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LIBRARY
JUL 2 21977
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PRESS RELEASES
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APRIL 1, 1976
THROUGH
MAY 24, 1976
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OTA Papers
r
The Optimal Taxation of
Commodities and Income
David F. Bradford
U.S. Treasury Department
Harvey S. Rosen
Princeton University
OTA Paper 8
December 1975
zfice of Tax Analysis
S. Treasury Department
ishington, D. C. 20220
5sued March, 1976
The Optimal Taxation of
Commodities and Income
David F. Bradford
U.S. Treasury Department
Harvey S. Rosen
Princeton University
OTA Paper 8
December 1975
OTA Papers are circulated so that the preliminary findings of
tax research conducted by Staff members and others associated
with the Office of Tax Analysis may reach a wider audience.
The views expressed are those of the author, and do not reflect
Treasury policy. Comments are invited, but OTA Papers should
not be quoted without permission from the author.
TABLE OF CONTENTS
Some History of Thought
Optimal Commodity Taxation
Optimal Income Taxation
Concluding Remarks
The last few years have seen a resurgence of interest in
the old question of how best to raise tax revenue.
Roughly
speaking, two different problems have been studied.
The first
is to find a set of commodity taxes that is optimal given certain
efficiency and (sometimes) equity considerations.
In a second
strain of the literature, it is assumed that the revenue system
is based upon income rather than commodity taxation, and the
problem is to determine the optimal degree of progressivity
(or regressivity).—' > —'
The principal motivation of some writers in the optimal
taxation literature seems to be the discovery of fairly simple
rules which policy makers actually can implement.
Others are
more interested in theoretical exploration of the implications
of alternative economic assumptions than in developing usable
policy recommendations.
Practically all the contributions,
however, have been quite mathematical and thus inaccessible to
many practitioners in the public finance area.
The purpose of
this essay is to discuss in a nontechnical way the methodology
and principal conclusions of the optimal taxation literature. ±*
In section I we present briefly the history of thought
on optimal taxation.
Sections II and III discuss the optimal
commodity and income tax literatures, respectively.
We conclude
with some observations on the accomplishments of the optimal
taxation research and on some open questions.
- 2 I. SOME HISTORY OF THOUGHT
The debate over the properties of a good tax system goes
back hundreds of years. Some of the discussion may seem at once
cynical and amusing to contemporary economists.- One eighteenth
century writer considered a good tax to be one that was easy to
disguise. (Jones, p. 93) Similarly, the French statesman Colbert
argued ". . . the art of taxation is the art of plucking the
goose so as to get the largest possible amount of feathers with
the least possible squealing." (Armitage-Smith, p. 36)
However, the striking aspect of the old literature is its
concern with the same efficiency and equity issues discussed
today. It was viewed as desirable that tax induced distortions
be kept at a minimum: "Taxation should interfere as little as
possible with the processes of industry.11 (Armitage-Smith, p. 55)
The effect of taxes on work incentives was a concern for politician
as well as economists. Gladstone opined that the income tax did
". . . more than any other tax to demoralize and corrupt the
people." (Wells, p. 516)
Equity was also a major issue, and the fairness of progressivity was hotly debated. Adam Smith believed that individuals should pay taxes ". . .in proportion to their respective abilities, that is in proportion to the revenue enjoyed."
(Stamp, p. 29) Mill characterized a graduated tax as ". . .a
- 3graduated robbery," (Stamp, p. 38) while others thought that
progressivity had a firm scientific basis in the theory of
diminishing marginal utility. (Stamp, p. 40).
As far as formal theorizing is concerned, the history of
optimal commodity taxation is rich and long, while that of
optimal income taxation is surprisingly thin, if not short.
This is no doubt because the commodity tax problem is formally
equivalent to the problem of pricing policy in nationalized,
increasing returns enterprise. Recent work is in a tradition
dating at least from J. Dupuit, writing in the middle of the
nineteenth century. However, the most famous forerunner is
Frank Ramsey, who derived the proposition that (second-best)
optimal commodity taxes cause an equi-proportionate contraction
in quantities of all commodities, in a paper published in 1927.
Subsequent development has consisted of refinement and rediscovery of Ramsey's result. Important landmarks since then
include Samuelson's 1952 U.S. Treasury memorandum (unfortunately
never published, but widely circulated informally) and Marcel
Boiteuxfs elegant treatment of the regulation of public monopolies
which are subject to budget constraints. In almost all of the
work the predominant question was the same: how can we raise
a specified amount of revenue (or finance a specified program
- 4 of expenditures), using commodity taxes, in such a way as to
minimize deadweight loss. While distributional issues were
generally acknowledged, the focus of attention was on the
efficiency question.
In thinking about income taxation the early contributions
tended to lean in the other direction, to the point that Edgeworth,
in the first important attempt to derive a tax schedule in an
optimizing framework, ignored efficiency altogether. He pointed
out that if all individuals have identical declining marginal
utility of income schedules and the government's goal is to
collect its revenue with the minimum aggregate loss of utility,
then the appropriate policy is to level off income from the top.
Edgeworthfs analysis does not take into account the probable
efficiency effects of the confiscatory tax rates. Perhaps
because the conclusion made so little sense, there seems to
have been no further attempt to derive income tax characteristics
from an explicit optimizing problem until very recently. Richard
Musgrave in his well known text reviewed and clarified this
and other criteria (equal absolute or relative utility sacrifice -interestingly, not derivable from a utilization maximizing framework) which might be used in determining equitable tax shares,
but he did not in that context formally introduce the equityefficiency trade off. Integrating these aspects has been the
principal objective of the optimal income tax theorists of the
1970's.
- 5II.
OPTIMAL COMMODITY TAXATION
Since the cited literature contains many and varied derivations of the principal theorems of optimal commodity taxes, we
shall not carry out detailed proofs here. We can point out,
however, some of the variations in the way the problem is posed.
Most commonly a revenue constraint is taken as a starting point,
together with an assumption that the government must use per unit
commodity taxes. (Thus lump-sum taxes are excluded.) If. x^ is
the quantity of the ith good purchased by the household sector
from the production sector (x. is negative if the households
are net sellers, as in the case of the commodity "leisure"), and
T^ is the per unit tax, the revenue constraint is
(1) £ T±Xi = R,
where R is the required revenue level.
The taxes are the difference between the prices, p., received by
producers and P^, paid by the consumers.
(2) T± = P. - p. .
It is frequently assumed that producer prices are fixed, so that
by setting taxes we set consumer prices and hence consumer welfare.
The problem is then to make the choice of taxes in such a way as
to maximize the resulting consumer welfare. Another way of
describing the objective is to obtain the required revenue with
- 6 minimum excess burden or deadweight loss to consumers -- the cost
in inefficiency which is in addition to the value of output
necessarily foregone to meet the government's requirements.
Samuelson uses a somewhat different formulation of the problem
and one which has the virtue of emphasizing the resource releasing
function of taxes.
He begins with the assumption that the
government wishes to obtain a vector g = (g^ . . . g n ) of
quantities of each of the
n
commodities.
Assuming constant
returns to scale (and hence no profits under competition) the
behavior of firms will be governed by the producer price vector
P
=
(Pi> • • • P ) while the demands and welfare of the households
will be determined by consumer prices P = (Pi, . . . P n ) •
p
At
the firms will supply the vector y(p) = (y\, . . . y ) of net
outputs; at
P
the households will demand x(P) = (x-^, . . . XQ) .
The trick of feasibility is to choose P and p so that
(3) y(p) - x(P) = g,
that is the amounts produced less the amounts demanded by the
household just equal the government's requirements.
