developed effectively, it never would have provided the thousands of jobs that it did, it never would have rewarded the risk-taking investors that it did, if it had not succeeded. And the only reason it was able to get off the ground was because this gentleman, who now doesn't like risk taking, took the gamble. That is the answer to his two questions at the end of his statement, and he knows the answer better than you and I do.

I would like to concentrate, if you don't mind, on that portion of our statement which relates to the discussion of the effect of this bill on investment and in particular the need for replacing the investment credit with an equivalent support for capital investment, assuming the credit is to be repealed.

The repeal of the investment credit we will not discuss as an issue, in accordance with the chairman's instructions, but the effect of that removal is relevant. The timing is extremely bad from the standpoint of the danger and the gap that it creates. The country is fortunate at the present time to be enjoying an accelerated rate of technological progress. Investment opportunities are not only plentiful but they are thoroughly challenging. At the same time that technological advance is surging and that there are these many challenging investment opportunities, we are pulling the rug out from under the tax support of capital investment.

To make your evaluation of what to put in place of the credit, should it be repealed, you should be aware of the number of limitations on the sources of funds for investment. Corporations relay primarily on internal funds-capital consumption allowance and retained earnings to support such capital investment. Retained earnings have been declining since 1966. Capital consumption allowances for tax purposes are likely to rise at a diminishing rate hereafter, especially if the reserve-ratio tax which has been referred to by the previous witness remains in effect. Moreover, as pointed out in the document which we have furnished as a supplement to the record, such allowances being based on historical cost, become increasingly inadequate because of inflation. Corporate tax depreciation will be deficient next year because of inflation by $7 to $8 billion. If forecasts are realized, corporate internal funds next year will cover only 80 percent of plant and equipment expenditures, the lowest ratio for more than 20 years.

Thus a great void has been created or will be created if the Congress and the administration stay on the track of repealing the investment tax credit. And we submit that a proper substitute for the investment credit and an equivalent substitute must be designed. We set out in our statement a number of alternatives, or items which could be considered in combination, and I will not take the time of the committee to repeat them. I should call attention to the fact that according to our preliminary studies the United States will have to go to 5-year amortization for all productive equipment across the board to achieve an equivalent of the present combination of the investment tax credit and the guideline system of depreciation.

Our statement goes much further in addressing this bill than merely covering the anti-investment aspects of it. We deal with particular technical provisions of the bill. We oppose the deferred compensation section. We oppose the restricted tax plan section. We think the moving expense section is a move in the right direction, but it does not go

far enough. The taxation of foreign earnings section represents a minimal look at a very complicated problem. The section of the bill on real estate depreciation reflects an obstinate determination on the part of the Treasury Department to discriminate against industrial realty. Why? If you have a speculative problem in real estate, deal with it. The capital gains and losses section we oppose. We agree with the modifications that Assistant Secretary Cohn suggested, but carry our opposition further.

And may I call the attention of the committee to the fact that tax reform ought to cut both ways. This is essentially a negative bill. We ought to have some liberalization in it beyond the personal income tax rate changes. One of the major problems that confront equipment industries in this country today is the question of advance payments taxation. The Treasury, subject to a current reevaluation study, is now trying to tax advance and progress payments when received even though a long-cycle piece of equipment that may not be delivered until 5 years later is involved. This makes no sense in tax policy, accounting thinking, or practical economics.

Another item that ought to be looked into in the sense that tax reform should cut both ways is the accumulated earnings tax which needs a thorough overhaul. And finally, obviously charitable contributions as dealt with in the bill badly need another look, as I am sure you have been hearing from educators and other heads of eleemosynary institutions who are terribly concerned that the "contribution well" may dry up as a result of some of these provisions.

In general, as the title to our statement indicates, the institute believes that the tax reform bill needs reform.

The CHAIRMAN. Well, thank you, sir. I will make you a fair proposition. I am willing right now to vote against nearly everything in this bill that does not raise the Government any money. And there is plenty of this that will lose money rather than make money. And insofar as those provisions exist, I personally plan to vote against

them.

