"Financing Small Business After the War"


By ROBERT A. TAFT, Senator from Ohio

Delivered before the Boston City Club, Boston, Mass., January 14, 1944

Vital Speeches of the Day, Vol. X, pp. 275-278.

IT is a pleasure to come to Boston from the pressure and confusion of Washington in wartime to discuss one of the most important of post-war problems. This is certainly an appropriate place to discuss the question because more work has been done on it here than anywhere else in the United States, and Mr. William Leavitt Stoddard, of the New England Industrial Development Corporation, is taking an active part in the preparation of legislation for the present Congress.

The tremendous interest throughout the country in protecting and developing small business is one of the encouraging features when we consider the kind of America we are to live in after the war. It proves that the American people really do want a system of free men and free enterprise, and no socialization of industry. There are plenty of discouraging features which are going to make it hard to attain our real desire. We will be burdened with a debt amounting to approximately three hundred billion dollars, with interest charges alone of six billion dollars a year. We will undoubtedly maintain a huge army and navy for many years to come. The necessary expenses of government are, therefore, likely to be sixteen or seventeen billion dollars a year. New projects for public works, social security, foreign trade, veterans' benefits, and countless others, good and bad, would make our federal budget more than fifty billion dollars a year if they were all approved. While we talk glibly of re-establishing free enterprise, we face proposals for government activity which can only lead to a totalitarian state. The National Resources Planning Board proposes corporations, owned at least half by the government, to operate power companies, transportation companies, shipbuilding, aviation, aluminum and magnesium. Spending plans would impose on industry such a crushing burden of taxation that there would be no incentive to continue working or totake a chance in any new project. Every man beginning a new industry would start with two strikes against him. We could avoid this burden only by a further increase in the public debt, and that would create an inflation which would destroy the value of all savings and investments. Either course would gradually force a socialization of industry in the United States.

While we talk of free enterprise, and our soldiers battle against the forces of totalitarianism, the whole thinking of the world has turned from the liberalism embodied in our Constitution for a hundred and fifty years to a planning of the lives of other people. Our thinking has turned away from local self-government to the solution of every problem by federal power and federal money. If those processes are not restored, we shall find ourselves a totalitarian state, with every detail of our lives planned by a benevolent, but arbitrary and inefficient, bureau in Washington.

There is no doubt that there must be increased federal activity. The very complications of modern life have forced legislation to preserve the very features of individual and business freedom which maintained themselves when life was more simple. But it becomes all the more important that when we draft legislation of this kind, it be framed so as to preserve individual freedom, and continue the reward the American system has given for initiative, ability, hard work, and genius, instead of suppressing all these qualities by a planned direction from Washington. Many New Deal measures are highly admirable in purpose. Nearly all of them have been used to impose rules and regulations limiting freedom, rather than carrying out the purposes of the legislation.

In small business we have a typical example of a condition necessary to a free enterprise system, which has been hampered and may be destroyed unless it is protected and assisted in some degree by federal legislation. But here also we must approach the problem of federal action with the most careful consideration. Whatever we do must foster and stimulate small business, old and new, and must not be diverted to create a new control from Washington either for political purposes or for economic planning. We must not attempt to change the character of little business itself, or cast every man in the same mold.

Small business, to a large extent, is the basis of our whole free enterprise system. That system is not free unless men with ability and courage are able to enter into it on their own account. It is not free if every man in the United States is only an employee who cannot rise above that status. Large business units may have many advantages. In some industries, like the utilities and the manufacture of steel, they must be large and require large units of capital. But large business units, like units of government, tend to settle down into fixed grooves. They adopt methods which cannot be easily changed. There is little incentive among their many employees to develop new ideas or new methods. Our whole system depends on rewards for individual work,, individual initiative, genius and daring. It depends on giving to the men who have those qualities an incentive to provide a better standard of living for their families, a better education for their children, and a better provision for their families after their death. It depends on substantial rewards for such men as against those who take no interest in their work and who have no ability to improve the conditions of their fellow men.

If this country becomes a country of big business, we are not a great deal better off than if we socialize the entire nation and let the government run business. As a matter of fact, the easiest road to socialism is through the formation of large business units which can be easily taken over by the government. The Communist, the Socialist, even the New Dealer has shown at times a strange friendliness to the biggest units of big business. They do not stand in the way of the so-called reforms, as does a vast group of independent American individuals. Fortunately we still have such a group, who are their own masters and do their own thinking. We have six million farmers, every one an independent businessman. We have hundreds of thousands of professional men, lawyers, doctors, engineers, most of whom are independent and develop their own ideas. We have over two million small businesses. They must be preserved if artisans are to have the freedom, after learning the trade, to step out for themselves and be their own masters, if clerks and other employees are to have the same right in the field of retail and wholesale trade.