The problem
of optimality is to pick from among the pairs of consumer and
producer price vectors satisfying (3) one which maximizes consumer
welfare.
To work out the problem it is generally easier to go
behind the producer supply relationships.
Thus if F(y) = 0
implicitly defines the transformation frontier of the economy,
the constraint (3) might be expressed by
- 7(4)
F(x(P)+g) = 0
F±(x(P)+g) = ap±, i = 1 . . . n,
where the subscripted conditions are those associated with
producer profit maximization.
Because the emphasis is generally on efficiency, a typical
approach is to assume there to be only one consumer (hence no
distribution problem). Thus the objective might be to choose
P and p to
(5) Maximize U(x(P))
subject to (4) and to
(6) U±(x(P)) = yPi, i = 1, . . . n
Conditions (6) are the familiar first order implications of the
household's optimization. More often an indirect utility function
V(P, 0) = U(x(P)) is used, (the zero argument draws attention to
the assumption of no transfer income) as the derivations become
very simple when use is made of "Roy's Identity"
(7) = -x±(P) . .
dV± 3M
where 8V/8M is the derivative of the indirect utility function
with respect to budget level.
Putting these pieces together in any of several sequences
leads to the famous Ramsey result on optimal commodity taxation:
(8) I Tisik
i
= 6x > k = lf
k
' ' *'
n
- 8where S i k is the Slutsky coefficient, the derivative of the demand
for the ith good with respect to the kth price, other prices and
utility being held constant, and 3 is independent of k. The
left hand side gives an estimate of the change in demand for
the kth good which would occur if the taxes were removed. Hence
(8) says that the proportional change in demand (thus estimated)
should be the same for all commodities -- the Ramsey result.
Condition (8) can also be expressed in terms of elasticities.
Probably the most familiar "optimal tax" result is the form which
applies when the off-diagonal elasticities are zero. In this
case the first order conditions associated with (5) lead to the
"inverse elasticity rule":
(9) tr = , r = 1, . . . , m,
rr
where t _ T /P , the percentage or ad valorem rate of tax, 6
r - r r
is a constant, and E r r is the elasticity of the ordinary (uncompensated) demand function for the kth good. This formula has
certainly been of importance in forming economists' intuitions
on tax and price regulatory questions. In underlies the notion
of charging according to "what the traffic can bear" in transportation, for example, and is the basis for the acceptance on
efficiency grounds of high taxes on tobacco and alcohol, the
demand for which is presumed price inelastic.
- 9One of the important contributions of the optimal commodity
tax literature, indeed, has been to reconcile economists1 sometimes opposing intuitions.
For example, the intuition that prices
should be set at marginal cost, so that producers' and consumers'
price vectors are at least proportional, is seefi to be correct
under the assumption- that (a) distributional objectives are
otherwise achieved and (b) sufficient revenue can be raised.
If there is insufficient profitability in the economy (as, for
example, in the case of constant returns to scale production
technologies with competition) the second of these conditions
cannot be met. —'
Where prices must deviate from marginal costs,
the inverse elasticity rule is appealing, but we see that it will
be strictly appropriate only under the rather strong assumptions
of independent commodity demands.
Another application of the analysis is to the presumptive
case for direct over indirect taxation.
The classic Hotelling
argument for marginal cost pricing seemed to support the conclusion that an "income tax" will involve no efficiency cost.
When it was recognized, however, that the "income" of the tax
system is not the "budget level" of the elementary theory of
consumer demand, but rather the product of a certain price,
the wage, and a demanded quantity (net purchase) of leisure,
the apparent a priori advantage of an income tax was lost.
The analyses of Corlett and Hague, Little and Friedman to this
effect all are applications of the theory of optimal commodity
taxation, as is neatly shown by Sandmo.
- 10 While the extensive subsequent work has shown how difficult
it is to sustain any simple rules for commodity taxation the
result of the spreading awareness of this work has been to make
economists think about tax questions in a new way and to hasten
the search for rules which are reasonably robust..
For example, as Sliglitz and Atkinson point out, optimal
tax analysis makes it clear that there is no a priori assurance
that the income tax is the single best instrument for income
redistribution. "Commodity taxes", such as housing subsidies
or food stamps, might contribute to an optimal program. Boskin
notes that, in view of the differences in the observed elasticities of household supply of the two types of labor (husband
labor and wife labor), it is probably efficient to tax these
"commodities" at different rates. Feldstein (1975) uses the
same basic approach to examine the choice between "tax expenditures" and direct expenditure methods of achieving an increase
in a specified activity.
A natural question in view of the interpretation of the
income tax as a commodity tax is whether taxation of labor only
(i.e., uniform taxation of commodities) is appropriate. Not
surprisingly, the answer is that it will be appropriate when
labor is inelastically supplied. Sandmo shows that this in
turn will follow if utility is separable between leisure and
- 11 all other goods and homogeneous in those goods. Intuitively
this separability means that further efficiency cannot be gained
by differential taxation of goods that are "related"to leisure.
Several writers have noted an important consequence when this
result is reinterpreted in an intertemporal context. If utility
is a function of consumption and leisure at different dates and
separability obtains, then no taxes on interest income should be
levied -- consumption is the appropriate tax base. This simply
illustrates the challenge, implicit in the optimal tax approach,
to the widespread acceptance of taxation on the basis of HaigSimons income which has been emphasized by Feldstein.
While an "income tax" can be regarded as a tax on the sale
of labor (negative net purchase of leisure), there is a feature
of actual income taxes which is slighted by such a point of view:
it is institutionally feasible to assess taxes at different rates
on different individuals; in particular progressive taxation of
earnings is possible. Depending upon the allowable features,
the possibility arises of, in effect, duplicating a lump-sum
tax by a (regressive) income tax structure. When distributional
considerations are introduced this is not terribly useful;
however, the fact that tax rates can vary from household to
household makes the income tax, and such related taxes as the
expenditure tax, the principal instruments for distribution
objectives. We now turn to the studies which consider the
trade-off between such distributional objectives and economic
efficiency.
- 12 III.
OPTIMAL INCOME TAXATION
As we noted in Section I , the problem of optimal income
taxation has a long history in economics.
However, most of the
recent literature stems from a paper published by James Mirrlees
in 1971.
A natural way to organize our discussion, then, is to
summarize Mirrlees' techniques and conclusions, and then view
the ensuing literature as an attempt to explain and modify some
of his results.
In Mirrlees' model, society is composed of individuals
who have identical atemporal utility functions in after-tax
income and leisure.
Individuals differ only in their earnings
abilities (wage per hour).
The government must collect an ex-
ogenously determined amount of tax revenue.
The problem is to
find an income tax schedule (tax function) which maximizes the
sum—' of individuals' utilities subject to this revenue constraint.
Using the tools of the calculus of variations to solve
the constrained maximization problem, Mirrlees finds that the
optimal tax function exhibits marginal tax rates between zero
and one, and that when it is operative, part of the population
does not work.
Although these results may seem weak, they are
really quite remarkable given the absence of specific functional
forms for the key relationships in the problem.
- 13 In order to get more specific results, more specific assumptions must be built into the analysis. Mirrlees assumes that the
utility functions are Cobb-Douglas, and considers both lognormal
and Pareto distributions of earnings abilities. With these
assumptions, the following results emerge: a) the optimal tax
function is approximately linear with a negative intercept, and
b) the optimal tax function is characterized by 'low' marginal
tax rates which fall somewhat with income. (Atkinson's interpolations of Mirrlees' results indicate rates in the neighborhood of 20 percent).
