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Tuesday, APRIL 24, 1979
12:00 P.M. MST (2:00 P.M. EST)

Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
at a meeting sponsored by
Westminster College,
The Chamber of Commerce, and
The Rotary Club
Salt Lake City, Utah
Tuesday, April 24, 1979

Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
at a meeting sponsored by
Westminster College,
The Chamber of Commerce, and
The Rotary Club
Salt Lake City, Utah
Tuesday, April 24, 1979

I am grateful to Westminster College and i t president, Dr. Helmut
Hofmann, for giving me this opportunity to address the Chamber of Commerce
and Rotary Club of Salt Lake City on the topic "Consumers and Producers in

In this free enterprise country, the consumer is king.

That is

elementary. A business will prosper if it can produce a better mousetrap
that the consumer wants.

It will have to go out of business if it insists

on turning out: goods that the consumer does not want, or if it just cannot

We do not allow the Government to make decisions as to what is to

be produced and consumed, give or take a few qualifications.

The consumer,

by casting dollar votes in a free market, makes those decisions.
what a free enterprise, market economy is all about.

That is why the

United States has achieved such a high standard of living.

That is

-2Thus far the textbook.

How about the reality? The consumer, or at

least consumer advocates, today are indeed in the saddle.

But the consumer

occupies this rightful role not only by virtue of competition for his dollar, but
through Government mandates laid upon producers. These mandates are farranging.

They run from rules concerning what is to be produced, how it is

to be produced, and on what terms and conditions it can be sold, to regula­
tions affecting the supply of essentials, such as energy, and further to
the tax system which determines how much the businessman will have left over to
invest and, therefore, how efficiently he will be able to produce.


large part, the thrust of these laws and regulations is to improve the lot
of the consumer at greater or lesser expense to the producer.
ultimate consequence is becoming obvious to all:

Today, their

Producers cease to be

efficient, their costs go up, the consumer pays more, and our standard of
living has almost ceased to rise.
The fundamental truth is, of course, that the consumer cannot live
without the producer.

In fact, most consumers are also producers, as

businessmen, workers, farmers, and in every other endeavor.

The notion,

therefore, that the consumer should be protected against the producer is
prima facie open to logical challenge.

The law, and even the language of

the law, seems to ignore this obvious fact.

In regulatory language today,

hundreds of pages of which sometimes come to the Federal Reserve Board
for approval in a single week, the word "consumer" is used where in the
past one would have said people, or individuals, or Americans, or men and

The law wants us to be a nation of consumers, in confrontation, it

seems, with our enemy the producer.

-3To document vhat I am saying, I would first like to go over
some of the most serious instances where national policy and legislation
pit consumer against producer and then to review some of the consequences
which are already becoming only too apparent.
First:, there are the transfer expenditures in the Federal budget,
which as a per cent of GNP have risen from 5 per cent through most of the
1960's to almost 10 per cent-for Fiscal Year 1978.

Not all of these transfer

payments, to be sure, are pure gifts from producers to nonproducers.

To the

extent that people paid Social Security taxes, and interest was accumulated
thereon, they are merely getting their own money back as they would from a
life insurance company.

But, of course, Social Security benefits far exceed

these amounts, being essentially financed by taxes on the working population
to support the retired population.

Unemployment compensation, welfare

benefits and a variety of other intrinsically meritorious but nevertheless
expensive programs swell the transfers from producers to nonproducers.
The tax system is set up to favor the consumer at the expense of
the producer.

At the corporate level, taxes are levied on profits that the

Department of Commerce does not classify as true profits.

During the past

year some 3G per cent of reported profits after tax resulted from under­
depreciation and from inflationary inventory appreciation.

These do not

add to a company's ability to pay taxes or dividends or to make new invest­

Because taxes must be paid on such phantom profits, less is left for

corporate reinvestment and for dividends out of which new investments might
be made by individuals.

In addition, the double taxation of dividends —

once as income to the corporation, and again as income to the stockholder —
cuts down a type of income that has a high probability of being reinvested.
At the level of the individual taxpayer, we have a steeply progressive
income tax that is bound to work as a disincentive even for income earners in
relatively modest income brackets.

On the other hand, we do not tax Social

Security income, making it more attractive to retire.

At the upper end of

the income scale, we distinguish between earned and "unearned" income.


earned income there is a cap of 50 per cent, on "unearned" income the tax
reaches as high as 70 per cent, not taking into account State, local, and
capital gains taxes as applicable.

"Unearned" income is the income from

investments that were taxed once before when the taxpayer saved the money
and made it available as capital to the economy by investing it.

For a

society that would like to raise its productivity, this is the most useful
type of income and it gets the worst treatment in our tax system.
The capital gains tax is another instance of anti-producer taxation.
It is aimed directly at the enterprise and risk taking that is needed in an
economy where investment decisions are made by individuals and not by the

Today, when inflation has doubled prices since 1968 and quadrupled

them since 1943, much of what the tax collector calls capital gains i > iirrply
the result of asset prices keeping up, more or less, with inflation.

