Senator FORD. Well, you made a statement a few moments ago which I noted. It's the first time I had heard it and I assure you it will be used again that HEW spends more money than any country, outside of the U.S.S.R. Would you say that the tobacco and its revenue helped Mr. Califano carry out the other programs as it relates to HEW?

Mr. BERRY. You know, I have wondered what might eventually happen to such agencies as HEW if we continue to dcrease the sources of revenue and increase the cost of Government. One of these days we've got to look around for who's going to pay the bill and that brings into focus, it seems to me, one of the big objections to this bill, and that is its consequent cost and the effect that it has or the implications it has as far as the role of Government is concerned.

What right does Government have to involve itself in this kind of thing? Historically, philosophically, it never had that right, and that right has been injected through the rationalization of those who work in Government and who have promoted a very liberal philosophy in this country. It's a very dangerous thing. It's one you all are dealing with in Congress every day and are frustrated because there seems to be no solution. Yet this bill would increase the severity of the problem it seems to me.

Senator FORD. You make an excellent point. I find that many of the agencies and departments will legislate by regulation legislation that they fail to get passed. If you pass a bill and you leave out certain items they wanted very badly established, then they find a way to promulgate regulations and get around to having their legislation anyhow.

So what we find here is that if we give them the vehicle to develop regulations they are going to basically get what they want. It is a struggle that you have to stay on top of and I might just mention at this point that this subcommittee will hold hearings in the middle of November on how much regulations are costing the consumer in the United States and how much those regulations are fanning the inflation that we face in this country. I think we may come up with some very surprising facts relating to regulations and what "Big Brother" is doing in the name of the consumer.

John, I'm very pleased that you came this morning and I'm grateful to you. I look forward to working with you in the future.

Mr. BERRY. Thank you very much.

Senator FORD. Thank you.

Our next witnesses are Secretary Short and Director Scott of the Agribusiness Division of the Kentucky Department of Commerce, and Claude Vaughan. Claude, I understand you're going to give Secretary Short's statement, and both of you are here to answer questions and support one another and help me if you can.

STATEMENT OF CLAUDE VAUGHAN, EXECUTIVE DIRECTOR, OFFICE OF DEVELOPMENTAL PLANNING AND RESEARCH, KENTUCKY

DEVELOPMENT CABINET

Mr. VAUGHAN. It's a pleasure to be here this morning representing Secretary Short in the development cabinet.

I'm going to deviate somewhat from my prepared statement because some of the numbers have already been produced and at your sugges

tion. Senator Ford, I'm going to talk about the economies of 194 proposal which I parenthetically should add teeme to be true avak of a "Catch-2.” It's very difficult to come to grips with us „propemak om in onomies or a public finance #tandpoint,

Section of S. 3119 would amend the Internal Ite venisse Code of adding a graduated production tax on the manufacture of Tus tax would be related to "oxie mite which are lo Gued grams of tar and milligrams of trotne. To wx First, from 10 to 1999 toxic id

In other words, cigarettes must be differentiated by time, appearance, place, or taste in order to prevent buyers from shifting to the low-price product. Admittedly, the product is differentiated in terms of toxic units; however, it remains a cigarette. Furthermore, implicit in the tax price differential proposal is the assumption that there exists no substitutability among various toxic units. The assumption is that a tax of $0.50 per pack or $5 per carton will induce the smoker to shift to the low-toxic cigarette that has a toxic .05 per pack or 0.50 per carton toxic tax on it. I admit this is the probable outcome of this proposal. However, one must wonder what is to prevent the smoker from substituting low toxic cigarettes for high toxic cigarettes in the ratio of 4 to 1. I suppose the only constraint there would be the amount of time one has to smoke. It also should be noted that the saving would amount to $0.30 per four packs or $3 per carton. It is also possible to substitute pipes, cigars, and roll your own for cigarettes. I am reasonably confident the dedicated smoker can easily estimate the saving that would result in this substitution.

If this taxing scheme was initiated, I would venture a guess that the impact on total amount of toxic units consumed would in fact be negligible. The impact would probably be an increase in equilibrium price in the neighborhood of $0.15 per pack, $1.50 per carton, with the consumer smoking more of the low toxic effect, less of the high toxic effect cigarettes. The net effect in toxic units consumed would therefore be zero.

If, however, this proposal is instituted, the effect of shifting from high tar-nicotine tobacco to low should be examined. It logically follows that manufacturers would substitute low toxic tobacco for high. Farmers would begin to shift production to these varieties, and under the present state of the art, they would attain lower yields per acre with about the same cost they now incur. This might allow a 5 to 10 cents a pound increase in the cost of production. The question that has to be asked is, how quick can producers shift over to these varieties. and at what costs? Quite obviously, in the short run, this could very well be catastrophic for the tobacco producing farmer. This may well contribute to the elimination of Kentucky's small family farmer who entirely depends on tobacco as a source of income or a large portion of his income.

Finally, I would like to pose the question: When is Congress-and I don't mean this as an indictment of you, Senator

Senator FORD. You can make a broad brush. Go ahead.

Mr. VAUGHAN. When is Congress and the American public in general going to learn about the role relative prices play in resource allocation? Energy is an example and in this instance it's the antithesis of the cigarette proposal, that artificially low prices will simply not make it attractive for resources to be channeled into solving the problem. The net result in terms of energy would be either a huge Government subsidy or an energy crisis of enormous magnitude.