Mirrless was surprised at how low the marginal tax rates
were: ". . .1 must confess that I had expected the rigorous
analysis of income-taxation in the utilitarian manner to provide
an argument for high tax rates. It has not done so." A study
by Fair in the same year also generated fairly low implied
marginal tax rates. Apparently, those who read the Mirrlees
paper also found the low marginal tax rates counter-intuitive,
for much of the literature appears to be an attempt to explain
them.
One concern was the maximand of Mirrlees1 problem, an
unweighted sum of individual utilities, which implies that a
'util1 to a rich individual adds as much to social welfare as
a 'util' to a poor individual. To what extent would more
egalitarian results (i.e., higher marginal tax rates) emerge
- 14 if a social welfare function were used which weighted the utilities
of the rich less than those of the poor? Atkinson and Feldstein
(1973) consider social welfare functions of the form:
(10) W = ( EUV)3-/^ u<l
Clearly, when u =1, welfare (W) is the simple sum of utilities
(Ui) . When u is less than 1, however, it can be shown that
a given increment to the utility of a low utility individual adds
more to W than if awarded to a high utility individual. It
should be noted, however, that the specifications of the social
welfare function and the individual utility functions are not
really independent of each other. We could, for example, specify
the utility of the ±^L individual to be U£\ -' and then write
social welfare as the arithmetic sum of these utilities.
Atkinson focuses attention on the case in which u approaches
minus infinity. Under such circumstances, maximizing W is
equivalent to maximizing the utility of the worst off individual
in society: the maximin case.—' This case has received considerable attention due to philosopher John Rawls' argument that
it is particularly compelling as an ethical criterion. (A number
of criticisms are suggested by Klevorik.)
Atkinson uses a Rawlsian social welfare function in a model
with a linear income tax, no net government revenue requirement
(i.e., taxation for redistribution only), and a Pareto distribution of skills in the economy. He finds that optimal marginal
tax rates range between 30 and 45 percent. Thus, one solution
- 15 to the mystery of Mirrlees' low marginal tax rates is his formulation of the objectives of the government. Social welfare functions which are more egalitarian than the classical utilitarian
variety may yield higher marginal rates.
Another potential explanation for Mirrlees' results is the
Cobb-Douglas assumption concerning the form of individuals'
utility functions. Stern has investigated this possibility by
assuming that individuals have constant elasticity of substitution (CES) utility functions in leisure and income. Using results
8/
on the elasticity of labor supply from the econometric literature,—
he finds that an elasticity of substitution of 0.4 is more realistic
1/
than 1.0.
When a variant of Mirrlees' problem is solved using
CES utility functions with this lower elasticity of substitution,
the optimal marginal tax rates are substantially higher -- without
appeal to a more egalitarian social welfare function.
So far, it has been assumed that there is one type of
labor, and individuals differ only in their ability to perform
it. Feldstein (1973) investigates the importance of this
assumption by analyzing a two person society consisting of a
skilled and unskilled worker whose wages are endogenously
determined. He finds that relaxing the exogenous determination
of wages has no major impact on optimal marginal tax rates, and
as in the Mirrlees article, they are still 'low'. Even for the
maxim in case Feldstein finds a marginal tax rate of only 45
percent (assuming Cobb-Douglas utility functions).
- 16 Reexamination of the social welfare function suggests
another possible explanation for the low tax rates typically
generated by optimal income tax studies.
Out intuition about
optimal income taxation may perhaps be conditioned on social
objective functions which are not utilitarian-individualistic.
For example, the presence in the social welfare function of a
variable parameterizing the 'aesthetics' of the income distribution would lead to more egalitarian results.— /
Similarly,
Feldstein (forthcoming) has shown that if interdependent utility
functions are allowed for, very high marginal tax rates may
be appropriate.
We now turn to a limitation of the Mirrlees model which
is just beginning to receive attention, its atemporal setting.
The appropriate taxation of capital income is one of the most
controversial aspects of the tax system, yet the studies cited
above for the most part ignore it.
Ordover and Phelps examine
the optimal mix of taxes on two factors of production (capital
and labor) in a one sector neo-classical growth model.—
Their model is very general, and therefore no results on tax
rates emerge which can be compared to those discussed above.
Moreover, the only social welfare function they consider is the
maximin case.
Despite these limitations, explicit attention to
the taxation of capital income in the optimal income tax framework is an important step which will no doubt stimulate further
research.
- 17 We could continue to list additional aspects of the Mirrlees
model which have been changed and expanded in order to determine
12/
their effects on optimal tax rates.—
However, the basic thrust
of the literature should now be clear. An exogenously determined
amount of tax revenue must be raised by income taxes on individuals whose economic choices are distorted by the presence of
those taxes. Given technological and behavioral assumptions,
the optimal tax schedule is that which leaves some social, welfare
function at a maximum after the tax is collected. The literature
shows how various assumptions on these components lead to different conclusions regarding the shape of the optimal tax
schedule.
- 18 IV.
CONCLUDING REMARKS
The accomplishments of the optimal taxation research have
been considerable. It has upset many comfortable rules of thumb
and lent precision to many informal arguments. But there remains
work to be done. Part of this work will, of course, consist of
increasing the stock of variations on the basic problems for which
solutions have been described. Another, and very important, part
will consist in the attempt to determine quantitatively which of
these problems best describes the actual economy to be taxed --
filling in all those empty boxes with real, estimated elasticities.
However, work of another kind is needed to advance the
normative power of the analysis. Normatively the optimal tax
literature rests on a utilitarian base. It is true that the
optimal commodity tax results, or some of them at least, can be
cast in a form which says: if your tax system doesn't look like
this there is a potential bargain which can be struck among your
citizens which would make all better off. However, these bargains are complex and their possibility tends to be eliminated
by the very assumptions that require the use of second-best
instruments in the first place. For practical application
implicit interpersonal utility comparisons are required. The
optimal income tax results are also dependent on such comparisons. The missing link is a welfare function, and the question
- 19 is how does one persuade a legislative or an electorate to decide
tax questions in accordance with some particular welfare function?
Asking the optimal tax researchers to resolve this problem is
effectively asking them to make welfare economics persuasive,
obviously a tall order.
Missing from the optimal tax arguments is the idea of
horizontal equity, the notion that "... people in equal positions should be treated equally." (Musgrave, 1959, p. 160)
(Customarily, "equal positions" are defined in terms of an'
observable index of ability to pay such as income, expenditure,
or wealth.) In none of the studies discussed above has the
injunction to treat equals the same appeared either as a constraint in the mazimization problem, or as an argument in the
objective function. Therefore, they will in general ±A' fail
to provide horizontal equity. In light of this, Musgrave
(forthcoming) and others have suggested that it is inappropriate
to characterize such schemes as 'optimal.'
Defining horizontal equity in terms of income is inadequate
because individuals with identical opportunity sets but different tastes will have different incomes. An alternative
way to define equal position would be identical opportunity
sets. However, it seems more in the spirit of the optimal
taxation literature to define equal position in terms of
utilities: individuals are 'the same' only if they derive
- 20 identical amounts of utility from their consumption and leisure
bundles. The choice of a criterion for horizontal equity is
important because when tastes differ between individuals,
different criteria may lead to different conclusions as to the
fairness of a given tax. For example, an income tax which is
perfectly fair according to conventional notions of horizontal
equity hurts an 'income lover' more than a 'leisure lover.'
