Parting the Waters

ON A HOT JULY afternoon in rural Maryland, Senator Russell Long's Finance Committee staffeked out an 8 to 7 softball win over William Simon's Treasury Department jocks. Although it represented one of the few Congressional triumphs over the Ford Administration for the summer of 1975, the game was not very reassuring. William Simon, in high dudgeon with Bermuda shorts and a Chevy Chase tennis tan, circulated, slapping backs and sipping beer, among assorted Congress people and Senators, all of whom seemed receptive to more of Simon than just the easy-to-hit pitches he had thrown all afternoon. One almost wished for the Nixon-era "political hardball" operatives back again--their deviousness was at least straight-forwardly obnoxious. Simon, while just as completely wrong, is so earnest and ingratiating that he is even more dangerous to this country's economic well-being.

In these times of 7 to 8 per cent unemployment and off-and-on spurting recovery from the worst recession since the Thirties, Simon and the Ford Administration are concerned not with the billions of dollars of potential GNP going unrealized, but with the possibility that financing the large federal deficits this year and next will contribute to future inflation and crowd out private investment. Regrettably, this Wall Street bond-broker's per-spective ignores recent history: it was the paranoia about inflation common to Ford, Simon and Federal Reserve Chairman Arthur Burns in 1974 which led to the excessively tightened money supply that slid the country into the 1974-75 recession.

Simon's recurring worry that the financing of large federal deficits will crowd out private investment from the capital markets also ignores the salient facts. Most of this year's deficit and over $50 billion of next year's estimated $70 billion deficit is attributable simply to a weak economy. The Congressional Budget Office, for example, points out that every extra one per cent of unemployment increases the deficit by approximately $16 billion because of lower tax receipts and higher outlays for unemployment compensation. This part of the deficit doesn't crowd out private credit. It merely compensates for the shortfall in private credit demands.

The second part of the deficit is composed of active policies to stimulate the economy: tax cuts and expenditures. To argue that this part of the deficit is going to crowd out private credit demands is nonsensical. The question really is: Crowd out compared with what? Suppose we had no tax cut and no extra fiscal stimulus. Then a recovery would probably be aborted, and this would really depress private credit demands by causing much greater inventory liquidation, cutbacks, and so on.

BECAUSE THE DEMOCRATS in Congress understand these principles of deficit spending in recessions so as to stimulate the economy, Simon has been forced to find a new language in which to couch his orientation toward investment and corporate well-being. Hence, Simon the Moralist and Prophet has made his debut in speeches around the country to business groups and in articles in Readers' Digest and Saturday Review. According to Simon, "the ethics of thrift and savings have been replaced by the ethics of instant pleasure, and we have turned to the modern state to satisfy our hunger." Simon says that the United States is spending too much of its income on consumption and not enough on capital formation and investment, that unless the country builds factories now there will be neither enough jobs nor enough goods at some future point--and the high rates of inflation and unemployment will continue.

Simon begins his argument with international comparisons, a sure device to get jingoistic Americans jumping. From 1960 to 1973, Simon told the Senate Finance Committee in May, the Japanese diverted 29 per cent of their total economic output each year into new plants and equipment, the West Germans 20 per cent, the French 18.2 per cent, the British 15.2, the Italians 14.4--and the United States only 13.6 per cent. This relatively low investment rate, according to Simon, is the reason America's growth rate is "among the lowest of the major industrialized nations." Economist Joseph Pechman of the Brookings Institution disagrees. International comparisons are irrelevant, says Pechman; other countries have been investing more because they have had to; they were behind economically, and trying to catch up. That is also why their growth rates have been higher--they had lower starting points. In other words, at the upper reaches of per capita output, marginal growth rates can only be very small.

