that tax exemption has on our economic well-being and our unemployment problem. If investment in productive industry has to any extent lagged because of this tax exemption, then the situation certainly calls for remedy. It is because I am strongly of the opinion that such exactly has been the case that I am here to urge removal of tax exemption.

While I would like to see the change brought about as quickly as possible, I am convinced that this must not be done at the expense of orderly constitutional processes. If there is serious doubt about the constitutionality of the proposed "short and simple statute," then by all means let's take the slower method; that of constitutional amendment. If that method seems too slow and inexpedient, it is surely the more advisable in view of the significance of the subject matter involved.

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Our States being directly interested parties in the controversy, this may well be the ideal occasion to invoke the process of amendment by constitutional convention. That method would offer our people a direct opportunity to speak their collective mind on this subject. amendment evolved in that form can probably be enacted in about a year's time. A statute might be enacted in a much shorter period. But in view of the certainty that any law enacted will have to go the rounds of adjudication through the United States Supreme Court, the orderly constitutional process may well prove to be the shorter in the end. At the same time, much confusion and uncertainty resulting from the litigation would be entirely avoided.

This would be true even if mere expediency were the only question involved, but the question is much more basic and fundamental. It involves the rights of every one of our 48 States and the power of the Federal Government over them. We will do well, therefore, to move with caution and with a full understanding of the significance of the problem. I shall make no attempt to delve into the legal controversy. That has already been covered quite thoroughly by others. Instead, I would like to confine myself to the economic phase of the problem as the businessman sees it.

Given a reasonable degree of safety of principal and income, the choice as between a stock or bond investment in private industry and a Government bond resolves itself down to a matter of attractiveness of net yield or possible net profit to the owner of capital.

Naturally, the higher the income-tax rate the more valuable the privilege of tax immunity, especially to the investor who has a large taxable income. The exemption feature becomes more and more an element of pressure in favor of Government tax-free bonds as incometax rates move upwards. But until 1933, the effect was seldom to deprive industry of its normal long-term capital needs. Since then, however, another and more potent capital pressure has been at work. This new element, in conjunction with the old, has made the taxfree Government bond well nigh irresistible to the man of large taxable income. By this new element, I refer to the uncertainties that have been caused by Government policies and which private industry has had to cope with in its endeavor to attract long-term capital, especially common stock or equity capital.

Boot-strap economics, oppressive taxation, a series of unbalanced budgets, a spending spree under the heading of pump priming or Government investing, a string of reform laws enacted in rapid-fire

succession, and Government competition with industry, are only a few of the reasons why the future of private industry "has not looked so good" to the long-term investor. In consequence, there has been an understandable reluctance on his part, whether he be of small or large means, to entrust his savings to the future of private industry. Government has, as a result, become the chief long-term borrower.

Staggering amounts are today lodged in these tax-exempt securities. Their gradual elimination and the substitution of taxables would, of course, make a tremendous difference to those persons of large income who now find the tax-exempt security about the only haven of escape from an otherwise intolerably high income-tax. But it would also make a tremendous difference to industry and to labor, for the money invested in these bonds is the very kind of money that will gravitate to productive industry and employ labor. Much of it is enterprise money; the kind of money that can best afford to take business risks.

And yet, shutting the door to tax immunity is one thing while actually getting this money into productive use is quite another. Removal of tax exemption would certainly be an important step in the right direction, but only one of the necessary steps. Coupled with it would have to appear some concrete evidence that industry will not be harassed and that it will be permitted, or even encouraged, to earn profits. Unless that be the case, owners of such capital will simply not risk it in any long-term enterprise. Instead, they will seek either to employ their capital in short-term projects where the risk elements are more nearly predictable, or they will continue to lend to Government even at a very much reduced net return. What is needed then, is not alone that lending to Government be made less attractive but also that long-term risk taking in private industry be made more attractive. That is the only effective means of closing the door of a lazy life to cautious money and at the same time induce it to go to work so as to earn profit for the investor, create jobs for the worker, and supply revenue for the government. And more important, that is the only way to revive our capital-goods industries, without the full functioning of which we have never yet had and never can have prosperous times in this country.

