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induce new capital to come into the shipping business, ship construction by private companies will be unimpressive.
Section 606 (5) of the law now provides that if the operator's profits exceed iò percent a year over a 5-year period, one-half of the excess is to be recaptured by the Government. Under the proposed amendment this would be changed to a 10-year period. This recommendation is based on the belief that a 10-year period is likely to cover the average business cycle in the steamship business, whereas a 5-year period may fall entirely within a period of slump or prosperity. For example, if the 5-year recapture provisions had been nade effective in 1925, the amount of recapture would have been determined by the boom-time earnings of the period from 1925 to 1930. On the other hand, the succeeding 5-year period would have coincided with depression conditions existing in this business from 1930 through 1934. As a result, the Government might have recaptured profits earned during the first period which, in accordance with sound business practice, should have been conserved to provide for disastrous losses incurred in the ensuing depression. A 10-year recapture period would have accomplished this result.
A study of the financial history of the steamship business indicates that such incidents are characteristic of the industry. Profits, while large in some instances, and in others enormous, during prosperous periods, are usually counterbalanced by equally large or enormous losses in depression years. The proposed amendment recognizes this fact and adapts the recapture provisions to the cyclical nature of the industry.
Two new subsections are proposed for section 607 of the act. The first provision, subsection (f), is clarifying in nature and merely inakes definite what we now believe to be the law, that upon the termination of any subsidy contract the reserve funds belong to the operator, except as otherwise provided in the subsidy agreement. The elimination of doubt on this point may encourage new investment in the industry.
The second provision, subsection (g), permits the operator to increase his capital or special reserve funds by depositing therein any part of the net earnings available for distribution. This is believed to be an important provision. The act now contemplates that profits up to 10 percent a year will be distributed to shareholders. In a very few cases, where the operator's working capital is adequate, such a policy may be sound. But in most instances this would not be the case in view of the urgent need for additional working capital and the inability to secure outside capital investment at this time. Consequently, most operators will have to look to earnings for replacement funds. This makes a conservative dividend policy necessary. The suggested provision encourages such a policy by permitting operators to deposit all or any part of the first 10 percent of profits in the capital reserve fund, where they could be used to finance replacements. An inducement for this policy is found in the fact that the moneys deposited in the capital reserve fund automatically escape undistributed profits and other taxes.
Section 607 (f) of the act is renumbered 607 (h), and is further clarified by the addition of a provision to the effect that earnings withdrawn from the special reserve fund shall be taxable as if earned during the year of withdrawal rather than the year when earned. This provision will bring the act into harmony on this point and will eliminate a potential tax hazard.
The amendments also provide for the addition of a new section, to be numbered 611 (a), which is intended to protect the operator against arbitrary cancelation of his contract or default thereunder. The enactment of this provision is believed to be of paramount importance. In view of the history of merchant marine legislation in this country, there is today a lack of confidence in the stability of the Government's shipping policy. Congress might at some future time completely change its policy, refuse to appropriate moneys for subsidy payments, or even cancel the contracts in favor of some new system, thereby making the subsidy contracts worthless.
Under these circumstances, operators and investors are reluctant to risk large sums of money in construction of new vessels when the Government could at any time discontinue their operating subsidy and leave them to compete with low-cost foreign lines under impossible conditions.
We believe that the suggested legislation will afford all of the protection necessary to the industry in this respect and at the same time allow the Government complete freedom of action as to future policy. This is accomplished by the simple expedient of giving the operator permission to transfer his vessels to foreign registry if his contract is canceled without just cause or if the Government fails to perform, by reason of a change in policy or otherwise, unless such failure is cured within a specified period after it has been established and determined by judicial action. Such transfer is to be permitted only upon payment of all indebtedness to the Government.
This will protect the investor against the danger that at some future time he may be forced to compete against low-cost foreign competitors without Government aid. At the same time, it does not tie the hands of the Government, nor does it obligate us to pay any damages. It merely assures the operator that the Government will deal fairly with him in case of a future change of policy.
