Let us now turn to Treasury and maritime policy.

These are some of the major international economic issues that have required our attention.

I would now like to attempt to address some of the issues directly related to maritime policy set forth in your subcommittee's letter of invitation.

Let me clearly address a central issue at the outset. The Treasury Department accepts that a strong merchant marine, adequate to the needs of our national defense, is necessary; and that, in order to sustain such a merchant fleet, subsidies are also necessary. That is well-established administration policy and it is not a point at issue at the Treasury.

Accepting then at the outset the national defense basis for the merchant marine program, I will turn to some of its economic aspects.

EFFECT OF MARITIME SUBSIDIES ON THE BALANCE OF PAYMENTS

The positive effects on the balance of payments of the maritime subsidy programs are difficult to quantify precisely, but our present analysis indicates that they are small relative to other transactions. I might say, Mr. Chairman, we have tried hard to do this kind of analysis. We were unable to find precedents for it, but we did put in a good deal of effort in trying.

Mr. DOWNING. You mean you were unable to find precedents within the Department of Treasury because there have not been studies made. on this since the American subsidy program was first initiated?

Mr. VASTINE. That is right, Mr. Chairman. We have not given specific attention to this problem before.

The use of maritime subsidies results in an initial positive contribution to our international accounts in two ways:

1. Foreign exchange earnings by U.S. vessels; for example, vessels manned by U.S. personnel and constructed in U.S. shipyards, carrying U.S. exports, and freight between foreign ports; and

2. Foreign exchange savings by the use of United States than than foreign vessels for carrying U.S. imports, and by the building of U.S. ships.

This initial positive contribution is, however, partially offset by other, related transactions. These must be taken into account. That is because what is relevant to the balance of payments is the net foreign exchange receipts to the United States resulting from a maritime. transaction, subtracting the costs incurred abroad (fuel, costs of loading and unloading, repairs, salaries spent abroad by U.S. crews) from the gross receipts.

Earnings of foreign carriers of U.S. merchandise exports and imports are in part offset by similar expenditures of those carriers in U.S. ports.

Because of these offsets, our transactions for ocean transport of freight to and from foreign countries were not badly out of balance as demonstrated by the table on page 11.

[The table referred to follows:]

Mr. VASTINE. We have attempted to make an estimate of the effect on the balance of payments of eliminating the operating and construction subsidies. In principle, the annual direct effect of the current subsidies on international transactions would be approximately equal to:

1. The wages paid to foreign crews which would replace U.S. shipboard personnel in the absence of operating subsidies-only wage payments would be transferred overseas, because other shipping costs, such as port and fuel charges, are not transferred if a foreign-flag ship is substituted for an American one.

2. The cost of buying abroad the ships which, without the subsidy, would otherwise be built in U.S. shipyards.

Mrs. SULLIVAN. Mr. Chairman, I wonder if we could have the gentleman read just a bit slower?

We have not had a chance to see this statement beforehand. I think this is one of the most important things that we want out of the witness, and I just think he is going a little too fast for anyone to digest it.

Mr. VASTINE. I will be glad to start over again.

Mrs. SULLIVAN. Is that satisfactory to you?

Mr. DOWNING. Yes; and I think since the statement is so important that you better read it in its entirety.

Mr. VASTINE. Shall I begin again on page 9.

Mr. DOWNING. Go to page 10 with "We have attempted to make," and take it from there.

Mr. VASTINE. Yes, sir. We have attempted to make an estimate of the effect on the balance of payments of eliminating the operating and construction subsidies. In principle, the annual direct effect of the current subsidies on international transactions would be approximately equal

to:

1. The wages paid to foreign crews which would replace U.S. shipboard personnel in the absence of operating subsidies-only wage payments would be transferred overseas because other shipping costs, such as port and fuel charges, are not transferred if a foreign-flag ship is substituted for an American one.

2. The cost of buying abroad the ships which, without the subsidy, would otherwise be built in U.S. shipyards.

According to Maritime Administration data, the total wages of subsidized U.S. crews are approximately $300 million a year. Since

the subsidy averaged some 72 percent of their wage rate, we assume that foreign crews would cost about 30 percent as much.

The direct outflow as a result of switching to foreign crews instead of subsidizing U.S. crews would therefore be approximately, we estimate, $100 million a year. This total should be modified slightly since foreign crews would spend some of their earnings in the United States, and U.S. crews now spend some of their earnings abroad.

The contracted value of U.S. ships being built with construction subsidies, and scheduled for delivery in 1975, 1976 and 1977, is approximately $2.8 billion. The subsidy rate averages about one-third of the contracted value of these ships so the cost of purchasing abroad would be about $1.9 billion, or about $600 million a year.

The $600 million a year figure might be higher than normal because of the sudden increase in shipbuilding following the 1970 amendments to the Maritime Act. This figure might also be lower in the future since about two-thirds of the vessels on order are tankers, which are now in worldwide surplus.

The total balance-of-payments saving of the operating and construction subsidies thus totals about $700 million a year for the next few

years.

If the current merchant marine subsidies were removed, the U.S. deficit in ocean transportation would increase from the present $100 to $200 million a year to $800 to $900 million a year. This is clearly a very rough approximation, and is probably an outside limit.

In the context of the current international monetary system, the net impact of the maritime program on the foreign transactions of the United States would tend to be reflected in the dollar's exchange

rate.

Were the operating and construction subsidy programs ended, the value of the dollar in the foreign exchange market would readjust to the new level of the U.S. international receipts and payments.