Ironically, although the optimal taxation literature ignored
horizontal equity, it has sparked new interest in the topic, and
modified the vocabulary of the discussion. For example, the
optimal taxation literature emphasis on efficiency has reminded
public finance practitioners that excess burden must be taken
into account when allocating tax burdens across individuals.
Similarly, the concern with the impact of tax changes on utility
has focused attention on the equity implications of the differential taxation of pecuniary and nonpecuniary forms of income.
It has been shown, for example, that if there is one type of
ability and tastes are the same, then horizontal equity is
satisfied even if identical individuals pay different amounts
of tax. (See Feldstein (forthcoming))
In an attempt to put the discussion of horizontal equity
and the optimal taxation literature on the same plane, Feldstein
(forthcoming) has redefined the principle of horizontal equity
in terms of utility rather than ability to pay.—' However,
complete integration of horizontal equity into the optimal tax
- 21 framework remains to be done. Perhaps this could be accomplished
by including some measure of departure from horizontal equity as
an argument in the social welfare function, but this approach is
bedeviled by conceptual difficulties in measuring departures
from horizontal equity.—
It may well be that horizontal equity, ancient and honorable
criterion of tax policy though it be, is not a helpful concept.
However, the apparent appeal of this nonoperational idea to
practical people suggests the attractiveness of properties of
a tax structure which are independent of the economy to which
that structure is applied. To discover whether there are any
such properties which significantly narrow the range of "good"
tax structures might be a useful topic of research.
- 22 -
REFERENCES
Armit age-Smith, Priciples and Methods of Taxation, London,
1907.
Arrow, K., et. al., "Capital-Labor Substitution and Economic
Efficiency," Review of Economics and Statistics,
August 1961.
Atkinson, A.B., "Capital Taxes the Redistribution of Wealth
and Individual Savings," Review of Economic Studies,
April 1971.
Atkinson, A.B., "How Progressive Should the Income Tax
Be?", in Longmans, Essays on Modern Economics, London,
1973.
Atkinson, A.B., J. Stiglitz, "Alternative Approaches to
the Redistribution of Income," Journel of Public
Economics, forthcoming.
Boiteux, M., "Sur la gestion des monopoles publics astreint
a l'equilib budgetaire, Econometrica (24), 1956,
reprinted in translation by W. J. Baumol and D. F.
Bradford, "On the Management of Public Monopolies
Subject to Budgetary Constraints," Journal of Economic
Theory, (3), September 1971.
Corlett, W. J., Hague, D.C., "Complementarity and the Excess
Burden of Taxation," Review of Economic Studies, (21),
1953-54, pp. 21-30.
- 23 -
Diamond, P.A., J. A. Mirlees, "Optimal Taxation and Public
Production:
II," American Economic Review, June 1971.
Dupuit, J., Troite theorique et pratique de la conduite
et de la distribution des eaux, Paris, 1854.
Edgeworth, "The Pure Theory of Taxation," Economic Journal,
1897.
Fair, R.C., "The Optimal Distribution of Income," Quarterly
Journal of Economics, 1971.
Feldstein, M., "On the Optimal Progressivity of the Income
Tax," Journal of Public Economics, 1973.
Feldstein, M. , "The Theory of Tax Expenditures," Harvard
University, mimeo, 19 75.
Feldstein, M., "On the Theory of Tax Reform," Journal of
Public Economics, forthcoming.
Jones, R. , The Nature and First Principle of Taxation, London,
1914.
Klevorick, A.K., "Discussion," American Economic Review,
Papers and Proceedings, May 1974.
Little
J.M.D., "Direct vs. Indirect Taxes," Economic
Journal, (61), pp. 577-584.
Mirrlees, J.A., "An Exploration in the Theory of Optimum
Income Taxation," Review of Economic Studies, 1971.
Musgrave, R.A., The Theory of Public Finance, New York,
1959.
- 24 -
Musgrave, R.A., "Optimal Taxation, Equitable Taxation and
Second-Best Taxation," Journal of Public Economics,
forthcoming.
Ordover, J.A., E.S.Phelps, "Linear Taxation of Wealth
and Wages for Intragenerational Justice:
S6me Steady-
State Cases," American Economic Review, September 1975.
Ramsey, F.P., "A Contribution to the Theory of Taxation,"
Economic Journal, (37), 1927.
Rawls, J., "Some Reasons for the Maximin Criterion," American
Economic Review Papers and Proceedings, May 1974.
Rosen, H., "Income, Utility, and Horizontal Equity Under
the U.S. Income Tax," Princeton University, mimeo,
1975.
Samuelson, P.A., "Theory of Optimal Taxation," unpublished,
approximately 1952.
Sandmo, A., "A Note on the Structure of Optimal Taxation,"
American Economic Review, September 1974.
Sheshinski, E., "Income Taxation and Capital Accumulation,"
Quarterly Journal of Economics, forthcoming, a.
Sheshinski, E., "On the Theory of Optimal Income Taxation,"
Journal of Public Economics, forthcoming, b.
Stamp, Josiah S., Fundamental Principles of Taxation in the
Light of Modern Developments, London, 1921.
Stern, N., "On the Specification of Models of Optimum
Income Taxation," Journal of Public Economics, forthcoming.
Wells, D , The Theory and Practice of Taxation, New York, 1900.
- 25 FOOTNOTES
The authors would like to thank Roger Gordon for useful
conversations and Jay Stuart for assistance in gathering
material.
There is some overlapping of these strains.
For
example, Atkinson and Stiglitz consider the problem of
differential commodity taxation in the presence of an
income tax.
Although we shall focus upon these problems in this
paper, the optimal tax literature has had a somewhat wider
scope.
For example, Diamond and Mirrlees concider the pro-
blem of optimal expenditure along with taxation, and
Atkinson considers the issue of wealth taxation.
^Our goal is not to provide a comprehensive literature review.
Consult Atkinson and Stiglitz and Sandmo for
more biblographical material.
^Thus, if y is the sector of net outputs of the production sector, net profits are given by p.y. Equilibruim requires that p.y=0 (otherwise firms would expand
all components of y proportionately, which is possible
under the assumption of constant returns to sale).
For a
vector T of taxes proportional to p, say T=rp, where r is
a scalar, the revenue raised will be T.y=rp.y=0.
words,
In other
a tax on economic profit would raise no revenue.
- 26 5
He also considers a social welfare function of the form
I -3(u )
" g
n
e
f
( n ) d n ' where
UR
is the utility of the nth
individual and f(n) is the distribution of abilities. In the
application Mirrlees takes the cases 6=0 (yielding a simple
sum of utilities) and 3=1.
Such a transformation changes none of the behavioral
implications of the utility function.
'The proof is similar to the demonstration of Arrow,
et. al., that as the elasticity of a CES production function
goes to zero, technology is characterized by fixed coefficients .
o
These are measures of the elasticity of hours per
year with respect to the wage, and thus do not take into
account other, perhaps more important dimensions of labor
supply.
9
If the elasticity of substitution were zero, lump
sum taxation would be possible. If the elasticity of substitution were infinite, no revenue could be raised.
l^Such a social welfare function would be non-paretian,
but there is nothing to prevent a reasonable set of value
judgments from allowing for such a possibility.
•^Sheshinski (forthcoming, a) considers taxation in a
one sector neo-classical growth model with earned and
unearned income taxed at the same rate.
12
For example, Stern has suggested changing the assumptions on the underlying distribution of skills, while
Sheshinski (forthcoming, b) focuses on a model in which
- 27 taxes influence human capital accumulation.