Other amendments which the Commission deems of importance relate to the dealings of a contractor with affiliate or associate companies, and to the salaries of officers and employees of the contractor. The Commission, as the law now stands, is given discretion to permit a contractor to utilize the services of a wholly owned subsidiary company, provided the profits of such subsidiary shall become a part of the earnings of the contractor and be accounted for in the recapture provisions. Based upon its experience so far in administering the act, and upon its business judgment, the Commission believes that in many cases it would be in the public interest to grant the same permission where a contractorowns less than the whole of any concern supplying the services mentioned in section 803— provided, of course, that such concern agrees to pay over to the operator any profits resulting from the performance of such services. On the other hand, the Commission is of the opinion that the discretion to make blanket waivers is not necessary. The proposed amendment to this section of the act will provide appropriate standards for the guidance of the Commission in granting the exemption, and, since it may be granted only upon the affirmative vote of four members of the Commission, it would seem that the interest of the Government is properly safeguarded.
The same general situation exists with respect to the provisions limiting the salaries of officers and employees of the contractor. Under the present act, such officers and employees may not receive more than $25,000 per year from a contractor. There are cases where, because of the extent and character of shipping operations carried on by the contractor, it is difficult to obtain the best executives at this salary. I should like to point out that other industries are under no suchhandicap. The shipping industry, as long as this provision remains unchanged, is not in a position to compete for the services of qualified executives. Since good management by qualified executives is essential to the success of any business, the Commission believes that the average investor would feel better satisfied with his company in the hands of a business leader whose services might not be obtainable for $25,000 a year. Likewise, the taxpayer's interest is safeguarded by competent management. The present provision does not really protect the Government or the inventor, if that was its purpose, because it is possible to employ any number of officials at $25,000 per year, all of whom might not be necessary to the efficient operation of the company and some of whom might be utterly incapable. The proposed amendment to section 805 (c) will, we believe, provide sufficient safeguard to accomplish the intent of Congress.
Construction costs, and amendment to permit building abroad:
The provisions of the act (title V) are designed to make possible the construction of vessels in domestic yards at the same cost to the operator as if he built his ship in a foreign yard. Under certain circumstances, however, these provisions may fail to accomplish their purpose. There is a specific prohibition against granting a construction-differential subsidy of more than 50 percent of the domestic cost. Consequently, whenever foreign shipyard costs are less than half of American costs the construction differential will be insuficient to place the American operator on a parity with his foreign competitor with respect to capital costs. It will then be cheaper to build abroad even after making allowance for the maximum construction subsidies provided by the act.
When this situation arises, there can be no new construction under the present act, because the Commission cannot pay the actual differonce between domestic and foreign costs, and because the vessel is not eligible for an operating-differential subsidy if built abroad. This is a very important problem and one for which some solution must be found.
One solution would be the granting of construction-differential subsidies to whatever extent might be necessary to achieve parity. The wisdom of this procedure is doubtful, however. It would increase the burden to the National Treasury and to the taxpayer; it would grant a tariff protection of over 100 percent; it would continue the existing virtual embargo on foreign-built vessels, thereby eliminating entirely any influence of international competition upon American costs.
A less expensive and more desirable manner of meeting this problem was the one suggested in the Commission's recent economic survey; that is, to permit construction abroad in any case in which the foreign costs are less than half the American costs, registry here being required as soon as practicable, and the ship so built and registered being eligible for an operating-differential subsidy as if built here.
The Government would not be required to pay out cash in either a loan or construction subsidy. The only payments would be those for national-defense features. Domestic shipping would be protected from the competition of a vessel so built and registered to the full extent that it is protected from the competition of vessels receiving construction-differential subsidies.
It is, of course, for the Congress to determine which of these solutions, if not some other solution, should be adopted. The plan sug; gested in the economic survey impresses me as being reasonable and in accord with sound national policy. It would provide a basis for the growth and maintenance of the merchant marine in times of high domestic shipyard prices without placing the burden of paying larger subsidies upon the National Treasury.
The question immediately arises as to whether it is good policy to permit the building abroad of vessels destined for our subsidized fleet, thereby depriving domestic yards and domestic labor of construction work. The answer is clear. The suggestion provides only for the building in foreign yards of vessels which would not otherwise be built for the subsidized fleet. Thus labor loses nothing with respect to such construction and is benefited to the extent that it is employed to operate a vessel which would not be in existence except for the fact that it was built abroad.