But Simon has more than one bogey in his bag of tricks. From various studies done by the Federal Reserve Board, Simon estimates that the demand for capital between now and 1985 will amount to more than $4.5 trillion. He anticipates particular demand growth in the field of energy production, with heavy requirements also seen for business efforts to meet government clean air and water and occupational health and safety standards. But if one breaks that mammoth number down into year by year figures, with allowances for inflation and for economic growth between now and 1985, $4.5 trillion is not quite so scary. Even a Simon ally, Federal Reserve Board member Henry Wallich, admits that the likely investment demands will rise only one percentage point of total GNP (to 11.5 per cent each year from the "historic" 10.5). And the demands Simon and Wallich anticipate may never materialize. As Walter Wriston, chairman of New York's First National City Bank, told the Business Council last fall, "compile a national shopping list...of capital investment aspirations," and "the estimate of the financial resources to fulfill them would always fall short...We would today, as always in the past, come up with a shortage." Perhaps, then, the capital shortage Simon bemoans is only a permanent optical illusion.

BUT WILLIAM SIMON, ever-resourceful, has a new wrinkle called "the profits depression," to explain the imminence of a capital crisis. There are three ways in which businesses acquire capital for plant and equipment expansion: they retain earnings or profits, they sell stocks, or they sell bonds. Over the past ten years, according to Citibank's Wriston, business has gone increasingly into debt (sold bonds) to finance its expansion; and the capacity of the bond markets is narrowing. Thus companies will have to look more and more to the stock market and to retained profits for capital sources. This, of course, puts a premium on profits: you can't retain earnings if you don't have any profits, and no one will want to buy your stocks if they don't pay dividends. In this context, then, Simon points out that profits, adjusted for inflation, for all domestic nonfinancial corporations have declined from a high of $41.1 billion in 1966 to $20.6 billion in 1974.

To William Simon, these figures are an imperative for government to cut corporate taxes so that businesses will be able to secure the capital necessary to assure enough jobs and goods in the future. Simon also rails against what he calls the "disincentive to invest of double taxation of dividends." He means that first the money is taxed as corporate profits. Then it is paid out and taxed again as personal income. One of these should be eliminated, says Simon. Economists like Joseph Pechman and Michigan's Harvey Brazer see no such imperative. Brazer told the House Ways and Means Committee in its June tax reform hearings,

I am struck, as I listen to the remarks of my fellow panelists, that over the 17 or 18 years through which I have from time to time appeared before this committee not very much has changed. All through that period there has been held the view that there is a capital shortage in the United States, that investment is inadequate, and that something ought to be done; and, at various intervals through this period, a variety of things have been done.

Brazer says that corporate taxes have been cut and cut again. Pechman calculates that the effective corporate tax rate has been reduced from around 40 per cent in the early 1950's to less than 30 per cent today. "Yet," says Brazer, "we apparently are still suffering from the ills we suffered from"

NO ONE SHOULD MISS the major point of the campaign Simon has started. It is designed to reduce taxes on the return from invested capital which, by definition, means trimming the obligations of those who hold capital, namely the relatively wealthy people. Simon is trying to sell the idea of a tax break for the rich, but his argument is that he is really doing it for all of us. The major purpose, he says, is to ensure jobs and goods in the future.

The simple truth, of course, is that more goods will be produced in the present plants (operating at three-fourths of capacity right now), and new factories will be built, when the demand is generated. The best way to assure adequate investment is to avoid recessions, and to return from the current one to high levels of employment as soon as possible.

But every time William Simon goes in front of the Joint Economic Committee, he opposes renewing the tax rebates, he condemns budget deficits, he attacks public service employment, and he refuses to entertain the possibility of giving aid to New York City. Simon inspired the Quote of the Month from Senator Hubert Humphrey for his obstructionist tactics:

Your're callous, Mr. Secretary. You people just don't care if some teachers out there get laid off and lose their savings, but if Chase Manhattan's portfolio starts sinking, the next thing we'll hear is Arthur Burns yelling, 'Part the waters, boys, I'm coming through.'

But to Senator Russell Long (D-La.), William Simon is "a fine man and a good softball player." And there's the danger--insidious reaction.