13
It can be shown that if all individuals have identical tastes and there is only one type of ability, then
horizontal equity will be satisfied by virtually any broadbased tax. (See Feldstein (forthcoming)). Such assumptions,
as we have seen, are built into a number of the optimal
tax studies. (For an exception, see Diamond and Mirrlees.)
"If two individuals would be equally well off (have
the same utility level) in the absence of taxation, they
should be equally well off if there is a tax."
See Rosen for a discussion of these problems and
some attempts to surmount them.
JV
DEPARTMENT OF THE TREASURY
FISCAL SERVICE - BUREAU OF GOVERNMENT FINANCIAL OPERATIONS
STATEMENT OF THE A
DEPUTY COMMISSIONER OF GOVERNMENT FINANCIAL OPERATIONS
FOR PRESENTATION TO THE SUBCOMMITTEE
ON LEGISLATION AND NATIONAL SECURITY
OF THE COMMITTEE ON GOVERNMENT OPERATIONS
GENERAL STATEMENT
MR. CHAIRMAN, MEMBERS OF THE COMMITTEE, IT IS A PLEASURE TO
APPEAR BEFORE YOU TODAY TO DISCUSS (1) THE INCLUSION IN SECTION 45
OF H.R. 12605 OF AN AMENDMENT TO THE CONGRESSIONAL BUDGET ACT OF
1974, SECTION 503(B), AND (2) THE PROVISION CONTAINED IN SECTION
209 OF H.R. 12606 WHICH PROVIDES FOR FUNDS APPROPRIATED TO AN
ACCOUNT FOR THE PERIOD JULY 1 THROUGH SEPTEMBER 30, 1976 TO BE
MERGED ON JULY 1, 1976 WITH THE BALANCES AVAILABLE FROM APPROPRIATIONS MADE FOR THE FISCAL YEAR 1976 FOR SUCH ACCOUNT.
TREASURY REQUESTED AMENDMENT OF SECTION 503(B) TO CORRECT
TIMING PROBLEMS IN THE FORMAL CLOSING OF THE BOOKS AND TO ACCOMMODATE THE EFFICIENCY OF THE GOVERNMENT'S ACCOUNTING SYSTEMS.
SECTION 503(B) OF THE CONGRESSIONAL BUDGET ACT OF 1974 AMENDED
LAW CODIFIED AT
31 U.S.C. 701(B). WITH THIS AMENDMENT 31 U.S.C.
701(B)(1)(A) DIRECTS THAT OBLIGATED BALANCES IN APPROPRIATION
ACCOUNTS FOR FY 1976 OR EARLIER FISCAL YEARS BE TRANSFERRED TO
MERGED APPROPRIATION ACCOUNTS OF THE AGENCIES CONCERNED ON THE
J
JUNE 30 WHICH OCCURS TWENTY-FOUR MONTHS AFTER THE END OF THE
APPROPRIATE FISCAL YEAR. THE AMENDED
31 U.S.C. 701(B)(1)(B) ALSO
PROVIDES FOR THE TRANSFERRAL OF OBLIGATED BALANCES ASSOCIATED WITH
THE JULY 1 TO SEPTEMBER 30, 1976 PERIOD, AND WITH ANY FISCAL YEAR
AFTER-OCTOBER
1, 1976/ ON SEPTEMBER 30oFfTHE-SECOND- FISCAL: YEAR
THEREAFTER.
THE AMENDED
31 U.S.C. 701(B)(2) DIRECTS THAT: (A) UNOBLIGATED
BALANCES IN APPROPRIATION ACCOUNTS FOR FY 1976 OR EARLIER BE WITH-
DRAWN FOR REVERSION TO THE GENERAL FUND OR OTHER SUITABLE FUND, NOT
LATER THAN SEPTEMBER 30 OF THE FISCAL YEAR FOLLOWING THE -FISCAL
YEAR IN WHICH AVAILABILITY EXPIRES, AND (B) UNOBLIGATED BALANCES
IN APPROPRIATION ACCOUNTS FOR THE JULY 1 TO SEPTEMBER 30, 1976
PERIOD, AND FOR ANY FISCAL YEAR STARTING AS OF OR AFTER OCTOBER 1,
1976, BE WITHDRAWN NOT LATER THAN THE NOVEMBER 15 FOLLOWING THE
PERIOD OR FISCAL YEAR IN WHICH AVAILABILITY EXPIRES.
THE PRESENT PROVISIONS OF SUBSECTIONS (B)(1)(A) AND (B)(2)(A)
- 3WOULD REQUIRE TWO CLOSINGS OF THE BOOKS EACH YEAR FOR TRANSFERS
TO MERGED ACCOUNTS AND WITHDRAWALS FROM ACCOUNTS., THESE PROVISIONS
WOULD IMPOSE ADDITIONAL AND UNPRODUCTIVE PAPERWORK AND ACCOUNTING
WORKLOAD REQUIREMENTS ON THE TREASURY AND REPORTING AGENCIES.
THE AMENDMENTS WHICH ARE NOW INCLUDED IN SECTION 45 OF
H.R. 12605 WILL CORRECT THESE TECHNICAL DEFICIENCIES.
WE ALSO SUPPORT THE PROVISION ;IN
SECTION
209 OF H.^R.^ 12606
WHICH PERMITS THE MERGER-ON JULY 1, 1976 OF TRANSITION QUARTER
APPROPRIATIONS WITH THE BALANCES AVAILABLE FOR FISCAL YEAR 1976
FOR AGENCY ACCOUNTING AND OBLIGATION CONTROL PURPOSES. THE PROPOSED AMENDMENT WILL SIGNIFICANTLY REDUCE" THE AGENCY ACCOUNTING '
WORKLOAD REQUIREMENTS RELATING TO THE CHANGE IN FISCAL YEAR.
AGENCIES HAVE INDICATED TO US THAT THEY WILL HAVE TO MAKE EXTEN-
SIVE
REVISIONS IN THEIR ACCOUNTING SYSTEMS IN ORDER TO MAINTAIN
SEPARATE OBLIGATIONAL RECORDS FOR AN ADDITIONAL ACCOUNTING PERIOD.
IT IS OUR PLAN TO ISSUE WARRANTS FOR THE TRANSITION QUARTER
AS OF JULY 1, 1976. THESE APPROPRIATIONS WILL NOT BE AVAILABLE TO
THE AGENCIES DURING FISCAL YEAR 1976. WE ALSO PLAN TO ACCUMULATE
DATA SEPARATELY FOR CASH TRANSACTIONS OCCURRING DURING FISCAL YEAR
1976 AND THE TRANSITION QUARTER IN THE ANNUAL COMBINED STATEMENT.
THE EFFICIENCY AND ECONOMIES RESULTING FROM PASSAGE OF SECTION
209 WILL ENHANCE THE ABILITY OF AGENCIES TO MEET OUR EXTREMELY
TIGHT REPORTING REQUIREMENTS FOR FISCAL YEAR 1976 AND THE TRANSITION QUARTER. WE PLAN TO ACCOMPLISH THE SUBMISSION OF THIS DATA
FOR.BOTH ACCOUNTING PERIODS IN A TIME SCHEDULE WHICH CUTS IN HALF
THE TIME PREVIOUSLY. AVAILABLE -FOR COMPILATION OF YEAREND ACCOUNTING
INFORMATION. THIS TIME SCHEDULE WILL PLACE EXTREMELY HEAVY WORKLOAD DEMANDS ON TREASURY AND THE AGENCIES DURING THE REMAINDER OF
1976.
