Secondly, I think the recent document which

Representative REUSS. Thank you very much, but how do you like the contingency plan?

Secretary FOWLER. Well, I am hopeful that it won't be necessary. I am hopeful that we are going to have accord, and that we are going to be able to maintain and improve the international monetary system pretty much in terms of its universality of operation, without going off into separate camps.

Representative REUSS. Thank you very much. I won't press you further on this unless you want to be pressed.

Secretary FOWLER. However, I think we must always think of contingency plans. That is why I welcomed the recent compilation of statements and views that this committee released last week. They are receiving careful study and attention, and although we hope we won't have to use any of them, I think that the one you mentioned would be one of the leading candidates for consideration, should such a contingency arise.

Representative REUSS. Thank you.

Let me turn to another aspect of the balance-of-payments situation. As you have demonstrated, the big cause of our current troubles is the war in Vietnam, which accounts for $1 billion-plus of our balance-of-payments deficit.

What happens is that we pay American troops and contractors in dollars over there, they translate them into Vietnam piasters, and the Vietnamese central bank ends up holding large numbers of these dollars, many of which I suspect leak out to French importers and so add to our troubles there.

Why don't we do what the United Kingdom did in World War II, and ask that our allies block their accounts of our currency? That would defuse a very major item on the balance-of-payments deficit. So why don't we do that?

Secretary FowLER. Because we don't think it is necessary, after careful examination of that situation. It has been repeatedly looked into since the summer of 1965, when we sent Mr. Zagorin from the Department over to view this.

Now the possibility of our Vietnam expenditures adding to the gold drain is one we have been aware of, and as I say, as soon as the buildup of our forces was initiated, we took steps to minimize this possibility. While we can't claim 100 percent success, we do believe that any such drain is relatively small, and well below the estimates that are frequently seen in the press. I would like particularly to note that we don't spend dollar currency in Vietnam.

Representative REUSS. Military payment certificates.

Secretary FOWLER. Yes. Our piaster needs and those of our contractors for both official purposes and the expenditures of personnel are acquired through the Vietnam National Bank.

Furthermore, the aid is very largely tied directly or indirectly to procurement in the United States, and aid funds are not used to import goods from France.

Representative REUSS. Aid is tied, but local expenditures by members of the U.S. Armed Forces and local contract work performed by the U.S. military are not tied.

Secretary FOWLER. No, but that is in piasters. That is not in dollars.

Representative REUSS. Yes, but do not dollars get into the Vietnamese central bank as a result of that?

Secretary FOWLER. They do, but I don't believe that

Representative REUSS. Some of the colleagues echeloned behind you are making no with their heads, but would you give me at this point in the record a Treasury statement on that?

Secretary FOWLER. Let me complete this short one, and I will give you a very, very long one I have here.

Representative REUSS. I appreciate it.

Secretary FOWLER. I am just trying to deal with it shortly.

(The material referred to and subsequently supplied for the record follows:)

VIETNAM COSTS AND FRENCH GOLD PURCHASES

Since the buildup of U.S. forces in Vietnam beginning in 1965 the Treasury has been quite concerned about leakage of dollars to other areas where they could bring pressure on our gold supply.

To deal with this problem and to channel our expenditures out of blackmarkets and into official Vietnamese hands where they may be constructively used, a number of steps have been taken.

In the summer of 1965 the Treasury sent an expert, Mr. Bernard Zagorin, to Vietnam to specifically look into the problem and suggest corrective action.

This mission resulted in the introduction of the MPC system whereby our forces, third country forces, and our civilian personnel, including those of contractors, were paid in a form of scrip, the Military Payment Certificate. This device did away with the previous practice of paying in regular U.S. dollars, which were spent directly in the economy and which afforded a ready means for blackmarketing. Instead, local currency needs are now met through piaster purchases through official sources. Along with adoption of the MPC, a special exchange rate, more favorable to the U.S. forces, was negotiated to reduce incentive for blackmarket activities. This rate has since become the principal rate in Vietnam.

In early 1966, a program was instituted to reduce the local spending of our forces by facilitating savings and remittances to the United States. The increased rate of interest which the Congress recently authorized to be paid on the accounts of our Armed Forces personnel, and the establishment of military banking facilities by branches of American banks in Vietnam-two major U.S. banks have opened offices there this year-have reinforced this program.

In an effort to improve the administration of local customs and taxing functions in Vietnam, which may relate to blackmarket activities as well as general loss of revenue, the Treasury has supplied personnel in both fields to assist the Vietnamese Government.