This number of small businesses, however, has not kept up with the procession m recent years. Reaching a height of 2,213,000 in 1929, one to every fifty-five persons in the population, it fell seriously during the depression, regained some numbers until 1941, but decreased again in 1942 as a result of the war. Small business is bound to suffer under war controls. It is bound to suffer under planned economy. No economic planner would plan a world of small business, because it can't be made to fit into any preconceived category. Rigid price control can be met by large business, but the small businessman who relies on special services and location to obtain a somewhat wider margin is forced into a straightjacket which eliminates any chance to make a living. The small businessman is usually unable to convert to war work, or at least finds it much more difficult.

After the war, therefore, we face the necessity of restoring the health of small business. In part this is a question of encouragement and the stimulation of morale by a new attitude towards business on the part of the government. A businessman ought to be assumed to be honest until he is proved to be a crook, instead of the opposite assumption now indulged in.

I don't know anything that will help as much as the removal of restrictions on business, not only those of price control, rationing and supply, but some of the regulations which were in force before the war, particularly those requiring questionnaires and reports. When I used to campaign in Ohio, and go into the stores along the main streets of small towns, the greatest complaint from storekeepers was that their whole time was taken up in filling out government reports. The large businessman employed more bookkeepers to do the work. The small businessman had to spend his own time, which ought to have been devoted to improving his own business. Certainly the whole system of taxation of business can be substantially simplified. If one policy can help small business. more than any other, it is the removal of regulation and government interference.

In the second place, there should be a clearer definition of unfair competition and a more rigorous enforcement of the laws against that competition. Small business, particularly in the retail field, has always suffered from the practices of large manufacturers and dealers in selling below cost, and otherwise taking unfair advantage of a more integrated business, or one operating over a wide territory. The Federal Trade Commission ought to concern itself with correcting the unfair treatment of small business.

There are further affirmative policies which can stimulate and encourage small business. There was a time when every man who saved money was a prospective investor in small business. If he had accumulated a substantial fortune of his own, he became the patron and backer of other men who seemed to possess ideas or ability. Undoubtedly many of the new ventures went wrong, but when one did succeed, the investor obtained such advantages as to balance his losses

in others. Industries which began with one or two employees were expanded by the investments of a half-dozen friends who had confidence in the enterprise or the enterpriser, until they gave work to hundreds of men, or thousands, or hundreds of thousands. Today that system has disappeared, principally because of the high rates of tax on income. If a man loses, he loses his own money. If he gains, the government takes from him a large part of his gains, and a large part of the additional income he might otherwise enjoy.

With the burden of taxation which the nation must meet after the war, there is little chance of a substantial reduction of the rates on income. It would be possible, however, to repeal the capital gains tax except as against professional speculators and dealers in securities. There is no capital gains tax in England. If men were encouraged to finance small industries, and knew that they could sell out their interest when the industry was established without paying most of the proceeds to the government, there would be a great incentive for such action, which might be many times repeated. The capital gains tax has produced practically no money. The tax has tended to freeze capital and prevent its turnover in individual hands. If we want capital to go into small industry, or into large industry, the market ought to be just as liquid as possible, and the government ought to do everything possible to encourage the transfer of property from one person to another, so that capital reaches the hands of those who can make it most useful for production and employment.

The second step to accomplish the same purpose is the relaxation of restrictions on the financing of small industry. The Securities and Exchange Commission has made. the business of public financing so expensive and difficult as to be almost impossible in the case of those small manufacturing concerns which have attained their first growth but need additional capital for expansion. Furthermore, these restrictions have hampered the existence of the stock exchanges in the smaller cities. Such stock exchanges should be encouraged and developed. It is hopeless for the small businessman to look to New York for capital. The great exchanges there can only be interested in big business. But with deliberate thought a market for the securities of small concerns can and must be developed in many smaller cities throughout the United States.

Finally, we have the question of government assistance to provide loans and equity capital for small business. This is the subject of the bill introduced by Senator Mead, which is now being considered by the Senate Committee on Small Business. Here we reach a field where the very interest of small business itself requires that we move slowly and with careful thought; for once you invite the government in; it is not unlikely to become a permanent guest. Yet I believe some steps may be safely taken.

Small business divides itself into two groups, one the small manufacturer, the other, and far more numerous, the retail and wholesale dealer. Their problems are substantially different. The encouragement of the manufacturer is more important to the community because he can develop new production, which will create new employment. Retail and wholesale service will undoubtedly be provided by someone without government assistance. On the other hand, from the standpoint of encouraging independence, freedom and opportunity! the maintenance of the independent dealer is just as important as that of the independent manufacturer. Retail business does not require as much capital, however, and I believe that the retail problem is more one to be dealt with by protection against unfair competition and removal of regulation than it is by deliberate government financing. When we consider the character of assistance to be sought, we find also a variation in the classes of help required. Businesses may require loans for current purposes, they may require capital loans for periods of from five to ten years, or they may require capital either in the form of preferred stock or in the form of common stock. I am inclined to believe that concerns which are adequately capitalized have no great need for current loans. The business of making current loans is the business of the banks. The banking business is also a small business in many communities, and it ought to be conducted by private enterprise just as much as the manufacturing and retail businesses ought to be conducted by private enterprise. Most complaints against the banks for refusing to loan are made by men or companies who are not entitled to loans and who really require equity capital.