Such a highly organized economic system as we have developed must continually invest in plant, machinery, and equipment for increasing the productivity of the worker. Such a system calls for a constant stream of new capital for modernization and expansion. If the money already invested in a particular enterprise or if an industry as a whole, is earning a fair return, no difficulty is usually experienced in raising additional capital. But should industry be unable to, or should it not be permitted to, earn a fair return on investment, or should it be forced to operate at a loss for longer than a normal period, it will have much difficulty in attracting capital to meet its needs.

Our President's goal is an 80-billion-dollar annual national income. That is not an extravagant goal. That was about our national income in 1929, when our population was nine or ten millions smaller than it is today. But that goal can only be attained, and if attained, can only be maintained, by the full revival of private industry, particularly our durable goods industries which have not yet really emerged from a 10-year depression.

Government borrowing and Government spending under any name or under any label cannot permanently produce a level of national income short of bankruptcy. If every time the Government spends a dollar, $2 in the hands of private owners go into hiding or are discouraged from active participation in productive industry, permanent business revival is clearly impossible.

We are not short of capital. If anything, we have too much of it. But it is a discouraged capital. There are possibly more discouraged dollars awaiting profitable investment today than at any other time in our financial history. What we are lacking is not financial means, but a willingness on the part of owners to risk these means against too many odds. Careful people who have some savings consider it much the smaller risk, and on the whole much more attractive, to lend to Government than to invest in industry. Here it may as well be frankly admitted that so long as enterprise capital is discouraged and money seeks security of principal, Government can probably continue for a long time to borrow vast sums at little, if any, additional interest cost, even without tax exemption. But that will not revive industry or return our army of unemployed to private payrolls.

Even when we do close the door to the haven of tax exemption and open it wide to investment for profit in private industry, there still would remain the very important question of how much of the profit, if and when made, will be taken by Government in taxes. This business of enticing capital to take risks in venturesome enterprise is not a mere matter of evolving a mathematical or financial formula upon which the investor can be expected to act. There is a human element involved which requires recognition. It is the urge for gain even at the risk of loss of one's capital. If, all things considered, a net gain is too doubtful of attainment, the risk will not be undertaken. And our failure in the past to fully appreciate the real importance of this principle in the formulation of our tax laws has militated to our great disadvantage.

Every job in private industry owes its existence to capital taking risks. Every new job to be created by private industry must depend upon the same motive power. Yet, our tax treatment of capital gains and losses has been such as to utterly discourage risk taking for gain. Even our present Revenue Act, which in this regard is a considerable improvement over some of the previous ones, still treats capital gains and losses as if to penalize rather than encourage enterprise. Shortterm gains are still subject to full tax rates which reach as high as 79 percent for Federal income tax alone. And if the result is a loss instead of a gain its tax deductibility is limited and circumscribed. Long-term gains (investments held over 18 months) are now limited to a 20-percent maximum tax. This State income taxes frequently increase to 25 percent or more; much too high a tax on capital gains for maximum economic and social benefit.

But it was not on that account that our President refused to give his approval to the 1938 Revenue Act. To the contrary, it was the stopping at the 20-percent point instead of continuing on up the scale of progressive surtax rates that he complained of. And he indicated that this Congress will be asked to tax capital gains at more progressive rates. The very fear of such increased taxation may alone be sufficient to deter the investor from risking his savings for a possible long-term gain. At least it should be obvious that the tax factor is

a very important element in the whole problem of investment for profit, and that it can well nullify any good results that would otherwise accrue from the elimintaion of the tax-free Government bond.

As Ralph Hendershot, the financial writer of the New York WorldTelegram, recently said on this subject, "If Uncle Sam wishes to catch the horse of capital in the pasture of economics he would do well to stop chasing him and, instead, hold out a panful of oats." Closely affiliated with the problem of borrowing and perhaps more difficult of solution, is that of run-wild Government spending. Our normal pre-New Deal annual Budget was less than $4,000,000,000. Now, it is almost twice that much. In 6 years, a 100-percent increase of normal Government expenses. We speak of being on easy street if we could but get our national income back to an $80,000,000,000 basis. But when our national income was that, the cost of running our Federal Government was less than half what it is today. We are now spending at the rate of nearly $10,000,000,000 a year, and it is perfectly obvious to anyone who is but willing to see, that a drastic reduction in the cost of Government is imperative if we are ever to regain our financial sanity.