Senator Anderson.

Senator Williams.

Senator WILLIAMS. No questions.

Senator HARRIS. No questions.

The CHAIRMAN. Thank you so much.

Mr. STEWART. The institute appreciates the opportunity to be here. The CHAIRMAN. Congratulations, Mr. Stewart. You hit the egg timer right on the bell.

(The prepared statement with attachments, of Mr. Charles W. Stewart, follows:)

STATEMENT OF THE MACHINERY AND ALLIED PRODUCTS INSTITUTE, PRESENTED BY CHARLES W. STEWART, PRESIDENT

THE TAX REFORM BILL NEEDS REFORM

We appreciate this opportunity to present our views to the Committee on Finance of the United States Senate on H.R. 13270, the proposed Tax Reform Act of 1969. The Machinery and Allied Products Institute and its affiliate organization, the Council for Technological Advancement, represent the capital goods and allied equipment industries of the United States. These industries naturally have a deep interest in the provisions of any comprehensive tax revision bill such as that now pending before the Committee. That interest relates not only to the direct impact of certain proposed changes on individuals and corporations but also includes a deep concern and sense of responsibility to address the public policy implications of provisions of the current bill. With our commitment to

research in the economics of capital goods, techniological advancement, and investment, we hope that some of the study work carried on by the Institute will be helpful to this Committee and to others concerned with tax legislation both in the Executive Branch and the Congress.

GENERAL OBSERVATIONS

It is with considerable reluctance that we state our general and strong objections to the overall character of the tax reform bill before the Senate Finance Committee because we fully appreciate the complexity of the legislative process, particularly when it is applied to federal tax changes. Moreover, we are sensitive to the tremendous work load carried in the Executive Branch, in the House Committee on Ways and Means, and by the very able staff of the Joint Committee on Internal Revenue Taxation, in connection with development of the content of the proposed Tax Reform Act of 1969. At the same time we do feel an obligation to underline our substantial reservations about the philosophy, the approach, and the content of this bill, so that the Senate Finance Committee, giving consideration to the views of others and the results of its own study, may be assisted in taking whatever action it feels is appropriate to modify H.R. 13270.

First, we have concern as to how this bill was developed. It is true that extensive hearings on tax reform were conducted by the Ways and Means Committee but the witnesses at no time had an opportunity to address themselves to all of the proposals contained in the bill as passed by the House and at no time had before them detailed bill language for consideration. The bill which was reported favorably by the Ways and Means Committee is long and complex. Debate on the floor was very limited by rule, amendments on the floor were precluded, and we believe it is fair to say that many members of the Congress had no opportunity to study and reflect on the detail and the implications of the contents of the bill. These hearings, therefore, take on critical importance because for the first time the views of interested parties can be addressed to the specifics of the Tax Reform Act of 1969 and the philosophy underlying it.

Giving due deference to the tremendous work load carried by those responsible for the development of the provisions of this bill and recognizing the political judgment that was apparently made that passing a tax reform bill promptly is a must, we submit that this is not the way to legislate in the tax area. Tax legislation is difficult enough when considered by the Congress under the best possible circumstances; it becomes almost impossible to produce a sound result when it is rushed through Congress and neither the technical aspects of the proposals nor the full implications from a broad public policy view can be given appropriate study.

Characteristics of the Bill and Its Approach

The thrust of the proposed legislation seems to be that without any particular pattern or overall criteria the Congress is attempting to identify a significant number of so-called "tax preferences" or "tax loopholes" and attack them. In many cases with respect to individual provisions of the bill there does not appear to have been an adequate examination of the probable policy implications of the tax action being taken. There seems to be too much of an atmosphere of a judgment that "we have to pass a bill which we can call a tax reform bill."

We have additional objections to the overall approach embodied in this bill. They can be summarized briefly as follows:

1. Tax reform cuts both ways. It should result in some tightening where justified and clearly liberalization should be considered where appropriate. This bill is essentially negative with the primary exception of the proposed reductions in personal rates.