In the

stock market, as we know, prices have kept up with inflation less rather than

The capital gains tax, therefore, is in large part simply a tax on

capital, not on gains.

Either way, of course, it penalizes the successful

Capital that is employed essentially in consumption, as in owner-

occupied homes, receives preferred treatment through roll-overs and lifetime

-5A third area in which the consumer is favored at the expense of
the producer is in the treatment of savings.

This discriminatory treatment

is effectuated through government regulation and through the tax system
which does not allow adjustments for inflation.

It is difficult enough,

in a country of rising taxes, rising inflation, and diminishing growth,
to make ends meet.

It is more difficult, under these conditions, to hold

expenditures below income to put aside regular amounts.

What is most

difficult of all, today, is to preserve the real value of what has been
Unlike practices in some other countries, in the United States
the saver gets no special tax advantages.

At most, savers who happen to be

debtors can look upon the deductibility for income tax purposes of the
interest paid as a form of subsidy to saving since debt repayment is a
form of saving.

The mechanism of the subsidy, which, of course, is quite

unintended by the legislator, works as follows.

At today's high rate of

inflation, the interest rate contains a sizable inflation premium.

In an

economic sense, this can be thought of as a form of repayment of capital.
The value of the principal of the debt diminishes through inflation, while
the debtor compensates the lender by paying him the inflation premium.


deductibility of the full nominal interest rate, including the inflation
premium, can, therefore, be viewed as a special aid to saving.

But in

order to get this subsidy to saving, the consumer must first have borrowed.
All the forces of inflation and taxation work against those not in debt.
Essentially it is consumption on credit, rather than net saving, that is
supported in this way.

On balance, tax deductibility of interest on housing



and consumer credit turns out to be simply one more of many devices favoring
the consumer against the saver.
The net saver, on the other hand, is really hurt by the same tax

The interest that the saver receives usually contains some

compensation for inflation, even though inadequate in many instances.


premium is not income in an economic sense, any more than are insurance
benefits paid for losses from accidents or fire.
are not treated as taxable income.

The latter, naturally,

The inflation premium, whose function

it is to make up for the damage from inflation, is taxable.

Money is the

only depreciating asset on which even a business user cannot charge
Unless the saver is well-to-do or even wealthy, moreover, worse
treatment looms.

Savings or time deposits are the natural investment

medium for a small saver.

Interest rates on all such deposits below $100,000

are subject to ceilings under Regulation Q of the Federal Reserve and other
Federal regulators.

Passbook savings at commercial banks are limited to

5 per cent; time deposits for various periods are capped at somewhat higher

All of these rates are below market rates and have been for some

time, with the exception of the recently introduced six-month money market
certificates which have been snapped up by many savers who could put up the
minimum of $10,000.

The plight of the small saver has come very much to the

forefront in recent weeks and is under intensive study by Government agencies.
It urgently calls for redress.

-7Another area in which the saver encounters adversity is the
stock market.

I have already conmented on the depressive effects of the

capital gains tax, the double taxation of dividends, and the taxation of
phantom profits in times of inflation.

These factors combine with high

Government-mandated costs for health, safety and environmental purposes
in reducing the attractiveness of American equities.

Pension fund regulation

makes it difficult for investment managers to buy stock, particularly in
small and new businesses, and contributes to the dismal experience that
savers who invested in common stocks have had over many years.


success, in recent years, has been limited largely to those who purchased
homes, usually by incurring debt rather than by using savings.
The adverse treatment and experience of the saver in the American
economy must properly be viewed as part of our general tendency to penalize
the producer and favor the consumer.
to suffer.

Without saving, production is bound

To grow, the economy needs investment.

To invest, there must be

The United States has become a low saving country, compared to

other nations.

The personal saving rate in the United States is in the

range of 5 per cent of disposable personal income.

This compares with

about 14 per cent in Germany and 24 per cent in Japan.

Accordingly, invest­

ment and growth in those countries historically have been on a much larger
scale than in our own country.

Savers are, in fact, among the most important

producers, since they produce capital.

Their neglect, to the benefit of the

consumer, is part of the syndrome of favoring consumption at the expense of


Government regulations of a wide variety have also tilted the
balance between consumption and production.
entirely different sorts.
production —

These regulations are of many

It is only their common denominator -- less

that is the same.

Many regulations, needless to say, pursue and sometimes achieve
good objectives including monetary savings.

Thanks to environmental invest­

ments imposed on business, we breathe cleaner air and enjoy cleaner water,
and, as a result, may have less illness and lower expenditures for medical

Workers are safer on the job and drivers are safer in traffic,

provided we do not allow the greater safety of seat belts, etc. to lure us
into more risky driving.

But the costs are undeniable.

