The CHAIRMAN. Our first witness at these hearings is the Honorable David M. Kennedy, the distinguished Secretary of the Treasury.

Mr. Secretary, we are pleased to have you here with us. I would suggest that you proceed and I would hope that we can have the Senators limit themselves to 10 minutes on interrogation on the first instance when we ask questions. After that why we will perhaps have a little more lenient rule.

STATEMENT OF HON. DAVID M. KENNEDY, SECRETARY OF THE TREASURY; ACCOMPANIED BY CHARLS E. WALKER, UNDER SECRETARY OF THE TREASURY; EDWIN S. COHEN, ASSISTANT SECRETARY OF THE TREASURY FOR TAX POLICY; AND JOHN S. NOLAN, DEPUTY ASSISTANT SECRETARY OF THE TREASURY FOR TAX POLICY

Secretary KENNEDY. Very good, Mr. Chairman.

Mr. Chairman and members of the committee: The Tax Reform Act of 1969 is a milestone in tax legislation. The administration strongly urges its enactment at the earliest practicable date.

ADMINISTRATION RECOMMENDATIONS FOR IMPROVING H.R. 13270 While we endorse its enactment, we believe that the bill should be improved in a number of respects. Broadly, these are—

The long-run revenue loss in the bill of approximately $2.4 billion should be scaled down by about half;

The balance of tax shifts in the bill-a $7.3 billion reduction for individuals and a $4.9 billion increase for corporations-should be redressed by including a two-point reduction in the corporate tax rate;

A number of structural changes in the bill should be modified, some because they go too far, others because they do not go far enough.

Let us make no mistake about the nature of the legislation approved by the House of Representatives. H.R. 13270 is not only the most sweeping tax reform measure in the history of the Internal Revenue Code. It also embodies a significant amount of tax reduction. Reduction of this type and amount at this time can be questioned on three grounds.

CONCERN OVER PROSPECTIVE REVENUE LOSSES

First, action now to reduce the national tax burden by a net $2.4 billion annually would represent a significant decision with respect to national priorities. Interim revenue losses, before all the revenueraising measures take effect, are even greater. To the extent future revenues are today committed for such reduction, they cannot be used to support important Government programs. (It should be noted that the $2.4 billion projected revenue loss is expressed in terms of today's income levels. With incomes expected to rise significantly in the next decade, the revenue loss would be much higher.)

The administration's concern over the proposed cuts in individual taxes does not mean that we attach a low priority to this goal. But tax

reduction cannot be carried out without due consideration for other national needs. The extent to which we can responsibly curtail our defense outlays has to be determined by future events, many of which are beyond our control. Domestically, the Congress has enacted programs which call for increased spending in future years. This administration is committed to renovation of national welfare programs and to an imaginative program of revenue sharing with State and local governments. Proposals also will be forthcoming to promote additional hiring and training of the hard-core unemployed and to foster investment in poverty areas.

The Nation is committed to the goal of adequate housing for all of its citizens. Recent studies demonstrate that Federal surpluses, which would bring down interest rates and stimulate the flow of funds into mortgages, may well be the best way in which to promote such housing.

Even though this administration is determined to pursue a prudent spending policy, we simply do not know enough about the future to commit ourselves today to the degree of tax reduction embodied in H.R. 13270. In our suggested changes, we have not attempted to attain a precise balancing of estimated increases and decreases over the period. Indeed, revenue estimating is far too imperfect a science for that purpose. However, we urgently recommend that you reduce the expected shortfall in H.R. 13270 by approximately half, to $1.3 billion.

IS THE BILL EQUITABLE?

The second major question concerning the tax reduction in H.R. 13270 is whether it is equitable. The largest cuts are appropriately centered in the lowest brackets. But, in too many instances, certain taxpayers are given reductions much higher than others in comparable economic circumstances.

Our recommendations would reduce these inequities by:

Restoring the "phaseout" in the proposed low-income allowance, but at a rate of $1 tax for $4 income as contrasted with the $1 to $2 curve in President Nixon's original proposal as submitted in April of this year. This still would remove 5 million taxpayers, including almost all of those at the poverty level, from the Federal tax rolls.

