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BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
FOR THE PRESS
For immediate release

June 1# 19U5
STATEMENT BY CHAIRMAN ECCLES
BEFORE THE
SELECT COMMITTEE ON SMALL BUSINESS
HOUSE OF REPRESENTATIVES
FRIDAY, JUNE 1, 19U5

The present is a strategic time for formulating a sound program
for meeting the long-term needs of small business. Small businesses at
present are prosperous, but small business as a type of enterprise is under
serious handicaps.
During the depression, it was assumed that if we could only pump
out more and more credit to small business borrowers, all would be well.
We conceived of the problem in terms of credit and relief. We now know that
a broader approach is necessary.
Small business in practice means independent individual enterprise.
It is fortunate for the economy that, along with the growth of a few thousand
large businesses in the last half century, enterprises of the individualistic
type remain very numerous, about three million in number. The small businesses have much to do with preserving competition, with adding variety to the
standard of living, and with supporting independent communities. Also they
tend to develop the type of individual that backs his own judgments and has
the spirit of enterprise and venture. In a democracy small business, small
farming, and independent professional life are important offsets to big enterprise. It may be, in the last analysis, that democracy depends upon the
maintenance of an adequate amount of individualism.
This type of enterprise has tremendous vitality. Many small businesses that disappeared during this war will revive, and more will be founded
as demobilization proceeds. This process is already underway* since May,
I9I4U1 the number of business births has exceeded the number of discontinuances.
After dropping from 3,398,000 in September, 19Ul to 2,8i|0,0Q0 in December,
19U3, the total number of business firms was 2,938,U00 last September, and
undoubtedly exceeds 3*000,000 today. This phenomenon would be gratifying if
the environment could assure that the new business births would not be off
set by a rise in business deaths.




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In particular, small business is important to employment. In
1939 eight million wage-earners and two million proprietors were employed
in enterprises having less than 50 workers each, which was about equal to
the total employment in all concerns having 1,000 workers or more» From
1939 to the end of 19U3* employment in the less-than-50-worker concerns declined by 1.7 per cent, whbreas employment in the more than 1,000-worker
enterprises increased by 95 P©** cent. This wartime distortion, however,
will tend to rectify itself if conditions are favorable. But conditions are
not favorable in certain basic respects, and we can hardly hope for either
the desired restoration of individualism in enterprise, or full employment
in the Nation, unless conditions are made favorable for the small enterprise.
Technological basis of the problem
T V a , then, is the small business problem? The basis of the problem,
/ht
it seems to me, is not financial, but technological. Over the years, machines
have become far more productive and hence far more costly. The mass producing
type of machinery has been greatly developed and applied. As a result of
these trends, the minimum capital requirement for successful operation in
nearly all fields of enterprise has greatly increased*
This higher capital requirement has had the effect of making it
more difficult to start a business. The higher capital requirements have
meant higher overhead costs and fixed charges. The higher costs have required a larger volume of business and broader markets. This, in turn, has
increased sales costs and required larger amounts of working capital. Investment funds have preferred the enterprises with the broadest market base
in order to reduce the risk»
Three approaches to the problem of small business
I should like to discuss briefly the problem of small business
from three general aspects; first, from the standpoint of technological and
managerial assistance; second, from the standpoint of adjusting the tax
structure; and third, from the standpoint of supplying credit and capital.
I. The technological approach
The first item in such a program would be to provide a means for
placing small business in closer touch with modern technology and, in general, with the best management information and technics of every type. The
big organizations have their own laboratories, some 2200 in number, and
large companies and associations covering the major portions of their industries are constantly in touch with the National Bureau of Standards. The
larger businesses also have their own economic and marketing experts and
staffs. Not only is the small business unable to support such services, but
its management often does not know where to write for the most reliable type
of information.




A central place should be established within the Government, to
which the small business may send in a query on any problem connected with
management, such as technological or production problems,, sources of materials, use of by-products, methods of personnel administration, accounting
standards, market opportunities, etc. The central bureau would, in effect,
do for business and industry what the Department of Agriculture does for
agriculture.
II«

