more heavily upon internally generated funds for its financing. These internal funds come, of course, from after-tax earnings which are becoming more difficult to maintain due to the increasingly hard bite of corporate income, and other taxes.

Our first recommendation gets directly to the problem of inadequate after-tax retained earnings and would graduate specifically the first $400,000 of corporate taxable income for all corporations. The following schedule is recommended : Taxable income:

$0 to $9,999__.

$10,000 to $19,999_

$20,000 to $29,999.

$30,000 to $39,999.

$40,000 to $49,999.

$50,000 to $59,999.

$60,000 to $69,999.

$70,000 to $99,999.

$100,000 to $149,999

$150,000 to $199,999

$200,000 to $249,999

$250,000 to $299,999.

$300,000 to $349,999_

Marginal rate

Percent

10

12

14

16

19

22

25

28

31

34

37

40

43

46

48

$350,000 to $399,999. $400,000 and up--

As you can see, the current maximum corporate rate would be reached at $400,00 rather than the current $50,000. Although this reduction would help all corporations, it would especially help smaller companies that do not have large taxable incomes and do rely heavily on every dollar they can retain for financial well-being and long-term growth.

An important concept guiding tax policy is ability to pay. The unintended result of present tax law is that those companies least able to pay (small companies) are assessed a greater percentage of their income in Federal taxes. The following excerpt from the 26th Annual Report of the Senate Small Business Committee portrays the problem in very explicit terms:

Initially, the committee analyzed the Federal Trade Commission Quarterly Financial Reports, which set forth before-tax and after-tax rates of return of manufacturers of many different asset sizes. This yielded a comparison of "effective tax rates" which is set forth below:

COMPARISON OF EFFECTIVE TAX RATES OF MANUFACTURERS OF DIFFERENT ASSET SIZES 1

1 U.S. Congress, Senate, Select Committee on Small Business, 26th Annual Report, 94th Cong., 1st sess., 1975, p. 85.

Smaller companies are not asking for a handout, a giveaway or a loophole. Small business is willing to pay its fair share-but let's not ask for more than that.

Our second recommendation calls for the adoption of simplified and liberalized depreciation schedules which can be used by small companies that cannot afford to hire sophisticated tax lawyers and accountants to help them avoid taxes via the skillful use of existing depreciation schedules. Adam Smith, the father of economics, professed that a tax should be certain, convenient and economical. While it can be argued that the complicated depreciation schedules in use today meet none of those requirements, the third is the impediment to which I feel compelled to speak. It is simply not economical for a small company to keep the records and hire the staff and counsel necessary to utilize sophisticated techniques to depreciate capital investment. Also, it is not ultimately economical for the federal government to police and enforce these statutes. As we all know, the simpler the tax code is made the easier it is for companies and individuals to comply and the easier and cheaper it is for the IRS to collect.

The third recommendation for small business tax policy change we support is one which we are glad to say has already been passed by both bodies of Congress. It is the job creation employment tax credit which will help provide a much needed incentive for investment in increased employment. Few people realize that Small Business not only generates approximately 43 percent of total Gross National Product but also employs 55 percent of the business workforce. Because small business is more labor intensive than business in general, the Employment Tax Credit is very useful to them and will certainly bring about increased employment.

THE SMALL BUSINESS CAPITAL GAP-LONG-TERM CAPITAL NEEDS

I'd like to now turn to an area in which SBIC managers have special experitse: long-term venture (debt and equity) capital financing for small business. As I mentioned before, I am president of Intercoastal Capital Corporation, an SBIC located in New York, and I have been involved in the SBIC industry nearly since its inception. I am convinced that there is a shocking dearth of long-term capital financing for small business in this country. This problem is, without a doubt, one of the most serious in terms of the long-term vitality of our freeenterprise system. We, at NASBIC, have in the past and hope in the future to play a significant role in providing "lifeblood' venture and equity capital financing for independent small business. That sector has fallen increasingly further behind as ever scarcer investment capital is parceled out in the markets. The capital shortfall to small business is directly traslatable into a loss to the American consumer via reduced product innovation and price competition.

We at NASBIC have just fiuished a comprehensive review of our industry and have designed a program which will serve to significantly increase the flow of dollars going into venture capital in this country. I would like to request that the NASBIC Legislative/Regulatory Program for 1977 be included as part of the record if it please the chair. Let me stress also that this will not be a mere

shuffling of scarce dollars from one sector of the economy to another, but rather an injection of vitality into an area which will earn, in the long-run, a fiscal dividend. This is possible since investment in small, fast-growing businesses generates, ultimately, a greater amount of economic activity which in turn provides greater aggregate wealth for the economy and additional tax dollars for the treasury. For example:

A recent study by Massachusetts Institute of Technology Development Foundation has arresting data on the importance of new companies and new technologies to property and jobs in America. It compares the performance of six mature companies, five innovative companies, and five young high-technology companies. From 1969 to 1974, the average annual contributions of these companies in jobs and revenues shaped up as follows:

2

2 U.S. Small Business Administration, "Report of the SBA Task Force on Venture and Equity Capital for Small Business," Washington, D C., p. 2.

