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STATEMENT OF GREG JONSSON, VICE PRESIDENT AND COUNSEL UNITED STATES BUSINESS AND INDUSTRIAL COUNCIL, WASHINGTON, D.C.

Mr. JONSSON. Thank you, Mr. Chairman. I appear before you today as the counsel for the U.S. Business & Industrial Council in support of S. 1600. Let me first say that I concur with the testimony given by the previous witness, especially with respect to his statement on depreciation and the need to index that portion of the Tax Code.

USBIC is a national organization of 3,000 senior corporate executives from predominantly medium-sized companies representing all sectors of the U.S. industry. It is a group particularly dedicated to defense of the traditional free enterprise system, composed of many entrepreneurs and independent owners of closely held firms. The objective of private enterprise is not to maximize return to the U.S. Treasury but rather to minimize the tax exposure to enterprise. With respect to statements made by one of the previous witnesses, there will undoubtedly be a revenue impact associated with capital gains indexing, but it should not be viewed with alarm. A recent analysis of the Council of Economic Advisors has indicated that the amount of capital gains reported on tax returns increased dramatically in the year after the tax rate on capital gains was reduced, that is, more revenue at a lower tax rate. The anticipated revenue loss prior to the reduction was certainly exaggerated and I think that the revenue loss associated with indexation of capital gains tax is also likely to be exaggerated.

Just as USBÍC views the Economic Recovery Tax Act of 1981, ERTA, as a profound turning point in the history of U.S. tax policy, we also view the import of S. 1600 as a logical extension of that policy. ERTA is nothing less than a first attempt to slow the increase in the Federal Government's share of our gross national product. S. 1600 is an interim step in the same direction for capital assets.

Prior to the passage of ERTA, it was estimated that the Federal Government would claim more than 21 percent of GNP in the years 1981 to 1985, and a continuously rising share thereafter. By reducing marginal tax rates for individuals by 25 percent over 3 years the Government's claim of GNP was reduced to an estimated 17.4 percent, and after adjustments via the highway gasoline tax and the Tax Equity and Fiscal Responsibility Act of 1982 [TEFRA] to about 18.6 percent of GNP.

One of the most significant features of ERTA is the provisions for the annual indexing of individual income tax brackets, the zero bracket, and the personal exemption in accordance with rises in the Consumer Price Index for Urban Households, to begin in calendar year 1985.

Indexing the tax basis of capital assets would eliminate the unfair and prejudicial effects of current law. Indexing parity between income and capital gains tax will force the Congress to confront head-on the underlying economic conditions which necessitate its use. Once indexing is in place, Congress will either have to approve continuous and regular tax increases for expenditures, something inflationary bracket creep has allowed them to avoid, or fight

the inflation that the Nation will once again inevitably face in response to horrendous budget deficits projected for the rest of this decade.

As USBIC has stated many times in its policy statement, inflation can be purged from our economy only by substantial reductions in Federal spending, particularly spending on entitlements. There can be no doubt that the widespread support for indexing as a concept is an expression of the American peoples' deep dissatisfaction with congressional failure to reduce deficits without visiting inflation on the economy.

In view of the widespread support for indexing, and given its obvious benefits, it is difficult to understand how it can be opposed on economic grounds. ERTA was approved by the U.S. House of Representatives by a decisive vote of 238 to 195. Yet today, just 2 years later and 17 months before indexing is to take effect, it is facing strenuous opposition. USBIC believes that the basis for these efforts to repeal indexing and resistance to the idea of extending indexing to capital gains is an unwillingness by Congress to accept fiscal discipline. Indexing is a means to insure that real tax revenues are consistent with real economic growth. To the extent that nominal capital gains represent simple inflation in asset values, no additional real capital is created, and taxation of those gains erodes our capital base. We must index the basis of productive assets so that the inflation component will not be subject to tax.

If revenues to the U.S. Treasury are restricted to the actual growth in the Nation's economy rather than the fictional growth attributable to inflation, the beneficiaries of inflation-Congress and certain special interests tied to entitlements-would become accountable to the taxpayer once again. USBIC believes that real economic growth is the best hope for ameliorating the deep and traumatic economic problems caused by the recession of 1981 and 1982. We believe that real growth can only be sustained if consumers, producers, and investors are confident that the labor they perform and the risks they take-in short, enterprise-will not be penalized by the hidden tax of inflation.

