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TO THE HOUSE
WAYS AND MEANS
COMMITTEE REGARDING
COMMENTS ON THE
ADMINISTRATION’S BUDGET PROPOSALS
March 25, 1997
INTRODUCTION
The United
States Council for International Business (USCIB) is pleased to
present its views on the Administration’s Budget proposals and their impact
on the international competitiveness of U.S. businesses and workers. The
USCIB advances the global interests of American business both at home and
abroad. It is the American
affiliate of the International Chamber of Commerce), the Business and Industry Advisory
Committee (BIAC) to the OECD, and the International Organisation of
Employers. As such, it
officially represents U.S. business positions in the main intergovernmental
bodies, and vis-a-vis foreign business and their governments.
The USCIB For International Business applauds the
House Ways & Means Committee for scheduling these hearings on the
Administration’s budget proposals.
We do not disagree with all of these proposals, as, for example, we
support expanded individual retirement accounts and extension of the tax
credit for research. These
provisions will go a long way toward increasing our declining savings rate
and enhancing the competitive advantage of U.S. companies. However, in devising many of its
other tax proposals, the Administration replaced sound tax policy with a
short sighted call for more revenue.
Many of the revenue raisers found in the
Administration’s latest Budget proposals lack a sound policy foundation. Although they may be successful in
raising revenue, they do nothing to achieve the objective of retaining U.S.
jobs and making the U.S. economy stronger. For example, provisions are found in the Budget to reduce
the carryback rules for foreign tax credits and net operating losses, arbitrarily
change the sourcing of income rules on export sales by U.S. based
manufacturers, eliminate so-called "deferral" for multinationals
engaged in vital petroleum exploration and production overseas, and
restrict the ability of so-called "dual capacity taxpayers" to take
credit for certain taxes paid to foreign countries.
In
its efforts to balance the budget, the Administration has unwisely targeted publicly held U.S.
multinationals doing business overseas, and The USCIB strongly urges that such proposals not
be adopted by Congress. The
predominant reason that businesses establish foreign operations is to serve
local overseas markets so as to compete more efficiently and effectively. Investments abroad provide a platform
for the growth of exports and indirectly create jobs in the U.S., along with
providing help in the U.S. balance of payments. The creditability of foreign income taxes has existed in
the Internal Revenue Code for over 70 years as a way to help alleviate the
double taxation of foreign income. Replacing such credits with less valuable
deductions will greatly increase the costs of doing business overseas,
resulting in a competitive disadvantage to U.S. multinationals versus foreign
based companies.
For
U.S. companies to better compete with foreign-based multinationals, Congress
should work with the Administration to do all it can to make the U.S. tax
code more user-friendly. Rather
than engaging in gimmicks that reward some industries and penalize others,
the budget should be written with the goal of reintegrating sound tax policy
into decisions about the revenue needs of the government. Provisions that merely increase
business taxes by eliminating legitimate business deductions should be
avoided. Ordinary and necessary
business expenses are integral to our current income based system, and
needless elimination of them will only distort that system. Higher business taxes impact all
Americans, directly or indirectly.
For example, they result in higher prices for goods and services,
stagnant or lower wages for
employees in those businesses, and smaller returns to shareholders. Those shareholders may be the
company's employees, or the pension plans of other workers.
Corporate tax incentives, like export sourcing
incentives, have allowed companies to remain strong economic engines for our
country, and have enabled them to fulfill even larger roles in the health and
well being of their employees, and for society generally . For these reasons, sound and
justifiable tax policy should be paramount when deciding on taxation of
business--not mere revenue needs.
POSITIVE TAX PROPOSALS
As stated above, two of the Administration’s tax
proposals will have a positive impact on the economy, expanded IRAs, and
extension of the research tax credit.
EXPANDED IRAs
One proposal would expand IRAs by increasing the
income limits on deductible IRA contributions and indexing the contribution
limit for inflation. Special
IRAs would be available for higher income taxpayers. This would help turn around the
serious saving crisis that the United States has faced for many years
now. Not only are we saving
considerably less than at any time since World War II, we are also saving
considerably less than all of our major international competitors. It has been firmly established that
the restrictions imposed on IRAs in 1976 playedan important role in the
decline of the U.S. saving rate.
The personal saving rate has averaged 4.5 percent since 1976, compared
to 7.2 percent when the IRA was available to all taxpayers.
Over the last few years, there has been an
abundance of academic research on the effectiveness of IRAs. A long list of top academic
economists have found that IRAs do increase saving. The list includes Martin Feldstein (Harvard), David Wise
(Harvard), James Poterba (MIT), Steven Venti (Dartmouth), Jonathan Skinner
(UVA), Glenn Hubbard (Columbia), Richard Thaler (Cornell)), and former
Harvard economist Lawrence Summers, now the Deputy Treasury Secretary. The IRA is a proven savings vehicle
that is popular with Americans as well as good for the economy. IRAs promote self-reliance by
encouraging Americans to prepare for retirement while at the same time
providing the economy with the investment growth capital it needs.