Of special significance in the drive to curb blackmarketing was the far-reaching stabilization program adopted by the Government of Vietnam in July of this year. An important feature of the program was a major devaluation of the piaster.

In summary, as a result of a variety of steps designed, first. to restrict the flow of dollars into the Vietnamese economy and, second, to stabilize the economy itself, we believe that the opportunity and incentive of individuals and businesses in Vietnam to acquire dollars and to remit them elsewhere has been effectively minimized.

RELATION OF U.S. EXPENDITURES TO FRENCH GOLD PURCHASES

A number of articles and statements have appeared alleging that much of our gold loss to France stems from dollar flows from Vietnam. These have been placed in the hundreds of millions of dollars.

Our analysis does not lead us to believe that anything approaching such a magnitude is likely or possible.

U.S. local expenditures, including those of contractors, are now all made in piasters which are acquired centrally by the U.S. Disbursing Officer with the

proceeds going into official Vietnamese reserves where their use can be controlled by the Government of Vietnam and observed by the U.S.

The charge that the U.S. in either its military on nonmilitary program pays out dollar currency to local civilians is incorrect. Furthermore, the large part of the AID program does not represent payments of any kind in Vietnam but involves the importation of goods, most of which come from the United States. Imports other than from the U.S. are primarily limited to developing countries in the area and are financed with letters of credit the proceeds of which in turn can be used only for imports from the United States.

Of the foreign exchange which accrues to the Vietnam National Bank a relatively small part, estimated between $10-$15 million, is used to import goods from France but both Vietnamese and French sources indicate a substantial portion of this outflow is offset by income from exports from Vietnam to France. There are also some invisible remittances to France such as for travel, study, debt payments, etc., but it is our understanding that remittance of current profits by foreign businesses in Vietnam allowed for nationals of most nations have not been permitted to those of France.

We have also examined the problem from the standpoint of French dollar accumulation. If the allegations were true we should see a sharp rise in French dollar gains beginning in 1965. The contrary is true. French reserve gains, on which their gold purchases are based, were about $200 million less in 1965 than in the two preceding years and it appears fell approximately another $200 million in 1966.

Further, the French balance of payments gains are fully accounted for by their surpluses with other areas.

It might also be noted, as a separate matter, that Vietnam holds its reserves almost entirely in U.S. dollars and holdings of French francs are now negligible. In summary it appears clear that as far as the U.S. expenditure of official funds and those of official personnel in Vietnam are concerned, for both military and non-military activities, no benefit accrues to France. Similarly it appears that official and commercial transactions between Vietnam and France give rise to only a relatively small gain of dollars to France.

Consequently, any significant flow of funds to France would have to be the result of illegal transactions. Obviously no statistics can be gathered on blackmarket transactions, let alone what portion may be of benefit to France. Certainly such transactions do take place in a war-torn country such as Vietnam but in view of the measures taken to curb blackmarketing and the fact that many participants would have no ties with France it is reasonable to assume that any benefits to France are small.

Representative REUSS. Let me turn to the proposed 6 percent tax

increase.

Last year we tried super-tight money, and that didn't work. It played havoc with the housing industry and with small business. It is now proposed to increase the tax on everybody right down to the poverty level, exempting poverty cases, at the rate of 6 percent, in order, I gather, to take some of the heat off monetary policy.

Secretary FOWLER. No. There are three reasons.

Representative REUSS. Three reasons. One, dampen inflation by slowing down-you tell me the three reasons.

Secretary FowLER. The first is to pay for the war. Our estimate is that in fiscal 1968 the war in Vietnam is going to cost between $5 and $6 billion more than it cost in fiscal 1967.

Representative REUSS. One, pay for the war.

Secretary FOWLER. That is right.

Number two, we want to hold the deficit, both in the administrative budget and in the NIA budget, into a measured confine.

Representative REUSS. Why? For cosmetic reasons?

Secretary FoWLER. No, no.

Representative REUSS. Well, why? I mean why is this reason additional to paying for the war?

Secretary FOWLER. Because as a real matter and as a psychological matter we think that the

Representative REUSS. Psychological is cosmetic.

Secretary FOWLER. You call it cosmetic. I would call it real and psychological.

Representative REUSS. What is the real part?

Secretary FOWLER. A lot of people live by these things.
Representative REUSS. That is the psychological?

Secretary FOWLER. That is psychological.

Representative REUSS. So that real equals the psychological, which I claim equals the

Secretary FOWLER. And in addition to the psychological, we think to pull back the level of the NIA deficit in fiscal 1968 will be economically desirable, assuming, as we do, that the social security program that the President has proposed will be enacted, and that some of the sectors that have been faltering, such as the housing sector, are in the process of responding and coming back to somewhat normal proportions.