MR. CHAIRMAN, I APPRECIATE THE OPPORTUNITY TO TESTIFY ON
BEHALF OF THE TREASURY DEPARTMENT AND WOULD BE HAPPY TO RESPOND TO
ANY QUESTIONS YOU MIGHT HAVE AT THIS POINT.
REMARKS BY THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE THE
AD COUNCIL, WASHINGTON, D.C.
April 1, 1976
*
Chairman Adams, President Keim and members of the Ad Council.
It is a pleasure for me to address this luncheon session
of your 32nd Annual Conference. In looking over your agenda
I see that you have taken great pains to hear from a broad
spectrum of people in government, including an impressive list
of senior spokesmen from the executive, legislative and judicial branches. And I notice that you have already received
one extensive economic briefing at the able hands of my esteemed
colleagues, Bill Seidman, Jim Lynn and Fred Dent.
Under the circumstances, there probably isn't much left
for me to say about the current state of the economy that you
havenft already heard. So, in my remarks today, I would like
to give you a brief account of my recent visit to the Middle
East, and some of the impressions I brought back with me, and
then go on to consider both our nation's economic future and
the role that people like you -- some of the most talented
communicators in the country -- can play in making that future
a bright one.
There isn't a more diverse, fascinating part of the
world than the Middle East. That turbulent area that is
terribly bound up with the future of global peace has many
problems and none of them is going to vanish overnight.
While I did return fully aware of the grave problems that
confront them, I did return with one positive impression.
Today, despite old animosities and differences, both the
Arabs and the Israelis, regardless of their other conflicts,
realize that the United States has developed the most dynamic
and efficent economic system the world has ever known. They
see the United States as the major source of strength and
stability -- economic as well as political — in an unstable world.
As Secretary of the Treasury, I find this both encouraging
and awesome. Encouraging, because I am convinced that the way
to a peaceful world political order can only come through a
strong, stable world economic order -- because, for the Middle
East, peace and prosperity can and must go hand in hand. And
I find it awesome because if reminds me once more of how vitally
important the American economy is, not only to our everyday comfort and convenience, but to the preservation of peace and freeWS-750
dom in the world.
- 2 -
J£
Economic statistics may make for pretty dull reading, but
the facts behind the figures are a massive, perhaps decisive
shaping force in the lives we live today, and in the future
course of America and the world.
We must never lose sight of the fact that a strong, noninflationary domestic economy is an absolute necessity. The
only way to be strong abroad is to be strong at home.
Now you would be perfectly right to ask how in the world
I can reasonably expect the general public to understand economics when even the experts disagree among themselves. And, up
to a point, you would be right. The same objection could be
made in almost any specialized field, from horse-racing to
psychiatry. There is no single, exhaustively all-embracing
economic formula that can answer all the questions and solve
all the problems.
But there are a number of economic basics -- fundamental,
common-sense guidelines and warning signals -- that can help
all of us — from Milton Friedman to Archie Bunker -- to understand where our country is heading economically and what we can
and should do about it.
There is where advertising and communication skills come
in. You, as skilled communicators, individually and collectively,
can make an enormous contribution by helping to educate the public.
For if my three years in Washington have taught me anything at
all, it is the vital importance of your specialty — getting an
often complicated message across in simple, lucid terms. Getting
to the essence of things clearly and forcefully.
The success of public policy, even more than the success
of a commercial product, is directly dependent on the communications ability of those who advocate it. In fact, one of the
biggest problems we face today in government is the paradox of
too many good communicators selling bad policies and too many
bad communicators selling good policies. A rhetorical spellbinder could sell ice cubes to Eskimos, but some of the advocates
of fiscal responsibility and the free enterprise system are so
unimaginative that they'd have trouble peddling Alka-Selzer on
New Year's morning.
Perhaps the most significant -- and distressing -- fact
confronting this country today is closely related to your field.
I refer to the decline in public confidence in our institutions.
Instead of observing our Bicentennial on the upbeat, we find
our nation in a mood of deep and widespread distrust of many of
the very elements that made our society great. No group —
business, government, the press, education, labor — enjoys the
credibility and trust it once did.
if
- 3 Many people sensed this decline in public confidence long
before the pollsters confirmed it. George Shultz, a former
Secretary of the Treasury, has summed up the problem pretty
well: "We need moorings in our society," he points out, but
"We have let go of many old moorings and we do not have new
ones to replace them."
This decline in public confidence has been, building for a
long time. Many different things have contributed to it:
Vietnam, Watergate, and the overpromising and underperformance
of government. It now seems to pervade every facet of our social
structure and poses a threat to the system that has enabled
this country to achieve the greatest prosperity and the highest
standard of living every known.
One of the institutions whose credibility has lost the
most ground is business — or what I prefer to call free enterprise. Today the American private sector is reexamining itself
to determine not only what has caused this loss of confidence
but also what it can do to regain it.
One opinion researcher says the major concern facing business
is to overcome the public's alienation and cynicism. I'm not
sure I agree. I certainly don't agree with those who allege
there is something basically wrong with the American enterprise
system itself.
Part of the problem, I believe, is that many people are
misinformed and misled on the economic issues. Most people
simply do not have time to read the fine print behind the headlines, and most detailed economic coverage is written for the
specialist rather than the general public. The result is often
serious misunderstanding of the private sector. According to a
recent study by the Opinion Research Corporation, the key issues
on which the public is most misinformed are the level and trend
of corporate profits and their interrelationships with prices,
wages, unemployment and inflation -- a major part of the system
of economic causes and effects that influence their daily lives.
They also found that people were misinformed about antitrust problems, monopolistic practices and competition and the relations
between corporations and governmental regulatory agencies.
If that worries you, there's more. Some of you may recall
that report last year by the Commerce Department and your own
Advertising Council, which portrayed the average American as
a virtual economic illiterate who perceives our economic system
almost solely in terms of his or her own personal situation
rather than in its broad functional aspects.
This is only human — but it is also dangerous.
- 4 People usually fear what they don't understand. And
people tend to reject what they fear. So we shouldn't be
surprised if they're tempted to unknowingly embrace programs -and quack economic remedies — that are destructive to our
system. Let's take a look at that system and ask ourselves
whether or not it is worth preserving. Even the most cursory
glance at recent history shows us that is has outperformed
all others, both in terms of the material benefits it has
produced and the free way of life it has protected. Here are
some measurable standards of performance:
— Since the late 1950's alone, real purchasing power of
Americans has jumped by 40 percent, average family income has
risen to over $13,000 a year, 20 million new jobs have been
created, and we have cut the number of people below the poverty
line in half.
— Our farmers harvest more than twice as much grain with
fewer workers compared to a generation ago.
-- Medical science has added 10 years to our lives over
this period.
-- Our economic abundance has made it possible for us to
give $110 billion in food and economic aid to less fortunate
nations since the end of World War II.
— And Americans today have more leisure time for study,
recreation and self-improvement than any society in recorded
history. We continue to spend about 90 percent of our personal
disposable income on ourselves.
No other country — no other system -- has achieved so much
for its people. Yet these tremendous achievements are the product
of the same free-market system that now finds itself under attack.
The Free Enterprise System, where does it stand today? For
all the talk about excessive profits, it's a system that, on
the average, offers a profit incentive of less than five cents
on the dollar, a small reward for all the effort and risk-taking
that goes into developing and operating a successful business.
Nevertheless, it remains the real productive source of our
nation's wealth, as well as that of each individual American.
Despite the growing influence of government over our lives,
this system produces the food we eat, the goods we use, the
clothes we wear, the homes we live in.
It is the source of five out of every six jobs in America,
and it pays the taxes to provide most of the rest of the jobs
in our all-too-rapidly expanding public sector.
