Chairman Mills, members of the House Ways and Means Committee. My name is Walter Wriston. I am President of the First National City Bank of New York. I am here to speak in support of the President's proposal for a temporary 10 per cent tax surcharge. My comments will deal primarily with the surcharge and the money market, as so many other aspects of the tax question have been previously covered.

I am not happy about the prospect of high taxes. My support of the present proposal does not mean I endorse the regular use of tax increases to stabilize the economy. But we are looking at a mushrooming deficit, under wartime conditions, that could run to $30 billion in fiscal 1968. There are only three ways I know of to shrink that deficit. One is to cut expenditures. The second is to stimulate economic growth and therefore a rise in taxable income. The third is to raise tax rates.

Taxable income has already fallen below last January's budget estimates. While there may be some improvement in the remainder of the Government's fiscal year, revenues will fall far short of what is required to keep the deficit within manageable proportions. Expenditure reductions and tax rate increases are in the hands of Congress and the Administration. And this is where control over the deficit rests.

Since the end of last year, as the economy moved into a near-recession, our Federal Reserve System has followed an unusually stimulative monetary policy. As a consequence, publicly held currency and demand deposits climbed at a 9. 2 percent annual rate from February through August. That is the highest rate of monetary expansion since World War II. It is almost three times the annual rate of increase in the period from 1960 through mid-1966.

Another consequence of the Federal Reserve's policy has been to produce, thus far this year, the biggest increase in commercial bank credit on record -- a total gain of nearly $15 billion by the end of July, with the usual period of strong seasonal credit demand still ahead. Two thirds of this increase is in security holdings, mostly state and municipal bonds, and one third is in loans.

Secretary Fowler, in his testimony before this Committee on August 14, described the congested security markets. He emphasized that a huge amount of corporate, state and municipal bonds has been thrown on the market to date this year. The volume of new issues continues to be heavy. In spite of the massive reserve injections by the monetary authorities, long-term interest rates climbed sharply. One of the main reasons for this increase can be found in the widespread expectations that the economy would soon recover as a result of fiscal and monetary policies and that heavy Treasury borrowings in the second half to finance a growing deficit would add to the market congestion. These expectations are being fully realized.

The markets for debt securities today remain tense and unsettled. Long-term interest rates are at, and in some cases above, the highs reached during last year's credit stringency.

Commercial banks are bracing for another wave of credit demand which may well begin this month with a seasonal pickup and should continue to grow through the year end.

Our economists at First National City Bank tell me that the monetary expansion to date this year has provided enough fuel -- even with an October 1 tax increase -- to propel the economy ahead into next year at rates matching those of the boom year of 1966, with one important exception -- inflationary potentials are much greater. In the same way that the impact of last year's tight credit policy lagged and spilled over into this year, we have yet to see the full stimulus from the monetary expansion that has already occurred.

Even though volume is still sluggish, manufacturers are faced with rising wage costs. Recovery from the first half near-recession is just beginning, with the unemployment rate below 4 per cent. This is an unusually tight labor market for the early stages of a pickup in economic growth. Consider this against the background of an extraordinary expansion in the money supply and a massive Federal deficit.

Inflationary psychology has seldom been stronger in investment markets than it is today. It is permeating the thinking of bond buyers. It is in part responsible for the higher interest rates. Investors in fixed-income obligations are becoming more aware of the eroding effect that inflation has on their capital.

If the Federal deficit is permitted to balloon without the tax surcharge the additional Treasury borrowing will push interest rates higher. The Federal Reserve may try to prevent a rise in rates by underwriting the Treasury offerings. To do this the Federal Reserve would in effect give money to the banks to buy the Treasury securities. This is the printing press operation. Its success at holding rates down is at best only temporary. It contributes further to inflation and in the long run adds to private credit demands and higher interest rates. Trying to keep interest rates from rising by pumping out more money in today's environment is somewhat like trying to smother a fire with gasoline.

Treasury needs will almost certainly have to be financed by the nation's savings in competition with private borrowers seeking to finance in an expanding economy. This combination of Government vs. private borrowing has already caused interest rates for everyone to rise. It will get worse, much worse, in the absence of the tax surcharge. The ingredients we are looking at here -- burgeoning credit demands, inflationary pressures, a huge Federal deficit and need for credit restraint -- could cause critical disorders for the nation's credit institutions.

I join with the many others who have testified before this Committee to urge Congress and the Administration to reduce non-defense spending, not just to satisfy the arithmetic of fiscal 1968, but more importantly to avoid another major deficit in 1969.

Even under the most ideal conditions, with full employment, the economy cannot throw off sufficient additional revenues at current tax rates to match the recent rate of increase in Government expenditure. We may well face another huge deficit in fiscal 1969 unless major expenditure cuts are initiated now. Moreover, this is the best way to assure the country that the surcharge will be temporary.

While I support the surcharge, it is not quite as simple as the basic idea suggests. As now proposed, the tax surcharge would be levied before credits for taxes paid overseas. Such credits are granted to prevent the inequity of double national taxation with the resulting cash drain. Yet this is exactly what will happen if the surcharge is enacted in the present form. We urge that this feature be eliminated.

In today's inflationary environment, having once aroused expectations of a tax increase, the reaction in the money and investment markets could be severe if no action is taken. It would be worse than if a tax increase had never been proposed. Borrowers and lenders would expect either accelerated inflation or tight curbs on credit, possibly controls. There would be a rush to borrow to avoid as many of the expected consequences as possible. Early action on the tax increase, for both individuals and corporations, would have a beneficial effect on the markets for money and capital.