2. The bill is terribly complicated. It does not take one constructive step toward simplicity; indeed, it adds complexity to an already terribly complex Internal Revenue Code. It is not only complex from the standpoint of its detailed provisions but the regulations and the interpretations which must follow will pile complexity and difficulty on top of the chaos which we already have under the present tax laws. In this connection, perhaps the Committee would like to have the record include an article in The Wall Street Journal of Wednesday, September 3, 1969, by a prominent tax attorney, Rene A. Wormser, entitled "Tax Reform: Adding Hodgepodge to Hodgepodge." Reference should also be made to the "Separate Views" of Congressman James B. Utt in House Report No. 91-413 (Part 1), page 216, on H.R. 13270. The Congressman's opening statement deserves most careful consideration:

"I have reservations about this legislation, not because I am opposed to tax reform, but because I realize it is so essential. The ostensible purpose of this bill is to comprehensively reform our Federal income tax law, and it is being heralded as the broadest and most comprehensive tax reforms that have been enacted since 1954. The actual result may be to introduce greater complexity and inequity into our tax laws."

3. It reflects the typical supertechnical, overprecise approach which has characterized tax thinking in the federal government for so many years. Simple solutions seem to be rejected out of hand, lint picking, fussy qualifications or exceptions are once again spread throughout the bill.

4. There seems to be a growing tendency to reject what for many years was a long-standing principle in tax legislation; namely, that changes adverse to the taxpayer would not be made retroactively. There are a number of retroactive effective dates in the present bill.

5. The bill clearly is unbalanced in terms of its treatment of corporations versus individuals. Not only is relief provided primarily for individuals but the negative provisions of the bill are balanced heavily against corporations. We deal with this in more detail below.

6. A most serious aspect of the bill is that it punishes investment versus consumption. This point is developed later in this statement.

7. Finally, certain sections of the bill seem to ignore inflation and the prospects for its continuance.

Discrimination Against Corporations

H.R. 13270, the bill currently before the Committee, would extend the surcharge at a 5-percent rate for the first half of 1970. In addition, the 7-percent investment tax credit would be repealed with respect to property acquired, constructed, or placed under a “binding contract,” after April 18, 1969.

Further, in the case of depreciation on industrial buildings, the corporate taxpayer would be required, with respect to buildings acquired after July 24, 1969, to use either the straight-line or the 150-percent declining-balance methods of depreciation instead of the double declining-balance method or the sum of the years-digits methods which are available under present law. In addition, the depreciation "recapture" on the sale of industrial buildings would be stepped up considerably.

Finally, the capital gains tax rate for corporations would be increased from a 25-percent rate to a 30-percent rate, an increase of 20 percent.

It seems to us that this treatment illustrates a very serious weakness in the bill. Unter the statistical information which was made available by the House Ways and Means Committee during House consideration of the bill, there would be a total tax relief provided under the bill of $1.7 billion in the calendar year 1970, $6.8 billion in calendar year 1971, and $9.3 billion in 1972 and future years. This is to be counterbalanced by a revenue increase from other provisions of the bill which would amount to $4.1 billion in 1970, and would gradually increase to $6.9 billion by 1979. A major item in this revenue increase would, of course, be the repeal of the investment credit which would increase federal tax revenues $3.3 billion by 1979. Beyond the repeal of the investment credit, it seems clear that corporations would be required to make up most of the remaining $3.6 billion in increased federal revenues.

This raises a very serious question of equity in our minds. We recall that, in connection with the Revenue Act of 1964 in which substantial rate reductions were accomplished, corporations were afforded approximately one-third of the total of $14 billion in reduced federal revenues (the 4-point corporate rate reduction, plus the effect of the investment tax credit and the depreciation guidelines). Now this earlier division of benefits is being offset by proposed repeal of the investment credit and the new bill as a package has a very negative impact on corporations. Beyond the question of equity, however, there is the very fundamental problem of the impact of the House bill on corporate investment generally. It seems clear to us that the effect of this legislation will very clearly be to discourage investment.