In terms of tobacco, apparently national prohibition has taught us very little about relative prices and resource allocation. If a supply of a commodity or service does not exist, somebody will move into the void if sufficient demand exists to justify the venture. Bootlegging of cigarettes from low tax States to high tax States is a common phenomenon. It occurs because of pricing differentials that exist be

cause of taxes. I can't help but ask myself the question, why do we want to pursue a policy at the national level which will encourage or further encourage an undesirable element to engage in smuggling cigarettes not from State to State but from Canada or Mexico to the United States? If the price differential is high enough-and we're talking about the difference between $1.50 and $5 a carton-you can rest assured somebody will take the chance.

I would just like to say that the application of this tax could have a grave impact on the tobacco industry in Kentucky. If the tax were applied in its higher ranges, it might even destroy the industry, and this would have a deleterious effect on the Commonwealth's economy as a whole. Its effect would be twofold as it impacts on both the producers and the processors.

First, Kentucky's tobacco producers received approximately $530.2 million in 1977 from tobacco sales. The destruction of the tobacco industry would not only incur this loss but also an additional $529.2 million which would be generated in the economy by the farmers. Additionally, many of Kentucky's small family farms would probably be put out of business in the absence of tobacco revenues.

Second, cigarette manufacturers added $699.6 million in value to the product in 1977. The dissolution of the industry would not only result in the loss of this income but also in an additional $640.4 million generated in the economy. The processing and handling portion of the tobacco industry also employs 14,200 workers who create support for another 17,040 workers in other sectors of the economy.

The tobacco industry also contributes revenue to the Commonwealth of Kentucky in the forms of various taxes. In 1975-76 these taxes-including the corporate taxes for 1975-amounted to $30 million.

In summary, it is questionable to jeopardize a State's tobacco industry by such dubious means as this tax when the industry has a total impact of $2.36 billion and an employment effect of 31,240 jobs on the private economy and $30 million effect on the public sector-$45 or $50 million of tax revenue collected at the State level. This does not-and Senator Barry alluded to the problem of the local level of tax collection. I think that, Senator, you have an appreciation for the problems at the State level and the impact this would have on the general fund of how you are going to provide services for the people of the State of Kentucky without increasing taxes. If we lose $45 million of revenue, I think it's obvious what would be the outcome. The services will have to be cut at the State level and the taxes increased.

This proposal simply doesn't make any sense from a development aspect or from a public finance aspect and from any other aspect that I can think of at the present time. Thank you, sir.

Senator FORD. Thank you very much for a very enlightened statement.

Mr. Vaughan, let me ask you one other thing. Did you get into additional cost that might be contained in this bill as it relates to the manufacturing of cigarettes, that is, the 10 labeling language that must be rotated among cigarettes?

Mr. VAUGHAN. No, I didn't.

Senator FORD. You just stated what this proposed legislation would cost the farmer and its effect on the economics of the State and the

relative problems that would be presented. Did you get into the bureaucratic cost?

Mr. VAUGHAN. This is what I referred to as a "Catch-22." When you talk about the bureaucratic cost and the labeling cost, it would probably be another 2 or 4 cents per package. You can estimate the bureaucratic costs.

In terms of employment, we talked about that at the State level. It just seems to me, especially in the immediate short run, that by "Catch22" I mean we continue to talk about improving the employment situation in the Nation and then we propose policies that are going to negate that. It simply doesn't make any sense.

Senator FORD. Jack, I understand you have a statement, so rather than go on with any other questions, I will let you proceed with your statement.

STATEMENT OF JACK J. SCOTT, DIRECTOR, AGRIBUSINESS DIVISION, KENTUCKY DEPARTMENT OF COMMERCE

Mr. SCOTT. Thank you, Senator Ford, I will keep my remarks brief, but this impact is a tremendous thing that it could have on our economy and, of course, all of these facts and figures have been given, but an overriding thing is that growing tobacco is the lifeblood of the rural economy of Kentucky.

You've got not only the growing, but the selling, the warehousing and the processing of tobacco. I think the most recent statistics there on annual income was a little over $600 million in 1977, so that would be an increasing thing along with our inflation.

It's been mentioned about these 143,000 burley quotas and 23,000 dark tobacco quotas having a great impact on land values in Kentucky. The exports, too. We have been in a squeeze with our dollar falling in value overseas in relation to the yen and the mark and so forth, and annual foreign exports of tobacco from Kentucky exceeds $200 million and we certainly need this foreign exchange to balance this trade deficit that we have. In fact, our agricultural segment is kind of holding up the rest of the country and letting us bring some of this oil in.

Then there's the jobs, and these jobs that are direct have much. effect on our merchants, our people in schools, our retailers, everything in our smalltown economy.

And so, overall, our State is heavily dependent upon our tobacco. and, as has already been said, tobacco is not a luxury. It's a necessity of life. You can double the price of cigarettes and it would force many people to do without necessities to go on and buy cigarettes. To destroy this tobacco industry with tax legislation would be demoralizing to say the least.

I think smoking is a moral issue that cannot be legislated, but, above all, is this fact that historically and at the present time, the overriding factor is that in Kentucky, growing tobacco is a way of life. The small farmer has been able to provide a wholesome standard of living for his family and any drastic change would put many, many people on the welfare rolls. It would affect not only those farm families, but employees of the tobacco industry, our smalltown merchants, our schools, our government units and on down the line. It's just