Tax reduction, the centerpiece of ERTA, is the only effective means available to the American people by which to impress upon the Congress the need to reduce Federal spending. Without ERTA's indexing feature and without the extension of this approach to capital gains, Federal revenues will continue to increase from bracket creep, notwithstanding the recent tax reduction features enacted by Congress. This is the legacy of inflation as well as the greatest economic threat for America's future.

USBIC specifically endorses the indexation of the capital gains tax to the GNP deflator, which is the substance of S. 1600. Thank you.

Senator ARMSTRONG. Mr. Jonsson, thank you very much for a fine statement. And I especially thank you for pointing out that real economic growth is the best hope for solving the economic problems that our country faces. I will be back to you in a moment. Next, Mr. Mark A. Bloomfield, executive director of the American Council of Capital Formation. Mr. Bloomfield.

[The prepared statement of Mr. Jonsson follows:]

Prepared Testimony of the U.S. Business & Industrial Council
For the Senate Committee on Finance (August 1, 1983)

Mr. Chairman, distinguished Senators:

My name is Gregory N. Jonsson and I appear before you today as Vice President & Washington Counsel of the U.S. Business & Industrial Council.

USBIC is a national organization of 3,000 senior corporate executives
from predominantly medium-sized companies representing all sectors
of U.S. industry. It is a group particularly dedicated to defense
of the traditional free enterprise system.

This year the Council observes the fiftieth anniversary of its founding. Our position supporting legislation to index capital gains to a reliable measure of inflation is an expression of our free market philosophy.

We believe that the Economic Recovery Tax Act of 1981 (ERTA)
represents a profound turning point in the history of U.S. tax policy.
ERTA is nothing less than a first attempt to slow the increase in
the federal government's share of our Gross National Product.

Prior to the passage of ERTA, it was estimated that the federal government would claim more than 21% of GNP in the years 1981-1985, and a continuously rising share thereafter. By reducing marginal tax rates for individuals by 25% over three years, the government's claim of GNP was reduced to an estimated 17.4%, and after adjustments via the highway gasoline tax and the Tax Equity & Fiscal Responsibility Act of 1982 (TEFRA), to about 18.6% of GNP.

One of the most significant features of ERTA is the provision for the annual indexing of individual income tax brackets, the zero bracket, and the personal exemption in accordance with rises in the consumer price index for urban households, to begin in calendar year 1985.

Indexing is tax technique which is long overdue. It is the best means by which to relieve the invisible tax of inflation on lower and middleincome taxpayers available to this Administration and this Congress. Indexing the tax basis of capital assets would eliminate the unfair and prejudicial effects of current law.

Indexing will force the Congress to confront head-on the underlying economic conditions which necessitate its use. Once indexing is in place, Congress will either have to approve continuous and regular tax increases, something inflationary bracket creep has allowed them to avoid, or fight the inflation that the nation will again inevitably face in response to horrendous budget deficits projected for the rest of this decade. As USBIC has stated many times, inflation can be purged from our economy only by substantial reductions in federal spending, particularly spending on entitlements. There can be no doubt that the widespread support for indexing is an expression of the American peoples' deep dissatisfaction with Congressional failure to reduce deficits without visiting inflation on the economy.

In view of the widespread support for indexing, and given its
obvious benefits, it is difficult to understand how it can be
opposed on economic grounds. ERTA was approved by the U.S. House
of Representatives on July 29, 1981 by a decisive vote of 238-195,
with 48 democrats voting for the President's bill. Yet today, just
two years later and 17 months before indexing is to take effect,
it is facing strenuous opposition.

USBIC believes that the basis for efforts to repeal indexing,
and resistance to the idea of extending indexing to capital gains,
is an unwillingness to accept fiscal discipline by the Congress.

Indexing is a means to ensure that real tax revenues are consistent
with real economic growth. To the extent that nominal capital gains
represent simple inflation in asset values, no additional real capital
is created and taxation of those gains erodes our capital base.
We must index the basis of productive assets so that the inflation
component will not be subject to tax.

If revenues to the U.S. Treasury are restricted to the actual growth in the nation's economy, rather than the fictional growth attributable to inflation, the beneficiaries of inflation, Congress and the carnival of special interests tied to entitlements and other largesse, would become accountable to the tax payer once again. It is no wonder that the opponents of indexing resort to the red herring of larger budget deficits between 1985-1988. (claims have been made of an additional $90 billion in the deficit for this period if indexing goes into effect)

Doomsday talk of higher and higher deficits is the first tactic of the tax-and-spend advocate. Big deficits will indeed be a serious problem for the U.S. economy for at least the rest of this decade, but deficits happen not because the government fails to collect sufficient revenue, but because it continues to spend too much.