When we come to loans for capital purposes, payable in five to ten years, there is a different situation. Banks have not regarded this as their proper function, bank examiners do not regard it as their proper function, and many banks refuse altogether to make such loans. Bank funds for the most part are deposits payable on demand, and bank assets must be liquid. There is no agency in the United States today which makes a business of handling capital loans of this kind. Nor are they saleable to the public in the case of small business.

It may be argued that there should be no capital loans. If business requires capital, it is much better that it be in the form of stock. Loans require the payment of interest in spite of losses. Ordinarily they must be amortized, and so the profits of the business must not only be reasonable, but must be of a sufficient size to pay off the loan. A small business, having such a loan, which encounters a depression, is likely to be wiped out. Nevertheless, many small businesses have been financed by loans of this character in the past. Many have borrowed, applied all their earnings to pay off the loan, and borrowed again. Many big businesses, like the railroads, have relied upon bonds to furnish a considerable portion of their capital. There seems no great objection to such a method of providing capital if if is confined to a proper percentage, perhaps a half, of the other capital in the business. My own view would be that in the retail and wholesale business there should be no such loans, but that, if we can, we should provide them for small manufacturing concerns.

The first step in this process would be to enact a clear authority to banks in the Federal Reserve System and the Federal Deposit Insurance System to invest in capital loans of manufacturing companies with a maturity of not more than ten years. Such loans might or might not be secured by mortgages on the permanent assets of the company, but should not be a lien on the inventory and accounts receivable, to the end that current loans might still be obtained.

The legislation before Congress proposes that a Small Business Finance Corporation be set up within the Federal Reserve System to make loans to small business. In my opinion the powers given are much too broad. Such loans should not be made directly by the government. A government corporation, however, might guarantee or insure loans made by banks up to 90% of their face amount, making a proper charge for that service. This would have the advantage of removing the matter largely from political influence, and leaving the determination of the soundness of the loans largely to persons familiar with local conditions and the record of the applicant. As I have suggested, any loan should be limited to one-third of the net capital after the loan is made.

In my opinion the provision of equity capital is far moreimportant than loans, but it is also the problem where we meet with real difficulty. I have cited the reasons why the sources of such capital have largely been dried up by our tax system. We have to consider now whether the government can assist in providing a certain proportion of the equity capital required in small business.

It seems clear to me that the government should not own stock, either common or preferred, in business concerns. The inevitable result is effective government control, no matter how small the percentage of stock may be. On the other hand, I believe the government can assist small business in obtaining capital from investors. I would suggest that we provide for the qualification of private investment companies as an instrumentality in such a plan. Any private investment company which met certain government requirements would be eligible.

I would suggest a limited guaranty to such a company by the Small Business Finance Corporation of capital loans for manufacturing companies, and preferred stock and common stock of manufacturing companies and retail and wholesale concerns. Not to bore you with figures, but to suggest the kind of guaranty I have in mind, we might provide that the Corporation guarantee for private investment companies 75% of capital loans, 65% of preferred stock issues, and 50% of common stock issues, which they purchase, making a proper charge in each case for the service. The balance of the risk would rest on the private investment company.

Of course the extent of the financing should have some relation to the capital already invested in the business by the owner of the business. For instance, we might provide that in the case of manufacturing companies a preferred stock issue could not exceed the amount of the capital already in the business, and that the amount of a common stock issue should not exceed twice the common capital already in the business. In the case of retail concerns, a preferred stock issue ought be limited to one-half the pre-existing capital, and common stock to a sum equal to the amount of that capital. Of course these figures are only suggestions, and it would require exhaustive study and perhaps some experiment before they could be correctly fixed. I believe they should be such that a large investment company with wide diversification and experience might afterwhile be able to go on its own and abandon the government guaranty. The ultimate goal, in any event, would be one of cooperative investment.

In the matter of investment we face a dilemma. The rich man no longer finds it profitable to take a risk. The small investor, for his own good, should not take a dangerous risk. Our effort must be to bring these small savers into the risk investment field. The machinery I suggest is designed to make this possible by diversification of investments and government guaranty. Undoubtedly these private investment companies would lose money on some of their ventures, but it would not be a complete loss. Some of their small businesses should expand rapidly and prove to be so profitable as to balance the failures. The government would have a far wider diversification than any investment company, and if a sufficient charge is made for the guaranty, there is hope that there might be no net loss. Even if the activity did cost the government something, it should be well worth while.

The proposal I have made sounds radical, but as a matter of fact it is not nearly as radical as the many proposals to put the government directly into the business of making private loans. It is only more complicated. It is an effort to use our present processes of saving and capital investment. The entrance of the government into the banking business is threatening to destroy the whole system today, and its extension after the war to the entire loan field would tend to destroy what is left of a free capital market.

I can assure you that the Senate Committtee on Small Business is determined to work out a solution of this problem. We shall welcome your advice and assistance.