$1
- 5 It is the foundation for defense security for ourselves
and most of the Free World.
It is the productive base that pays for government spending
to aid the elderly, the jobless, the poor, the dependent and the
disabled. Indeed, far from being the anti-human caricature
painted by political demagogues, the American private sector is
in reality the mightiest engine for social progress and individual
improvement ever created.
In a nutshell, the values we live by — all of the material
and spiritual values that make our country unique and make us so
proud to be Americans — could not exist without the free enterprise system. Yet many people still fail to understand the crucial
link between our economic and our political freedom. Destroy
one, and the other will soon disappear.
If the prospect of seeing a system like ours go down the
drain doesn't worry you, let me call you attention to a recent
syndicated column by Charles Bartlett: "More than 10 years ago,"
Mr. Bartlett said, "Arthur Koestler wrote that a loss of incentive was ailing Britain far more than its loss of empire, and
the glummest aspect of today's scene is the bowed spirit of a
creative, courageous, ebullient people."
If that can happen to a nation that once was one of the
proudest bastions of free enterprise, we are in no position to
assume that it can't happen here.
Every generation hopes it will leave its children a better
world. But there is no guarantee of endless prosperity in the
United States any more than in any other country. Properity
doesn't happen by accident. Tamper with its source and the shock
is felt throughout our entire society.
And I am convinced that, today, the private sector — indeed,
our very society — is enduring the greatest series of shocks
and challenges since the 1930s. In my opinion the threat can
be traced directly to the explosive growth in government and the
ominous concentration of power on the Potomac. Today government
spending at all levels accounts for some 38 percent of our gross
national product.
If recent growth patterns continue, it will reach 6 0 percent
before the end of this century.
It is my firm belief that any government that
more than half of what people earn has robbed
economic freedom. And can there be any doubt
economic freedoms are destroyed, our personal
freedoms will not long survive them?
taxes away
them of their
that when our
and political
- 6 The head of one of our major corporations says it's no
longer just a challenge. In the New York Times' annual economic
roundup last January, Richard Riley, the President of Firestone
Tire and Rubber Company, was reported to have pronounced free
enterprise already dead. I shudder to think how many other business leaders share in that counsel of despair. If they give up,
who is left to uphold economic freedom?
Yet the same article quoted another executive as saying
that unless something is done to halt "the systematic destruction by federal and state government of the ability to make
profits, the word 'corporation' will be something to be studied...
along with the buggy whip."
Now no one would seriously question the role of government
in such areas as health and education. But the layer upon layer
of regulations that government has piled on all aspects of the
private sector, and its proliferation of programs and administrative devices has seriously hobbled the American businessman —
especially the small businessman, the very backbone of our free
enterprise system. Every business in America, from the little
shop around the corner to General Motors is being buried under
a growing load of federal paperwork and requirements to the tune
of $20 billion a year.
The men and women who run this country's businesses turn
to many of you in your individual professional capacities. You
work with them daily. Both you and they know there is justification for some of the charges lodged against their industries.
Most of them recognize that they must put their own houses in
order by correcting these faults. And most realize that failure
to do so would surely contribute to the further underming of the
system they profess to cherish.
But survival requires more than internal reform, and that
is where you become so important.
Even the misinformed consumers who were studied in that
survey by Opinion Research Corporation said they had no wish
to destroy our free enterprise system. They said they still
consider business a progressive force, but they would like to
see it "cleaned up."
According to the same pollsters -- and here I quote: "The
pressure is on coporations to overcome misconceptions about
their activities while correcting abuses for which they are
responsible."
- 7 Advertising, it seems to me, has its work cut out. It's
a big job and a critical one. There is an urgent need for
leadership in helping to restore the faith of the American
people in their economic system, as well as in government, and
I don t know of any group of professionals better qualified
to do it than you.
It's been said that communications is the web holding
civilization together — the central nervous system of any
organized society. It's also the only means of perpetuating
the traditional values handed down by our forefathers which
give our civilization stability and continuity.
Never has that function been more important than today.
It is largely up to you to communicate the great story of
freedom — to dispel the confusion that has made free enterprise
a dirty word; to let our lawmakers and leaders in government
know they cannot let the system that generates our wealth, our
strength, and our freedom be destroyed. If ever communication
of the highest professional caliber was desperately needed, it
is NOW; if ever there was an assignment that challenged your
profession to the core, it is this one.
Too many in government have too long acted on its assumption
that good economics is not good politics. We must show them the
error of their way. We must make it politically attractive to
support responsible economic policies. Our lawmakers must be
convinced that this is what the public wants. For they know better
than anyone that the public attitude of today is the public
statute of tomorrow.
Given the facts about the very real threats to our economic
system, I for one have no doubt about what the public's reaction
will be. But the public must know them in order to act on them.
The people have a right to know how government restrictions
are undermining individual and industry initiative. They must
learn how our Government's tax and spending policies are sopping
up capital needed for investment and the creation of jobs.
They must understand that runaway spending and unending
deficits fuel inflation — a silent thief that picks every
American's pocket, undermines public confidence in the future and
turns the desperate to government for still more illusory help.
In short, the job before you — if you hope to preserve
this system of ours — is to convince both the public and it:
leaders in Washington that government just can't go on wring.
the neck of that marvelous goose that lays those golden eggs
8
This is not a question of liberals versus conservatives
or Democrats versus Republicans; it is a matter of sense against
nonsense, freedom against oppression. There is no doubt whatever
in my mind that you can do this job. But all of us must be
united in our resolve:
. To set a high moral and ethical standard by eliminating
any practices in our own organizations and operations that may
be questionable,
. To square practices with principles by refusing government
subsidies, quotas, handouts, bailouts or other inducements that
offer an illusory, empty promise of security in exchange for
sacrifices of freedom, and
. To initiate, and, in some cases, redouble our efforts to
inform and educate the public about the benefits and realities
of the private enterprise system.
Given this commitment, you can help to create a real understanding of how the private enterprise system benefits individuals
and groups, and of its absolute essentiality to progress,
prosperity... and, above all, our freedom.
Sages throughout history have placed freedom at the top of
all the things we hold sacred. Our founding fathers built a new
nation around that concept and, ever since, freedom has been
synonymous with American itself.
This, ladies and gentlemen, is the crucial theme* that must
be communicated broadly and deeply into the national consciousness
The American production and distribution system is the very
wellspring of our Nation's strength — the source of present
abundance and the basis for our hopes of a better future.
America can solve all of its pressing problems if it preserves
and continues to improve this immensely productive system. And
in this process, we'll also be preserving the freedoms that
made it all possible.
This is one ad campaign none of us can afford to lose. And
you, more than anyone else can help us to win it.
-0O0-
MEMORANDUM TO EDITORS
April 2, 1976
FROM: William F. Rhatican ""
Special Assistant to the Secretary
Public Affairs
The Department of the Treasury will reissue the twodollar Federal Reserve Note this April 13. The new bill
will be available at all savings and loans banks and Federal
Reserve Banks on that date.
The front of the bill will feature an engravira of
Thomas Jefferson, while the reverse of the bill will carry
an engraving of "The Signing of the Declaration of Independence." By April 13, 225,000,000 of the new notes will be
printed.
Public acceptance and frequent use is the key to success
of any currency or coin issuance. While the issuance of
the new two-dollar bill is connected with the nation's
bicentennial, it is intended to be a permanent and practical
part of our currency system and is not intended simply as
a commemorative or special issue.