Even at that, deficits are directly related to economic growth. We have just seen our economy grow at a rate of 8.7% for the second quarter of 1983, the strongest pace since the 1st quarter of 1981. The Office of Management & Budget has lowered its projections of the deficit for fiscal 1984, from $190.2 billion to $179.7 billion, as well as for the out-years through 1988.

USBIC believes that real economic growth is the best hope for
ameliorating the deep and traumatic economic problems caused
by the recession of 1981-82. We believe that real growth can
only be sustained if consumers, producers, and investors are
confident that the labor they perform and the risks they take,
in short, enterprise, will not be penalized by the hidden tax of
inflation.

Tax reduction, the centerpiece of ERTA, is the only effective
means available to the American people by which to impress upon
Congress the need to reduce federal spending. Without ERTA's
indexing feature, and without the extension of this approach
to capital gains, federal revenues will continue to increase
from bracket creep, notwithstanding the recent tax reduction
features enacted by Congress. This is the legacy of inflation,
as well as the greatest economic threat for America's future.

USBIC concurs with Senator Armstrong that the Consumer Price Index

is an unreliable measure of inflation in its present form. There is a consensus among economists that reference to the GNP-deflator would be a more accurate index.

USBIC, therefore, specifically endorses the indexation of the tax on capital gains to the GNP-deflator.

We commend Senator Armstrong and other members of this Committee for their iniative in this area of economic policy and thank you for inviting USBIC to express the views of its members in this forum.

STATEMENT OF MARK A. BLOOMFIELD, EXECUTIVE DIRECTOR, AMERICAN COUNCIL FOR CAPITAL FORMATION, WASHINGTON, D.C.

Mr. BLOOMFIELD. Mr. Chairman and members of the committee, I am Mark Bloomfield, the executive director of the American Council for Capital Formation. I am pleased to be here today to urge enactment of S. 1600 introduced by Senator Armstrong, which would index the basis of capital gains for inflation and address a very real problem in the taxation of capital, that is, the mismeasurement resulting from inflation.

Mr. Chairman, tax policy is a primary vehicle through which the Government can dramatically affect capital formation, the saving and investment necessary to stimulate productivity growth, restore real income gains, and provide for job creation.

Congress took a dramatic step forward in procapital formation tax policy in 1978 when it reduced the excessive taxation of capital gains. Skeptics at that time said it would do little for capital formation and it would do much to erode Government revenues. On both counts they have been proved dead wrong. First, the economics. We have two historical periods to compare. There is the period 1969 to 1977, where we had increasingly higher capital gains and a bad investment climate. There is the period subsequent to the 1978 capital gains tax cut to the present, where we had lower capital gains and a better investment climate. What happened? In the latter period, venture capital, new stock offerings, the value of corporate equities blossomed. Why? We again restored the reward for risk taking and investment.

Now what about Uncle Sam's coffers? The Government predicted in 1978 that there would be a $2 billion raid on the Treasury. What happened? After 1978 when tax rates were reduced, revenues went up. Actual taxes paid on capital gains were up by more than $2 billion in 1979, the first year of the lower capital gains rate. Up again in 1980, and in 1981, actual revenues from capital gains were still substantially higher than in 1978, the last year of the old lower

rate.

Economists, however, also compare actual revenues with what would have happened if the tax laws had not been changed. In a January 1983 paper commissioned by the ACCF: Center for Policy Research prepared by Dr. Jerry Auten, a former Treasury consultant on capital gains, capital gains taxes actually paid under the new law were compared with taxes that would have been paid under the old law. What did Dr. Auten find? He found that in 1979 revenues were more than $1 billion higher; in 1980, almost $2 billion higher; and in 1981, again over $1 billion higher than they would have been under the higher old capital gains rate. Given the benefits to capital formation also to Uncle Sam's Treasury, much more needs to be done. We still tax capital gains much more harshly than our major industrial rivals. Much needs to be done, including S. 1600. S. 1600 is long overdue because it would insure that tax would be paid on real, not inflated, capital gains.

Dr. Martin Feldstein, the current Chairman of the Council of Economic Advisers, in a 1978 study, found that in 1973 Americans actually paid taxes on more than $4.5 billion of nominal gains. But

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