The taxation problem

The second, and perhaps the most important, approach to the small
business problem is in the tax field. The tax structure should be revised
so that, in effect, it will'put a premium on funds invested in new ventures
and a penalty on funds that are put into existing ventures for speculative
capital gains.
YJh^t would greatly encourage small business after the war is ended
would be, first, to reduce the excess profits tax from the present 95 Pe** cent
maximum to, possibly, 65 P$r cent, and to make the corporation tax, say, 25
per cent instead of l. per cent as it is now with the surtax. Secondly, to
j0
exempt from the 25 per cent corporate tax all profits paid out in dividends
which would be taxed in the hands of the recipients. This would avoid the
double taxation that is so great a deterrent to the investor in productive
enterprise. It would also have the desirable effect of inducing corporations
to pay out rather than to retain profits. Third, to give an exemption of
$25,000 to all corporations under the excess profits tax. This would be of
little moment in the case of a large corporation, but it would be a tremendous
benefit to the smaller and medium sized concerns.
(1) Excess Profits Tax
I am in accord with the recent proposals of the Joint Committee for
Internal Revenue Taxation and the Treasury Department for raising the
specific exemption under the excess profits tax from $10,000 to $25,000. This
will reduce the number of excess profits tax paying corporations greatly and
will do much to render investment in the smaller business unit more attractive.
Similarly, small corporations will profit from the accelerated carry-back and
amortization provisions included in the Committee1s proposal.
For the duration of the war this will be a satisfactory arrangement, but what shall be done thereafter? There is a tendency in current tax
discussions to consider the excess profits tax as a tax to be discarded immediately, once the last shot is fired. I disagree. Some reduction in business taxes will be possible and helpful, but we should not give all the
benefit to the corporations with excess profits. Elimination of the excess
profits tax, while retaining corporation income tax rates at their present
level, would give the greatest tax relief to those who need it least. This
would be a tax differential unfavorable to the weakest corporations.




It should not be forgotten that excess profits in the next few
years will be as direct a result of the war as are the excess profits of
today* I can see no justification for failing to tax those war profits•then,
as now» Beyond that, however, complete elimination of the excess profits
tax will make it impossible to provide the tax benefits that I have mentioned
for the smaller enterprises*
(2) Corporation Income Tax
Among various adjustments that need to be made in the corporation
income tax, the treatment of dividends and of losses are of particular
importance to the small corporations*
Under present and prewar practice, equity capital is taxed under
the corporation income tax, and again, under the personal income tax, when
distributed in the form of dividends* Income from fixed debt forms, on the
other hand, is not taxed at the corporate level, interest payments to bondholders being taxed but once, under the personal income tax» The resulting
discrimination against income from equity capital is serious, particularly
for the small enterprise which needs new capital* Numerous schemes have been
proposed to give tax relief to equity capital* I should prefer to give the
relief at the corporate level, and exclude from taxable income such part of
corporate profits (or a fraction thereof) as is distributed in the form of
dividends* This tax credit would take care of the problem of double taxation
and, in addition, would exort a healthy pressure for the distribution of
dividends* Also, it would be a good deal simpler than some of the other»
methods which have been suggested* To protect small corporations in need of
funds for capital expansion, it might be well to provide that some minimum
amount of retained income, say $50*000* receive the same favorable tax treatment as that given to distributed profits*
Adequate provision for carry-over of losses is also vitally
important to the small corporation,, which is not in a position to spread
its risks over a wide variety of products and markets and is, therefore,
more likely to have a fluctuating income* If a 5 or 6-year period for the
carry-forward of losses is allowed* combined perhaps with a 2-year carryback period* this disadvantage of the small firm will be reduced*
The great mass of truly small business units, however, are unincorporated* Their tax problem, therefore, is under the personal, rather
than the corporation, income tax* From a social point of view, these are
the very units which it is most important to encourage* But at the same
time the technical problems of providing encouragement under the personal
income tax are the most complex and difficult of solution.




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The financial problem

Undoubtedly, there is a lack of an adequate mechanism today for
providing equity capital f 3 ' the smaller ventures* The exemption from SEC
<r
requirements for financing up to $500,000 should be of help to the smaller
concerns in obtaining equity capital* However, even with this exemption,
costs of new financing will still be high on small flotations.
The Investment Bankers Association of America has presented a plan
which is directed toward filling a gap in our investment institutions,» The
local investment company, directed by local business leaders and locally administered, is the best replacement for the individual investor, and un<questionably better than any central or large-scale investing institution,
private or governmental. Local business leaders know their localities and
the enterprises in them, and community patriotism is a force that should be
brought to bear*
The plan is also sound in clearly recognizing that additional
funds will also be needed, by such local investment companies, if the job
is to be properly- done. But there are other features of the IBA plan that
are less convincing* The required additional funds under this plan would
be borrowed direct by sale of debentures to the Federal Reserve Banks, whereas
it seems to me that the private investment market, or such pools of private
capital as the credit pools recently formed by commercial banks throughout
the United States, would be a more appropriate source*
The funds that the IBA plan proposes to use would not be available
if the Wagner-Spence Bill is enacted, as I hope it will be* Federal Reserve
funds are not appropriate for this purpose because there should be no mandatory
requirement for their creation which might conflict with over-all credit and
monetary policy. Hence, if the plan is not to be supported by private funds,
a Government appropriation will be necessary.
There are some other features of the IBA plan which I think should
be modified, but I shall not undertake to discuss them here.
Turning to the credit problem as it affects small business, I feel
that it should be clearly conceived of as one of stimulating the flow of
private credit to small business, as opposed to direct governmental lending*
The great majority of all banks are themselves small businesses, and Government should encourage them, not compete with them in the lending field*
Many small businesses, which are not in need of long-term credit,
have satisfactory short-term credit relations with their banks, and for them
no credit problem exists* The problem is how to bring the commercial bank
loan further over into the area of the marginal credit risk, particularly
for long-term credit*