EXTENSION OF RESEARCH TAX CREDIT
Another
proposal which we support would extend the research tax credit. The credit, which applies to amounts
of qualified research in excess of a company's base amount, has served to
promote research that otherwise may never have occurred. The buildup of "knowledge
capital" is absolutely essential to enhance the competitive position of
the U.S. in international markets--especially in what some refer to as the
“Information Age”. Encouraging private
sector research work through a
tax credit has the decided advantage of keeping the government out of the
business of picking specific winners or losers in providing direct research
incentives. The USCIB recommends
that Congress work together with the Administration to extend the research
tax credit on a permanent basis.
PROVISIONS THAT SHOULD NOT BE ADOPTED
We set forth below our comments on certain specific tax increase proposals in the
Administration's budget.
FOREIGN OIL AND GAS INCOME
The USCIB’s
policy position on foreign source income is clear. We strongly believe that a full,
effective foreign tax credit should be restored and the complexities of
current law, particularly the multiplicity of separate ‘baskets,’ should be
eliminated. Deferral of U.S. tax
on income earned by foreign subsidiaries should not be further eroded.
The
President's budget proposal dealing with foreign oil and gas income moves in
the opposite direction by limiting use of the foreign tax credit and
repealing deferral of U.S. tax on foreign oil and gas income. This selective attack on a single
industry's utilization of the foreign tax credit and deferral is not
justified. U.S. based oil
companies are already at a competitive disadvantage under current law since
most of their foreign based competition pay little or no home country tax on
foreign oil and gas income. The
proposal increases the risk of foreign oil and gas income becoming subjected
to double taxation which will severely handicap U.S. oil companies in the global
oil and gas exploration, production, refining and marketing arena.
CHANGE IN CARRYOVER / CARRYBACK PERIODS
Two of the Administration's proposals would
decrease the time period for carrying back foreign tax credits
("FTCs") from 2 years to 1 year, and decrease the net operating
loss ("NOL") carryback period from 3 years to 1 year. At the same time, the FTC
carryforward period would be extended from 5 to 7 years while the NOL
carryforward period would be increased from 15 to 20 years. Although these changes were arguably
made to simplify tax administration, they are clearly revenue raisers that
will actually cause highly inequitable results.
When companies invest overseas, they often receive
very favorable local tax treatment from foreign governments, at least in the
early years of operation. For
example, companies are often granted rapid depreciation write-offs, and low
or even zero tax rates, for a period of years until the new venture is up and
running. This results in a very
low effective tax rate in those foreign countries for those early years of
operation. For U.S. tax
purposes, however, those foreign operations must utilize much slower capital
recovery methods and rates, and are still subject to residual U.S. tax at 35
percent. Thus, even though those
foreign operations may show very little profit from a local standpoint, they
may owe high incremental taxes to the U.S. government on repatriations or
deemed distributions to the U.S. parent. However, once such operations are ongoing for some length
of time, this tax disparity often turns around, with local tax obligations
exceeding residual U.S. taxes.
At that point, the foreign operations generate excess FTCs but without
an adequate carryback period, those excess FTCs will just linger and expire. Extending the carryforward period will
not alleviate the problem since the operation will likely continue to
generate excess FTCs in comparison with the U.S. residual tax situation,
resulting in additional FTCs for eventual expiration.
The U.S. tax system is based on the premise that
FTCs alleviate double taxation
of foreign source income. By
granting taxpayers a credit against their U.S. liability for taxes paid to
local foreign governments, the U.S. government allows its MNCs to compete
more effectively in the international arena. However, by imposing limits on carrying back excess FTCs
to earlier years, the value of these FTCs diminish considerably (if not
entirely, in many situations).
Thus, the threat of double taxation of foreign earnings becomes more
likely. A similar argument can be
made for NOLs. If Congress truly
intends to allow taxpayers to offset positive earning years with loss years,
fewer limits should be placed on the ability to utilize those NOLs.
REPEAL OF SECTION 863(b)
When products manufactured in the U.S. are sold
abroad, §863(b) enables the U.S. manufacturer to treat a substantial portion
(usually one-half) of the income derived from those sales as foreign source
income, as long as title passes outside the U.S. Since title on export sales to unrelated parties often
passes at the point of origin, thisprovision is more often applicable on
export sales to foreign affiliates.
Additionally, unless a U.S. manufacturer has foreign affiliates or
subsidiaries, it will not generally benefit from generating additional foreign
source income.
The Administration proposes to repeal Sec. 863(b)
because it believes that it gives MNCs a competitive advantage over U.S.
exporters that conduct all of their business activities in the U.S. It also believes that replacing
§863(b) with an allocation based on actual economic activity will raise $7.5
billion over five years.