Raising the present standard deduction of 10 percent with a $1,000 ceiling to 12 percent with a $1,400 ceiling, instead of 15 percent with a $2,000 ceiling, as in the House bill.

Liberalizing taxation of single persons as compared to married couples through a new rate schedule rather than allowing head-ofhousehold status to those single persons over 35.

BIAS AGAINST INVESTMENT

The third shortcoming of H.R. 13270 is that it is weighted in favor of consumption to the potential detriment of the Nation's productive investment. To be sure, President Nixon recommended on April 21 the repeal of the 7 percent investment tax credit. Such repeal represents over half of the $4.9 billion increase in corporate taxes in the bill. While the administration's position on repeal of the investment

tax credit is unchanged, we are concerned about the bias in the bill against investment in favor of consumption. Such overweighting, embodied in the proposed treatment of capital gains as well as corporate tax increases, could impede economic growth in the years ahead by curtailing the incentive to make productive investments.

To help guard against this drag on growth, the administration is strongly urging, recommending that the tax rate on corporate profit be reduced by one point in calendar year 1971 and an additional point in 1972. This would reduce corporate taxes by an estimated $800 million in 1971 and $1.6 billion by 1972 (in terms of today's profit levels), thereby reducing the net increase in corporate taxes in H.R. 13270 from $4.9 billion to $3.5 billion (after other recommended adjustments). This change in the bill would not be unfair to individuals. Their tax relief, concentrated in the lower brackets, would still amount to a gross amount of $7.3 billion and a net figure of $4.8 billion.

Although no one can forecast perfectly the trend of the economy over the next 2 years, the administration's current timetable in its anti-inflationary program would allow for growth-inducing corporate tax reduction in 1971 and 1972. If not, the situation with respect to the entire program of tax relief in H.R. 13270, individual as well as corporate, will have to be reevaluated in the light of then existing conditions.

Investment in the years ahead may also be impeded by the proposed changes in tax treatment of capital gains. We believe these changes go too far. Our original proposals were designed to prevent excesses rather than fundamentally alter such tax treatment. Accordingly, we recommend retention of the 6-month holding period, as contrasted with the extension to 1 year in H.R. 13270. In addition, we favor retention of the maximum 25-percent rate on capital gains, except in cases of very large gains relative to ordinary income. In these instances, which would affect a relatively small number of individuals, the rate could rise as high as 3212 percent, or to half the new top bracket rate of 65 percent.

CAPITAL GAINS TAXATION

Our recommendations concerning capital gains taxation and other provisions of H.R. 13270 are outlined in detail in Assistant Secretary Cohen's statement, which has been submitted to the committee. Before responding to questions, I would like to summarize several of these recommendations, and while Secretary Cohen will not read his statement but will answer questions or go over areas of it for you I think it would be well to cover just a few of the items.

PETROLEUM TAXATION

First, petroleum taxation. In its tax proposals of April 22, the administration made no recommendation for change in percentage depletion as it affects the petroleum industry, except to include such depletion in the limit on tax preferences (LTP) and the allocation. of deductions rule (ADR). We recommend that intangible drilling costs that would otherwise be capitalized also be included in the

LTP and ADR. Further, we propose 1 that certain sales of production payments be treated as loans to avoid manipulation of income and losses in mineral transactions.

The House of Representatives accepted our proposals relating to production payments. It included percentage depletion and intangible drilling costs in the allocation of deductions but dropped them from the limit on tax preferences. The House action also disallowed percentage depletion on foreign operations and reduced depletion on domestic operations from 27% to 20 percent.

Although the administration did not recommend a cut in domestic percentage depletion, we accept the House approach to increasing the share of the national tax burden borne by the petroleum industry. But this cut in domestic depletion will not close the loophole which permits a wealthy oilman to pay little or no Federal income tax. To do so, we recommend that the Senate restore percentage depletion to the LTP. However, intangible drilling costs, included originally in the administration's LTP proposal, should be restored to the LTP only for investors and not for those individuals who receive 60 percent or more of their income from oil and gas operations.