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The technique of the so-called V-loan, which has provided billions
of dollars of credit for war production, is a logical answer to the problem.
The idea was by no means new. It was an outgrowth of the credit plan
adopted by Congress in 193k in adding section 13b to the Federal Reserve Act.
That legislation authorized Federal Reserve Banks, under narrow restrictions,
to make direct loans to busine$s and industry, participating, however, with
local banks wherever possible in these loans and commitments.
The Wagner-Spence.Bill, which is pending before the Banking and
Currency Committees, ivould carry over into the reconversion period and,
specifically, until the end of X9k9$ unless further extended by Congress,
this guarantee principle of governmental aid which has worked out so successfully in FHA financing and in the so-called V and T loaning operations
for war production and for transitional reconversion purposes.
Instead of setting up governmental lending agencies financed out
of taxes or deficits to supplement or, as so often happens in fact, to
compete with banks or other private lending institutions, it would be far
better, if we are to preserve a free enterprise system, to aid the banks and
similar institutions to function more effectively in meeting the varied and
changing needs of business, industry, agriculture and individuals in the
communities they serve. "Where oppressive and restrictive regulations beyond
those required for public protection cripple private lending institutions,
they need to be liberalized and amended in the light of modern needs and conditions.
Some progress has been made in .that direction, notably in the revision of bank examination policy in 1938* The revised procedure, under
which appraisals of bank assets are based on intrinsic worth rather than on
fluctuating current market values, has been adopted in principle by the three
Federal bank supervisory authorities and by those of practically all of the
states. If it has not been carried out adequately in practice, it is largely
because old habits die hard.
Similarly, the Banking Act of 1935 liberalized the authority of
the Federal Reserve Banks to lend to member institutions. Nevertheless,
additional provision should be made for encouraging the flow of Ipcal bank
credit by a mechanism such as is provided in the Wagner-Spence Bill. This
measure would repeal the restrictive provisions of 13b. The loans would be
made by private banks. To the extent that the banks made them without re**
liance upon the guarantee, so much the better. For borderline or marginal
risk loans, a guarantee in part, that is, up to 90 per cent, xvould be available. As in the V and T loans, the fee which the lending banks would pay
fot* the guarantee would increase with the percentage of the loan guaranteed.
Hence the inducement would exist for the banks to assume as much of the risk
as they felt they safely could. No appropriation would be required from
Congress, since the fund originally provided under section 13b, amounting to
approximately 139 million dollars derived from the gold increment, would be
made available. This would permit upwards of one-half billion dollars to be




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loaned through this mechanism. 1 V i e it is my opinion that many of the
/hl
estimates of the amount of credit that would be needed by small business
after the war are exaggerated, to the extent that the need does, exist, this
mechanism would go far to meet it*
The loans, of course, would be made by local banks to local
people whom they know and with whose character, capacity and reliability
they would be familiar. Loans by governmental institutions, unfamiliar
with local conditions, are a very different matter. It is obvious that
there can be no justification for giving easy Government credit to
competitors of existing and established small businesses who have relied
upon private credit and who could not compete against what in effect would
be go vernmen tally subsidized newcomers in the field*
The Wagner-Spence Bill, if enacted, would serve an all important
need in the reconversion period by bridging the gap between termination (T)
loans and those needed especially by smaller business enterprise to acquire
plant, machinery, inventory, etc., that otherwise would be taken over and
disposed of by the appropriate surplus disposal agencies. As you know, the
V-loan program enabled the Reserve Banks to act as guarantors for the Army,
Navy and Maritime Commission in war production loans made by private banks
to war contractors and subcontractors» Similarly, the T program was developed to finance contract cancellation pending settlement by the Government. 1 ¥ e settlement is made, the money has to be applied to the T loans,
/hn
and the Amy, Navy and Maritime Commission have no further authority whereby
loans that will then be needed to finance purchase of surplus property could
be guaranteed. The Wagner-Spence Bill would supply this deficiency, and
would facilitate and simplify disposal of surplus property. War contractors
and subcontractors desiring to acquire government-owned plant, machinery,
inventory, etcf, would be enabled to finance such purchases through the
same channels using the same guarantee mechanism with which they are familiar,
and the Government's interest would be safeguarded as it has been in the V
and T loans. Contractors in possession of surplus property would be able to
negotiate for purchase at the time of contract settlement, thus avoiding
delay, expense and other complications that would arise if the property had
to be removed and disposed of elsewhere« Jt would be most unfortunate te
let this mechanism lapse. It can be most effective in facilitating recenversion, in disposal of surplus property, and in meeting credit needs,
particularly of small business, after the war*
Summary
The small business program should be three-fold
making available technological and managerial information that small business can readily
usei readjustment of the tax system so as to favor particularly the smaller
enterprises; and continuance of the V-loan mechanism to enable the banking
system to extend credit*
Nothing that I have said is intended
interest in small business. It is an economic
Nation has been the small enterpriser and that
its survival depend upon fostering individual,




to reflect a mere sentimental
fact that the backbone of this
our entire economic system and
not collectivef enterprise.