Disparate Impact on Investment Versus Consumption

It follows from the discussion above regarding the impact on corporations that the bill bears much more heavily on investment that on consumption. This, of course, would have a very negative effect on economic growth in the United States. The corollary to that proposition is that economic growth not only supports prosperity but is the principal contributor to the creation of jobs. It is a

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major prop to tax revenues. It is essential to our national security. Yet this bill, seemingly on a deliberate basis, punishes investment. Repeal of the investment credit has already been discussed before congressional hearings at length. Its negative investment implications, at least over the long run, are clear and largely conceded. Continuation of the surcharge and the other provisions affecting corporations as briefly referred to above and discussed in more detail later in this statement all add up to a very unfavorable effect on investment. Certain of the provisions affecting individuals have negative investment implications also.

Especially bad timing.-The timing of this action seems to be especially poor. The country is fortunate to be enjoying an accelerated rate of technological progress. Investment opportunities are not only plentiful and challenging but in terms of some of the competitive pressures confronting this country domestically and internationally and the cost-push pressures, notably a skyrocketing increase in cost of labor per unit of output, the necessity for investment at a high level seems obvious. The investment needs of the economy are also traceable in significant measure to the accelerated rate of growth in the labor force, a labor force which must be equipped with tools to produce, and an accelerated rate of growth in household formation which in turn will increase the demand for goods and require increased production to meet that demand.

Limitations on sources of funds for investment.—If we proceed from the premise that the investment needs of the economy are very large and will grow and can be expected to grow further, and perhaps at an even more accelerated rate in the 1970s, it is logical to inquire into the extent to which there are limitations on the sources of funds to support this needed investment.

In brief, with respect to the supply of funds for investment, the following points are critical:

1. Corporations rely primarily on internal funds capital consumption allowances and retained earnings.

2. Retained earnings have been declining since 1966.

3. Capital consumption allowances for tax purposes are likely to rise at a diminishing rate hereafter, especially if the reserve-ratio test of tax depreciation lives is continued in effect.

4. Moreover, such allowances, being based on historical cost, become increasingly inadequate because of inflation. Corporate tax depreciation will be deficient next year by something like $8 billion for this reason.

5. If forecasts are realized, corporate internal funds next year will cover only 80 percent of plant and equipment expenditures, the lowest ratio for more than 20 years.

Ratio of fixed investment to internal funds.—Let us discuss the question of internal sources of funds for corporate investment in a bit more detail. General indications from preliminary studies now being conducted by MAPI are that internal sources of nonfinancial corporate financing are falling well short of fixed investment. Historically, investment tends to be approximately determined by the availability of internal funds as indicated by the fact that fixed investment has averaged out at roughly 100 percent of internal funds (corporate depreciation plus retained earnings) over most of the post-war period.

During 1966-68 the ratio of fixed investment to internal funds has substantially exceeded 100. This clearly reflects the urgent need felt by business to offset rising production costs (wages, interest, and materials prices) through the use of modern, cost-cutting machinery. It may also reflect some recognition of the expected growth in demands to be put on our productive capacity as the U.S. Government increases its efforts to meet expanding social needs.

Yet, however high the urgency ratings assigned to prospective investments, business cannot go on indefinitely increasing their reliance on external sources of financing at present rates. Ultimately, they will be forced to cut back to levels more consonant with internal sources of financing in spite of future needs to further reduce costs and increase productive capacity.

At the same time there are indications that the future growth in internal funds may be adversely affected by a reduced rate of growth in capital consump tion allowances which represent the major component of the total. This growth will be reduced further from the increasing impact of the reserve-ratio test as it serves to extend tax lives of depreciable plant and equipment over the next several years.

Fundamental fallacy in the bill.-Yet, in spite of these indications of growing investment requirements in excess of the growth in the means for financing these investments, this bill is essentially anti-investment in thrust.