On oil and gas we recognize that it is in the national interest that certain tax provisions be used as incentives for discovering new reserves. Accordingly, in our judgment, provisions in the form suggested will apply more reasonably to persons whose principal business. is the discovery of new oil and gas deposits and to whom intangible drilling costs are more in the nature of an annual expense. They should avoid creating any serious disincentive to drilling. However, even in this form the limit on tax preferences should insure that substantially all taxpayers, including those in the oil business, will pay some reasonable amount of tax each year. Given the reduction in incentive resulting from the House passed cut in depletion to 20 percent, we strongly urge that the tax treatment of intangibles not be altered with respect to those persons whose principal business is the discovery of new oil and gas deposits.

FINANCIAL INSTITUTIONS

On financial institutions: The administration does not object to the provisions of the bill which would base bad debt losses of commerical banks, mutual savings banks, and savings and loan associations on actual experience-subject to a 10-year carryback and 5-year carry forward for net operating losses. But we are concerned about the continued heavy reliance on investment restrictions to promote a flow of money into residential construction. Such restrictions limit the ability of the thrift institutions to compete for savings during periods of tight money. They also fail to recognize other important national goals.

We therefore recommend a special tax deduction for each of these three institutions, designed to encourage the flow of credit not only into residential construction, but also into other socially preferred uses, such as guaranteed loans to college students and loans guaranteed by the Small Business Administration. At the outset, this deduction could consist of 5 percent of gross interest income from such

loans. However, the deduction could not serve in any year to reduce the taxable income of any such institution to an amount less than 60 percent of taxable income, adjusted to include the full amount of dividend income and tax-exempt interest in the institution.

The result of these provisions would be to create tax equity among these competing institutions, enhance their competitive ability relative to other outlets for savings, and encourage the flow of money into uses determined by the Congress to be socially preferable.

5 ADDITIONAL ADMINISTRATION RECOMMENDATIONS

Other provisions: Five other administration recommendations should be noted:

H.R. 13270 goes to far in taxing foundations. We recommend that the proposed 712 percent tax on income be replaced by a 2 percent "supervisory tax," which would raise sufficient funds for an adequate audit program in the Internal Revenue Service.

In order to make certain that the bill does not unduly restrict donations of property to charities, colleges, and other tax-exempt activities, we recommend deletion of the provision which would include appreciation on such property in the limit on tax preferences and the allocation of deductions.

The personal deduction allowed for State gasoline taxes should be repealed. Inasmuch as the State tax is, like the Federal tax, essentially a user charge, the existing deduction in effect shifts the burden of those taxpayers who itemize to the general taxpayer. Repeal would raise the average tax on those who itemize by only about 10 to 15 dollars.

The House bill goes beyond the administration's recommendations and includes interest on State and local bonds in the LTP. The administration opposes this inclusion for the same reasons we gave on April 22-there are constitutional doubts as to inclusion as well as the possibility of adverse repercussions in the market for State and local securities. However, we recommend as we did in April that the full amount of tax-exempt interest be included in the allocation of deductions rule, without the 10-year phase-in contained in the House bill.

To simplify compliance by millions of low-income individuals, persons not subject to tax under the new higher levels resulting from the low income allowance should not be required to file returns.

A MILESTONE IN TAX LEGISLATION

Mr. Chairman, I repeat that the bill before you is a milestone in tax legislation. Almost all of the 16 substantive tax proposals which President Nixon submitted to the Congress in April, including the limit on tax preferences and the low income allowance, are included in the bill. The House Ways and Means Committee, as a result of its exhaustive hearings, added a number of constructive measures to those proposed by the administration. The resulting legislation was overwhelmingly approved by the House of Representatives.

Now it is up to the Senate. I am confident that this committee will proceed with the same determination shown in the House and that we