In other words, in the absence of shipping subsidies, our net foreign expenditures would initially rise somewhat, and other things being equal, the exchange rate would have a tendency to decline and estab lish a new equilibrium.

The likelihood that the maritime program would affect the exchange rate of the dollar depends on the relative size of the net flows ascribed to maritime services and the construction program. In our overall balance of payments picture, they are quite small.

The estimated balance of payments savings from the subsidy was estimated at $700 million, only about 7 percent of total U.S. export earnings, which last year was about $100 billion, and only 35 percent of total U.S. import-export trade.

Other factors, such as United States and foreign interest rates and levels of economic activity, are thus much more significant in determining the foreign exchange value of the dollar than maritime subsidies.

In conclusion, considering (a) the relatively small magnitude of the balance-of-payments contributions from foreign shipping in comparison with other components of our balance of payments and the forces that affect it and. (b) the offsets which have to be taken into account, the net effect of the maritime subsidies on payments and re

ceipts for transportation probably has a marginal impact on the value of the dollar.

Moreover, to the extent these subsidies increase the value of the dollar, they will tend to be offset in the balance of payments by increases in net receipts or reductions in net payments.

TAX REVENUES AND THE MARITIME PROGRAM

Shipping is one of the most preferentially taxed industries in the

economy.

As you know, the basis of this preferential taxation is the Merchant Marine Act of 1936 as amended in 1970. This act allows shipowners to shelter much, if not all, of their otherwise taxable income resulting from the operation of their vessels, by putting such income into a capital construction fund to be used for the future purchase of vessels. As estimated in the fiscal year 1976 budget, the annual revenue loss of these provisions is about $40 million. No other industry is granted this privilege of acquiring its stock of capital assets with tax-free dollars.

Some maintain that this description overstates the advantages of the capital construction funds. Under the Merchant Marine Act, vessels which have been purchased from these funds must take lower depreciation charges than capital assets acquired from conventional retained earnings or from borrowed funds. These lower depreciation charges mean higher future taxable income and it is, therefore, argued that the capital construction funds permit only the deferral of income taxes and do not provide a tax exemption for all income.

However, we believe this argument understates the actual economic advantages of the capital construction funds.

First, even if taxes are simply deferred, rather than completely avoided, the result is still an interest-free loan from the Government to the shipowner until the tax liability is fully paid.

Second, earnings on the capital construction funds are totally exempt from taxation with no repayment requirements.

Finally, there may not be any recapture of revenues in future years. This is because there is nothing in present law to prevent shipowners from placing all the income generated from vessels purchased with capital construction funds back into these funds as the income accrues.

Thus, even if those vessels do carry reduced depreciation charges, the resulting higher income may not be taxed but may be deposited tax-free right back into capital construction funds for the purchase of additional vessels. In this way, U.S. shipowners' tax liabilities may be deferred indefinitely.

Although these tax benefits are exceptional, the view has been expressed that these benefits "pay for themselves" since they generate additional economic activity and tax revenues which would not otherwise be realized. This is the so-called feedback effect of tax benefits.

In our view, the revenue-generating feedback effect is a vastly overused argument in justifving any type of economic subsidy. In fact, one could regard particular subsidies as having separate revenue-creating effects only if it were true that without these subsidies the economy would be forced to operate at lower levels of overall economic activity than it does now.

However, we have broad fiscal and monetary policy instruments at our disposal which influence the aggregate level of economic activity. Thus specific subsidies such as those to the maritime industries are best seen as an artificial influence on the share of aggregate activity going to various sectors of the economy.

There is no positive contribution to the aggregate itself. On the contrary, the subsidy may actually misdirect resources and reduce the aggregate level of national economic activity.

Thus, although maritime subsidies increase the size of the maritime industry, they do so perhaps at the expense of employment and income in other sectors of the economy.

Therefore, we do not believe that the maritime subsidies can be supported on the ground that they have aggregate revenue increasing effects.

In fact, to the extent that the maritime industry is expanded, there are likely to be revenue losses, since shipping, as I have explained, is one of the most preferentially taxed industries in the economy.

As I said earlier, the Treasury position is that the maritime industry must be subsidized for reasons of national defense. Our analysis shows that it is not possible, however, to justify the subsidy program on the basis of a net contribution to tax revenues.

It may even be the case that the tax benefits resulting from the maritime subsidies are less than the tax effects of a subsidy to some other industry. We also question whether preferential tax action is a desirable form of maritime subsidy. Given that the industry must be subsidized, we suggest that the subsidies take the form of explicit budgetary expenditures.

I would like to turn now to the question of the effect on U.S. trade of the U.S.-flag merchant marine.

Defenders of the U.S.-flag merchant marine argue that the existence of a U.S.-flag merchant flect benefits our trade by improving services available to U.S. traders, and by preventing foreign owners from extracting excessive or discriminatory rates on U.S. exports and imports.

The participation of U.S. ships in our trade is said to be protection against the possibility of collusion by foreign shipping lines to reduce services to the United States, or increase rates unreasonably, either within or outside shipping conferences.

We believe that to the extent the existence of a U.S. merchant fleet increases international shipping competition, U.S. shippers are benefited. Through increased competition, services received by U.S. exporters and importers should be improved, and prices paid should be reduced.

I want to stress, however, that these benefits arise only if the U.S. fleet offers shippers competitive services.

Unforunately, we are seeing increased efforts by the less developed countries to reduce competition by such methods as cargo sharing which limit the access of third flag shipping to cargoes. The existence of a U.S. fleet gives the United States some negotiating leverage in opposing efforts by those countries to reserve trade for their own fleets.

If such efforts were nonetheless to prevail, countries without their