Further, one Government study sampled SBIC-financed small businesses and found that those companies achieved annual growth rates of 25 percent for employment, 27 percent for revenues, 27 percent for profits and 35 percent for assets. It must be stressed that these companies are the innovative, high-growth type which have high potential for employment at a time when sustained, excessive unemployment remains one of our country's most severe economic problems. The availability of financing for small and independent businesses is and should be a high priority for a sound national economic policy. Because of high risk and reduced reward (the latter coming from strict government regulation and oppressive tax policies), however, traditional sources of venture capital financing are drying up. This phenomenon prompted the comment by Thomas Murphy writing in the April 15, 1977 issue of Forbes magazine that: "If Adam Smith could return, I think he'd be upset to learn that in a world's biggest capitalistic country the Government has become the biggest venture capitalist." He was referring to the fact that only the SBA loan guarantee program and the SBA-assisted SBIC program are making financing available to much-in-need small business. He goes on to further explain that:

"Roughly half the American economy is small business. It happens to be the half that furnishes most of the jobs everybody says we need entry-level jobs for youngsters service jobs for women and something else that you cannot quantify— it finds places for the millions who don't fit the tidy mold at Xerox and the phone company."

To make matters worse, while venture funds are drying up small companies also cannot look to the public markets where they, once received a great percentage of their funds. The following is a chart showing the number of new issues sold for firms with net worth of less than $5 million for the period from 1969 to 1975:

In addition to small businessmen and venture capitalists, high level business and government leaders have addressed the problem of inadequate internal and external capital financing availability. In May of 1976, Treasury Secretary William Simon appointed the Treasury Small Business Advisory Committee on Economic Policy which recommended, among other things, the implementation of 10 specific tax proposals and further study and consideration in several other

areas:

"Recognizing that Federal taxation has the greatest adverse impact on capital formation for the bulk of all small independent business, the Committee ranked tax policy as its highest priority. In principle, we support H.R. 13687, the COSIBA small business tax bill, but we have focused on several items which we recommend for adoption or study. The first three items constitute the principal recommendations of the Small Business Administration Venture and Equity Capital Task Force chaired by William Casey."

Specific Treasury Advisory Committee proposals included:

(1) Adjustment of depreciation schedules so that a taxpayer would be permitted to write off any amount up to and including 100 percent of an asset value in the year of acquisition (up to $200,000).

(2) Revision of the corporate rates to graduate the tax at four levels with the maximum rate of 48 percent being reached at a taxable income of $200,000. (3) Deferral of capital gains tax if the proceeds from an investment in a qualified small business concern are reinvested in another small business

concern.

In January the Report of the SBA Task Force on Venture and Equity Capital for Small Business was released. That blue ribbon group, chaired by former SEC Chairman Bill Casey, recommended a number of changes which would significantly help the capital-short small business sector. Their tax recommendations included the following:

Tax laws and regulations

"Increase the corporate surtax exemption from the present level of $50,000 up to $100,000;

"Allow greater flexibility in depreciating the first $200,000 of assets; "Permit investors in qualified small businesses to defer the tax on capital gains if the proceeds of the sale of a profitable small business investment are reinvested within a specified time in other qualified small business investments; "Increase the deduction against ordinary income of capital losses in a small business investment made under Section 1244 of the Internal Revenue Code from $25,000 in annual deduction to $50,000, and increase the limit on an offering from $500,000 to $1 million and on issuer size from $1 million to $2 million in equity capital;

"Permit underwriters of the securities of smaller businesses to deduct a loss reserve against the risks inherent in the underwriting and carrying of such securities;

"Revise methods by which revenue impact of tax changes are estimated to reflect revenue gains from the business use of tax savings and the stimulus to capital formation that tax incentives provide."

Expounding upon the lack of external capital available for finance and expansion, the Casey Task Force reported:

"It is alarming that venture and expansion capital for new and growing small businesses has become almost invisible in America today. In 1972 there were 418 underwritings for companies with a net worth of less than $5,000,000. In 1975 there were four such underwritings. The 1972 offerings raised $918 million. The 1975 offerings brought in $16 million. Over that same period of time, smaller offerings under the Securities and Exchange Commission's (SEC's) Regulation A fell from $256 million to $49 million and many of them were unsuccessful. While this catastrophic decline was occurring, new money raised for all corporations in the public security markets increased almost 50 percent from $28 billion to over $41 billion."

Prompted by the deteriorating small business climate and by the disconcerting lack of profitability in the SBIC industry NASBIC produced its 20-point Legislative/Regulatory Package for 1977. I would like to turn now to our industry and the specific tax changes we feel are necessary in order to improve the long-run health and viability of the SBIC industry-changes which, by strengthening SBICS, will ultimately benefit small businesses by strengthening one of their few remaining sources of long-term capital.