The annual compliance

costs of energy and environmental regulation imposed upon industry have been
estimated at $7.8 billion.

For consumer health and safety, the analogous

costs have been estimated at $5.1 billion.

The additional cost of safety

features in automobiles have been estimated at $666 per car.


with such numbers, one is bound to wonder whether the consumers appreciate
what they get, and where they bear measurable cost, whether they consider
it worthwhile.
Regulation proliferates rapidly in many other areas, including
the financial, which I have an opportunity to observe and participate in
at close quarters.

Its purpose usually is to protect the consumer against

the producer, although in many cases it also deals with issues of producer
versus producer and among competitors.

Sometimes it is the public interest

in a broader sense that régulât


to quarrel with the objective.

' s with the unintended side


Usually it is difficult

-9Sometimes these side effects simply imply higher costs.
times, however, there are unintended anti-competitive effects.


It is

particularly small businessmen, the small bankers, who are hard hit.


cannot personally keep up with the flood of regulation and often cannot
afford in-house legal talent.

A large firm or large bank, with a specialized

staff, obtains a competitive advantage.
A few days ago, The Washington Post ran an editorial entitled
"Regulation, Regulation, Regulation," in which they took to task the
Congress and the Federal Reserve Board for producing 3,000 pages of inter­
pretations and explanations on one single regulation, dealing with Truth
in Lending.

Few regulations had a better purpose, and few have ended up

creating so much difficulty for bankers and other lenders.

Not long ago a

banker told me that he could not spend time with customers any more because
he was so busy studying Federal Reserve regulations.

Since he can be sued

and penalized for failing to obey them, he is probably making a wise alloca­
tion of his time.

But it is not clear that the customer gains.

In Washington, there exists a built-in momentum of regulatory
activity that is a cause for deep concern.

The Government, through all

its labyrinthine channels, is geared up to produce regulation the way
Detroit produces automobiles.

Many thousands of people in Washington,

dedicated and sincere, have assigned to them the job of turning out more

They cannot go home at night with a sense of a job well done

if they have not turned out some more regulation.

Many people's careers,


in Congress and in the agencies, depend on their success in accomplishing
more regulation.
being written.

Their families' livelihood depends on more regulation
This way, the supply of new regulations becomes independent

of the need for it.
The final result of anti-producer orientation of the U.S. economy
is to be read in the productivity statistics.

Historically, productivity,

that is, output per work hour, has grown at 2-3 per cent, on the average,
over many decades.

Since the late 1960's, there has been a dramatic slowdown.

The Council of Economic Advisers estimates annual productivity gains over the
past five years at less than one per cent, down by one-half if not by more.
Consumers' real per capita income and living standards accordingly have

Much of this slowdown must be attributed to regulatory, although

the tax system and other factors also have contributed.

The effort to

benefit the consumer has turned against itself.
Low productivity has contributed to inflation.

Because wage

earners have been accustomed to good annual gains in the past, gains which
the economy can now no longer provide, they have sought to overcome the
slowdown of income gains by escalating their demands.

They have only

escalated inflation, and inflation, by hurting saving and investment, has
further reduced productivity.
The value of our currency has declined in consequence.


to D-mark and yen, the dollar is worth roughly one-half of what it used to

The United States has an enormous trade deficit while Germany and Japan

have large surpluses.

We are being outproduced and outsold around the world,

as our nation of consumers vainly tries to compete with these nations of


What is to be done?

To continue along the present path will

bring continuing dissatisfaction at home and diminishing strength abroad.
As we become poorer in relation to others, our influence and our ability
to defend ourselves diminish.

We need a new orientation.

We need to restore a better balance in the relative role of

producer and consumer.

We must stop taking production for granted, like

rain from heaven that falls alike on the just and the unjust.

The consumer

cannot flourish when the producer cannot perform.

We need to review our tax system.

The corporate tax, the

capital gains tax, the treatment of "unearned" income must reflect the need
for greater saving, investment, and productivity.

Particularly during a

period of inflation, the anti-production effects of these taxes need to be

The saver must be given a better break, especially the small

The present imbalance in our regulatory and tax framework which

favors debt and penalizes thrift must be recognized as part of the anti­
production syndrome.

The institutionalized outpouring of regulation needs to be
Whether this overpowering proliferation of Government activity

is consistent with a free society may be debatable, but it certainly is not
consistent with a productive society.
In a free society, it takes time for people to realize that
Government is encroaching.

In a totalitarian society, people naturally

are much more conscious of encroachments.

I had never believed that I


would find myself appealing to the authority of the late Chairman Mao Tse Tung,
but his thought "The struggle against corruption, waste, and bureaucracy should
be stressed as much as the struggle to suppress counter-revolutionaries" has
a ring of political wisdom about it.

As Jefferson put it many years earlier,

"The natural progress of things is for liberty to yield and government to
gain ground."

Very different points of view lead to the same conclusion on

this subject.