The Social Cost of Federal Financing 115 



increaso of business borrowing. The effect of the drop in low-risk 

 interest rates would be gradually diffused through the credit struc- 

 ture, as banks and other financial institutions adapted their port- 

 folios to the changed pattern of interest yields. Because the primary 

 impact of an increased supply of funds is on the low-interest, low- 

 risk sector of the capital market, and only the spill-over occasioned 

 by secondary repercussions makes funds available to risky invest- 

 ments producing higher yields, we assume an average rate of 5 per 

 cent to apply to this part of our tax cut. 



The investment behavior of small corporations is considerably 

 more sensitive than that of large corporations to changes in tax 

 rates. ^^ Companies with high growth potential are affected most 

 adversely by corporate taxes, which prevent internal accumulation 

 of the capital they need. External sources of long-term capital are 

 available to small companies only at high cost in terms of both 

 money and loss of control.^*' The corporation income tax also 

 diminishes the attraction of risky investments, since a small firm is 

 less likely to be able to take advantage of the loss-offset provisions 

 to reduce the tax liability on profitable operations. But the signi- 

 ficance of these arguments should not be overstated. Not all small 

 business would grow rapidly in the absence of taxes; the need for 

 new capital of many companies is small and can be satisfied. A 

 recent survey of the Department of Commerce ^^ found that of all 

 the firms in their sample, 56 per cent had no desire for outside 

 financing, 24 per cent obtained all the funds they desired, 13 per 

 cent obtained some, and only 7 per cent failed to obtain any. New 

 firms were somewhat less successful in raising capital and, most 

 significantly, it was the demand for long-term and, particularly, for 

 equity funds which failed to be met. On the basis of this evidence, 

 we assume that 50 per cent of the increase in retained earnings is 

 invested within the small firm; to this we assign a rate of 18 per 



" Lintner, "Effects of Corporate Taxation on Real Investment," op. cit., 

 p. 533. 



^ For an analysis of the case of the growing firm, see J. K. Butters and J. 

 Lintner, Effect of Federal Taxes on Growing Enterprises (Boston: Graduate 

 School of Business Administration, Harvard University, 1945). 



^ Loughlin F. McHugh and Jack N. Ciacco, "External Financing of Small and 

 Medium-Size Business," Survey of Current Business, op. cit., October 1955, 

 pp. 15-22. 