I am not fooling myself about the difficulties which lie in the path of reducing Government spending. In spite of the graveness of the problem, there is little likelihood for spending to be greatly reduced until popular will encourages such a course. I know it will hardly be popular to undertake radical reduction of expenditures for relief, for public works, for social security, for pensions, for agricultural subsidies, or for so many of the other Government expenditures which are rapidly becoming vested rights on the part of their recipients. Yet, expenditure reduction on a substantial scale there must surely be. For, in the next 18 months alone, our Federal expenses will exceed revenues by the staggering sum of $5,700,000,000; and no end in sight.

Governmental unbalanced budgets financed by borrowing chiefly from banks, are definitely a form of progressive inflation. Their effect in the long run is exactly the same as that produced by printing press money. The process may be slower, but the ultimate effect is just as devastating. How long we can continue on this course before real trouble develops is difficult to say. Ours is a large country with vast resources and it can stand a great deal. But no nation on earth, regardless of its resources, has ever escaped financial chaos and ultimate financial collapse if it failed in time to curb continuous and substantial budget deficits. Certain it is that most persons called upon to trust the future with their present savings are in agreement with what President Roosevelt himself said in 1932 about loose fiscal policies of government, namely, that they are "a veritable cancer on the body politic and economic."

It is here that the taxing of now exempt Government salaries takes on an aspect of major importance. Not for the amount of tax that the Federal Government can collect from these 2,600,000 State, municipal, and local government employees whose salaries are now wholly exempt from Federal income tax or the 1,000,000 or more Federal employees whose salaries are now exempt from State income tax, but for the greater tax consciousness that the removal of such tax exemption will create on the part of these people and those they influence.

It is useless to appeal to the present income taxpayers in an attempt to influence Government spending policies. They are much too small in number to have any real effect politically. Due principally to our system of large personal exemptions, there are only about 2,500,000 individuals who pay any Federal income tax at all. This is not to say that the remaining 128,000,000 people do not pay taxes, but it is to say that they do not pay them directly and knowingly. That is the great crime of our taxing system.

In spite of the fact that about one-fifth of our entire national income is consumed by taxes, the average man pays mighty little of his share directly as taxes. His taxes are instead hidden in his cost of living; and because he pays little, if anything, directly, he is usually under the impression that it is the other fellow and not he who is footing the bill for Government spending. Until we obtain in this country a much larger number of direct taxpayers who are keenly conscious of the fact that their own tax bill varies in direct proportion to Government spending, there seems little basis for hope that Government spending will be greatly reduced.

In removing tax exemption from this large army of persons who are closest to Government, I see an opportunity to greatly increase the number of those who will hereafter pay their tax bill directly and knowingly and thus to bring about a much keener interest in Government spending policies than exists today. That, to my way of thinking, would be the most important achievement that removing reciprocal tax exemption from Government salaries can result in.

I do not anticipate that after the situation adjusts itself, the net Government revenue from this source, Federal, State, and local, would be increased to any great extent. Rather am I of the belief that the Government employee now pays well for this privilege of tax exemption and that on balance, he may perhaps be ahead of the game if he were paid what is due him as salary. This would at least be calling a spade a spade both as to his own pay and as to the amount. that he in turn is called upon to pay for Government spending. This vast army of Government employees might then well become an army of model taxpayers for other of our citizens to emulate and follow.

In conclusion, therefore, I urge upon you to take such steps within constitutional propriety as will make it possible for the Federal and State Governments to reciprocally impose income taxes on all Government salaries and all interest from Government obligations hereafter to be issued.

The CHAIRMAN. Thank vou, Mr. Seidman.

We will now hear from Mr. Henry Epstein, Solicitor General of the State of New York, representing the attorneys general of the States submitting a defense.

STATEMENT OF HON. HENRY EPSTEIN, SOLICITOR GENERAL OF THE STATE OF NEW YORK, REPRESENTING THE ATTORNEYS GENERAL OF THE STATES THROUGH THE CONFERENCE ON STATE DEFENSE

The CHAIRMAN. Before you start on your statement, Mr. Epstein, I hope that you will touch as lightly as possible on the economic problems on which we have had statements, for the past several days.