The
proposal has one glaring defect.
To compete effectively in overseas markets, most U.S. manufacturers
find that they must carry on activities in those foreign markets to sell and
service their products. Many
find it necessary to manufacture products specially designed for a foreign
market in the country of sale, although, importantly, importing vital components of that
product from the U.S. Thus, the purported competitive advantage over a U.S.
exporter with no foreign assets or employees is unrealistic. There are many situations in which a
U.S. manufacturer with no foreign activities simply cannot compete effectively
in foreign markets.
At present, the U.S. law has very limited tax
incentives for exporters. Given
our continuing trade deficit, it would be unwise to remove one of the few
remaining tax incentives for MNCs
to continue making export sales from the United States. Ironically, this proposal could
result in multinationals attempting to use foreign manufacturing operations
instead of U.S. based operations to produce export products. We encourage Congress not to adopt
it.
LOWERING THE DIVIDEND RECEIVED DEDUCTION
The Administration proposes to
both lower the corporate dividends received deduction(DRD) from 70% to 50% for
dividends received by corporations that own less than 20 percent of a
dividend paying corporation, and to have taxpayers establish a separate and
distinct 46 day holding period in a stock before its dividends qualify for
the DRD. We believe that both of
these proposals will be making changes to the law that are ill advised. Currently, the U.S. is the only major
western industrialized nation that subjects corporate income to multiple
levels of taxation. Over the
years, the DRD has been decreased from 100% for dividends received from over
80 percent owned corporations, to the current 70% for less than 20 percent
owned corporations. As a result,
corporate earnings have become subject to multiple levels of taxation,
driving up the cost of doing business in the U.S. To further decrease the DRD would continue a trend which
heads in the wrong direction.
Since the DRD is intended to
avoid multiple levels of corporate taxation, the imposition of any holding
period in the stock cannot be justified. Again,over time, the requisite holding period
requirement has risen from 16 to 46 days. The reason for the adoption of this rule was to stop
taxpayers from purchasing the stock just prior to a dividend record date and
selling the stock shortly thereafter, resulting in both a tax-preferenced
dividend and a capital loss.
However, imposing a separate holding period requirement for each
dividend does not enhance the rule and, in fact, just adds needless
complexity.
MODIFICATION OF THE SUBSTANTIAL UNDERSTATEMENT PENALTY
The Administration proposes to make any tax
deficiency greater than $10 million "substantial" for purpose of
the penalty, rather than applying the existing test that such tax deficiency
must exceed 10% of the taxpayer's liability for the year. While to the individual taxpayer or
even a privately-held company, $10 million may be a substantial amount of
money--to a publicly-held MNC
such amount is usually not "substantial." Furthermore, a 90% accurate return,
given the agreed-upon complexities and ambiguities contained in our existing
Internal Revenue Code, should be deemed substantial compliance, with only
additional taxes and interest due and owing. There is no policy justification to apply a penalty to
publicly-held multinational companies which are required to deal with much
greater complexities than are most other taxpayers.
The difficulty in this area is illustrated by the
fact that the Secretary of the Treasury has yet to comply with Section
6662(d)(2)(D) of the IRC, which requires the Secretary to publish a list of
positions being taken for which the Secretary believes there is not
substantial authority and which would affect a significant number of
taxpayers. The list is to be
revised not less frequently than annually. Taxpayers still await the Secretary’s FIRST list.
INCREASED PENALTIES FOR FAILURE TO FILE RETURNS
The
Administration also proposes to increase penalties for failure to file
information returns, including all standard 1099 forms. IRS statistics bear out the fact that
compliance levels for such returns are extremely high. Any failures to file on a timely
basis generally are due to the late reporting of year-end information or to
other unavoidable problems.
Under these circumstances, an increase in the penalty for failure to
timely filed returns would be unfair and would fail to recognize the high
level of existing compliance by the U.S. business community.
EFFECTIVE DATES
The
USCIB believes that it is
unsound tax policy to effect significant tax changes retroactively . Business should be able to rely on
the tax rules in place when making economic decisions, and to expect that
those rules will not change substantially while their investments are still
ongoing. It is ill advised and inequitable to encourage businesses to make
economic decisions based on a certain set of rules, and change those rules
after the taxpayer has made significant investments in reliance thereon. Thus, whenever possible, we call on
Congress to assure that significant tax changes do not have retroactive
application.
CONCLUSION
The
USCIB strongly urges Congress, when formulating its own proposals, not to
adopt the provisions identified above, which, as noted, are based on unsound
tax policy. Congress, in
considering the Administration's budget, should elevate sound and justifiable
tax policy over mere revenue needs.
Revenue can be generated consistent with sound tax policy, and that is
the approach that should be followed as the budget process moves forward.
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