There are only four domestic yards equipped to construct a vessel of the MC design, to be built for the United States Lines Co. as a companion ship to the Manhattan and Washington. Bids were received from three of these. Only the bid which was accepted-submitted by the Newport News Shipbuilding & Dry Dock Co.-was low enough to make possible the construction of the vessel. The Commission determined that the estimated foreign cost of constructing a like vessel, excluding items not furnished by the shipyard, was $10,500,000. The fixed price bids of the two bidders whose bids were rejected were $21,308,000 and $21,947,000, being in each case more than 100 percent above the estimated foreign cost. Thus the MC design vessel could not have been built at the price quoted by either of these yards.
Furthermore, the American shipyards continue to enjoy a complete monopoly for all building for the domestic trade and for such of the Navy construction as was not done in navy yards. It must be remembered that the subsidized fleet now consists of only a million tons, as compared to 10,000,000 tons—vessels of all sizes-operated in the protected domestic trade.
In any event the domestic yards would retain, in addition to construction for the domestic trade and for the Navy, by far the major part of the construction for subsidized foreign operation. The yards would still be protected against foreign competition by a 50-percent differential on the basis of the American price, which may be regarded either in the nature of a 100-percent tariff or a preference similar to that provided by the “Buy American law” approved March 3, 1933 (47 Stat. 1520).
That law directs Government departments to purchase American products and gives such products à preference, in addition to any applicable tariff; but the law provides that foreign goods may be purchased for public use when the cost of American goods is determined to be unreasonable. According to the regulations of the Procurement
Division of the Treasury Department, pursuant to that law-circular letter No. 37 of June 20, 1934-American costs are held to be “unreasonable” on purchases which involve more than a few hundred dollars if the American price is more than 25 percent higher than the foreign cost. Under the Commission's suggestion, the American price for a vessel would have to be 100 percent higher than the foreign price before the right to build foreign would become effective.
Practically no other American industry receives such protection. The average rate of duty collected on American imports was 42.8 percent in 1935. The trend has been downward since 1932, due to the upward movement of prices. It is at the moment believed to be somewhat less, perhaps about 40 percent. The tariff on repairs made abroad to American vessels, which was requested by the domestic yards, amounts to 50 percent. If 50 percent is sufficient for repairs, which are, after all, a form of construction, 100 percent should be very generous for construction.
The protection given to materials used in shipbuilding is but a fraction of that afforded to the completed product under the Commission's proposal. Iron and steel products, which constitute the bulk of the material cost of a vessel, are given protection ranging from 10 percent to 37 percent, with the average lying between 20 percent and 25 percent. Electrical machinery is given 60 percent protection; steam engines get 15 percent, and internal-combustion engines receive 30 percent. Obviously, if the principal items which go into a ship require only 20 percent to 25 percent protection, 100 percent should be ample for the finished product, even allowing for a generous differential in the wages of yard workers. I see no reason why a 100-percent protection against international competition should not be ample for the builders and labor involved in this industry, especially when the industry also enjoys a monopoly of construction for the domestic trade.
For the reasons which I have just given, there appears to be no reason to believe that the maintenance and development of the domestic shipyards as effective units, capable of functioning as an important part of our defense machinery, should suffer from the adoption of this suggestion. On the contrary, the introduction of foreign competition might well result in an improvement of our domestic shipbuilding facilities. Should experience prove that the diversion of some shipbuilding to foreign yards under this suggestion—which should be minor and unusual-does in fact result in a material weakening of this vital part of our national-defense machinery, Congress can, of course, increase the protection accorded the domestic shipyards by raising the 50-percent construction differential limitation or adopting such other course as it may deem wise.
If this suggestion is adopted, it will be possible to invite bona fide foreign bids under conditions where the foreign bidder can feel that there is a reasonable prospect of getting some business. The plan thus brings other benefits which would not be achieved by authorizing an increase in the allowable construction-differential subsidy. It would have the effect of providing more competition in bidding for the construction of new ships by domestic as well as by foreign builders. The foreign competition would doubtless influence American bids, thus stimulating our own yards to higher standards of efficiency.
Furthermore, and this is a very important point, it would greatly,