Representative REUSS. Let me state, you having stated the pre
Secretary FOWLER. The third reason is the monetary.
Representative REUSS. Yes.

Secretary FOWLER. We think that what is most needed in terms of a balanced economy in the period ahead is the assurance to the businessman that money and credit are going to be available on reasonable terms. We believe that avoiding a return to any monetary stringency of the sort that characterized 1966 will be highly desirable. We believe that the surcharge is some additional assurance that that will not be the case.

Representative REUSS. Thank you for stating your reasons. My difficulty with the whole business-and I want to return to this lateris the reasons you have named for the tax increase easing monetary policy, and paying for the war, and diminishing the deficit, for real or cosmetic or any other reasons. Your 6 percent tax increase, if it works, and I think it probably would, is going to diminish consumer demand and investor demand, and raise our unemployment, particularly of Negroes and teenagers. In fact, there is a perfectly good way, though it takes some courage, of achieving the fight the war and reduce the deficit and reduce the impact on monetary policy aims, and that is to have a big loophole plugging tax operation.

The Economic Report mentions some scandalous loopholes in interest exemption of high-bracket taxpayers, and there are a lot more, such as abuses of capital gains, that aren't even mentioned. Why not send up a good loophole plugging program that raises $3 to $5 billion, and let Congress take the onus.

(The material referred to by Mr. Reuss is reprinted from page 167 of the Annual Report of the Council of Economic Advisers, January 1967.)

Among other problems requiring better coordination of Federal-State-local taxation is one dealing with the exemption from taxation, under the Federal individual income tax, of interest paid on State and local government securities. Because of the exemption, these governments can borrow more cheaply-paying

lower rates of interest and competing more effectively for funds against other borrowers in capital markets. However, the exemption also reduces the progressivity of the Federal individual income tax, since it produces much bigger tax savings to those in high income tax brackets than to those taxable at lower rates. This is a relatively inefficient means of channeling aid: the Federal Government loses far more revenue than the States and cities gain in reduced interest costs. Apart from the general question of interest exemption, and of immediate concern, is the use of so-called industrial development bonds. Through the use of these bonds, localities have passed to private industries the benefit of the exemption of their interest from Federal tax, in many cases without assuming any real obligation for repayment of the bonds. This questionable practice is becoming increasingly widespread, and the lack of any obligation by the locality authorizing the bonds permits proliferation without limit. The use of the Federal tax code in this fashion is inefficient and inappropriate.

Another fiscal problem concerns State taxation of corporate income. Since most corporate income is generated by interstate corporations, States must establish formulas to apportion the income assumed to be earned from business done in other areas. The formulas give various weights to such factors as location of plant, percent of payroll, sales destination, location of sales offices, and "origin" of sales. In 1966, after several years of study, the House Judiciary Committee recommended legislation that would require a uniform State formula based solely on two factors, property and payroll. The States have responded unfavorably to this proposal. As an alternative, additional Federal grants to the States might be used to persuade them to relinquish a tax which is more efficiently collected at the national level.

Secretary FOWLER. Congressman Reuss, you will have an opportunity to deal with some of those problems, because in the President's economic message, he said that there will be a second tax measure which would come forward.

Representative REUSS. Right, but why have the first tax measure which will have the effect of

Secretary FOWLER. Just by reason of the fact that experience has shown that there is a timing problem on loophole-closing tax measures. It is a very lengthy process. I would have no expectation that the Congress would be able to act with the promptness on that type of measure that it will on the surtax which carries out the thrust of the recommendations of the Subcommittee on Fiscal Policy which Representative Martha Griffiths chaired last year. The subcommittee report described an acceptable neutral type of pattern for increasing revenues which I think, if it is accepted by the Congress, could be accepted much more promptly and with much more dispatch than the other kind of measure so as to be effective for the entire fiscal year beginning July 1.

Representative REUSS. I would say, that the long day's battle on loophole plugging is not going to begin until the administration sends up its loophole-plugging package, and there is enough in the collected works of Stanley Surrey, sitting behind you, to get together a great package.

Secretary FOWLER. I have him very busy on lots of things, but you will have your package, Congressman Reuss.

Chairman PROXMIRE. Senator Miller?

Senator MILLER. Thank you, Mr. Chairman.

Mr. Secretary, as I understand it, our gold stock is down to a little over $13 billion, and we need $11 billion of this as backup for our currency. Is this substantially what the figures are?

Secretary FowLER. My latest figures, at least as of December 31, show that the so-called free gold, which is what you have reference to, is $3,213 million.