Following are suggestions, for your use, of how the
reissuance of the two-dollar bill may be utilized in the
creation of feature stories or photo features on the subject.
Also enclosed is a press kit containing information on the
new note, as released by the Treasury Department on November 3,
1975, at a press conference announcing the reissuance.
(1) Photo feature of local Federal Reserve Bank
disbursing bills on first day of issue.
(2) Photo feature of local banks disbursing bills on
first day of issue.
(3) Photo feature of citizens using the new bill in
grocery stores, retail stores, etc.
(4) Story on cash-handlers in banks, stores, fastfood chains, etc. and their reactions to the new bill.
(5) Story on consumer reactions to new bill.
WS-751
- 2 (6) Story on local banks one week after release
date on numbers of two-dollar bills moved.
(7) Story on local businesses one week after release
date on numbers of new bills received.
(8) Story on history of new bill.
(9) Photo feature on bills being unloaded from
armored trucks into banks.
(10) Story on currency distribution process.
(11) Photo feature with local bank officials and
new bill day before issuance.
oOo
ie Department of the JR[/[$URY
;HINGTON,D.C. 20220
TELEPHONE 964-2041
tf
March 31, 1976
FOR IMMEDIATE RELEASE
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION
Tenders for $3,200 million of 52-week Treasury bills to be dated
April 6, 1976, and to mature April 5, 1977, were opened at the Federal
Reserve Banks today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
High
Low
Average -
Price
Discount Rate
94.196
94.143
94.155
5.740%
5.793%
5.781%
Investment Rate
(Equivalent Coupon-Issue Yield)
6.09%
6.14%
6.13%
Tenders at the low price were allotted 90%.
TOTAL TENDERS RECEIVED AND ACCEPTED BY FEDERAL RESERVE DISTRICTS:
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Received
$
27,590,000
4,740,620,000
49,440,000
131,130,000
64,775,000
39,465,000
419,270,000
41,055,000
92,770,000
20,145,000
24,845,000
393,455,000
Accepted
$
17,090,000
2,484,505,000
28,940,000
99,630,000
35,075,000
27,670,000
169,420,000
16,055,000
66,770,000
11,135,000
21,645,000
223,840,000
TOTAL
$6,044,560,000
$3,201,775,000
District
The $3,201,775,000 of accepted tenders includes $114,920,000 of
noncompetitive tenders from the public and $ 920,330,000 of tenders from
Federal Reserve Banks for themselves and as agents of foreign and international
monetary authorities accepted at the average price.
WS-752
FOR IMMEDIATE RELEASE
March 31, 1976
CUSTOMS-ATF EFFORTS CUTTING CARGO THEFT LOSSES,
ASSISTANT SECRETARY DAVID MACDONALD REPORTS
Inroads against cargo thefts are being made by the
U.S. Customs Service and the Bureau of Alcohol, Tobacco
and Firearms, David Macdonald, Assistant Secretary of
the Treasury for Enforcement, Operations, and Tariffs,
disclosed today.
Both agencies, branches of the Treasury Department,
participate in the National Cargo Security Program to
reduce theft and pilferage from U.S. piers, terminals,
and carriers.
Speaking at the National Cargo Security Conference
in Washington, Macdonald reported progress both in ATF's
Interstate Firearms Theft Project, initiated in 1973,
and Customs1 ongoing Cargo Security Program.
Through the voluntary cooperation of the U.S. trucking industry, ATF has received, to date, 1,794 reports
of thefts or losses of firearms from interstate shipments
involving approximately 12,250 firearms, Macdonald said.
WS-753
-2Criminal action has been brought against 66 defendants/
29 of whom were trucking company employees.
The Customs Program Against Cargo Crime (C-PACC)
made 247 seizures and 66 arrests during calendar year
1975, according to Macdonald.
Macdonald described Imported Merchandise Quality
Control (IMQC), a second facet of Customs' three-part
program, which determines the amount of cargo manifested,
unladen, and delivered, and develops statistics to pinpoint specific piers, terminals or warehouses, and types
of merchandise involved in thefts of cargo being imported
into the country under U.S. Customs control.
The IMQC program accounted for 64 seizures for
manifesting violations between July and November 1975,
he said. These violations led to the assessment of
nearly $3 million in penalties against carriers. Discrepancies detected between invoiced quantities entered
«
and quantities actually landed subjected $14,132,830
worth of merchandise to seizure during calendar 1975.
Customs' program to educate and inform the cargo
industry on crime prevention, Macdonald continued, has
conducted more than 500 cargo security surveys of airport
and marine terminals, warehouses, foreign-trade zones,
and container stations since its inception in 1972.
V
oOo
DepartmentoftheJREMURY
OFFICE OF REVENUE SHARING
TELEPHONE 634-5248
WASHINGTON, D.C. 20226
0
FOR IMMEDIATE RELEASE
FRIDAY, APRIL 2, 1976
CONTACT: PRISCILLA CRANE (202) 634-5248
The U.S. Treasury Departments Office of Revenue Sharing
mailed 37,490 checks for $1.6 billion to units of State and
local government today, in the 15th regular payment of general
revenue sharing funds made since the program was authorized,
in 1972.
Today's payment represents the third quarterly payment
of funds allocated for Federal fiscal year 1976 (entitlement
period six). The fourth and final quarterly checks for the
current period will be issued at the end of the first week of
July.
Including the amount distributed today, the Office of
Revenue Sharing has returned $25.1 billion to nearly 39,000
States, counties, cities, towns, townships, Indian tribes and
Alaskan native villages since the first checks were mailed in
December 1972. A total of $30.2 billion will have been paid
these governments when the currently authorized five-year
program expires at the end of calendar year 1976.
The City of Chicagofs revenue sharing payment was withheld
today by the Office of Revenue Sharing, as required by Court
order, due to ?. finding of discriminatory employment practices
in Chicago's Police Department. Since January 1975, a total of
WS-754
49
-2-
$113.7 million has been withheld from the City of Chicago.
Approximately one million dollars also is being held for
514 local governments which have not reported their planned
and actual uses of revenue sharing funds to the Office of
Revenue Sharing. Use reports are required by section 121 of
Title I of the State and Local Fiscal Assistance Act of 1972
(P.L. 92-512, revenue sharing law). The funds to which these
governments are entitled will be paid when the reports have been
received and accepted by the Office of Revenue Sharing.
The General Revenue Sharing Act will expire December 31, 1976
and final payments under the presently authorized program will
be issued during the first week of January 1977. Legislation
to continue the program is now being considered by the U. S.
Congress.
30 --
^
Contact: Richard B. Self
Extension 8256
March 31, 1976
FOR IMMEDIATE RELEASE
TREASURY ANNOUNCES
PRELIMINARY COUNTERVAILING DUTY
DECISION ON BONELESS BEEF
IMPORTS FROM EC COUNTRIES
Assistant Secretary of the Treasury David R. Macdonald
announced today the initiation of investigation and preliminary determination under the Countervailing Duty Law
(19 U.S.C. 1303) that bounties or grants are being paid or
bestowed on imports of frozen boneless beef from Denmark,
The Netherlands, West Germany, Italy, Belgium, Luxembourg,
France, United Kingdom and Ireland. Notice to this effect
will be published in the Federal Register of April 1, 1976.
Interested parties will be given a period of seven days
to present views regarding this action.
Information before the Treasury indicates that boneless
beef is receiving bounties or grants in the form of export
restitution payments under Common Agricultural Policy of the
European Economic Community.
During 1975 imports of frozen boneless beef from EC
countries were $3,635,000.
*
WS-755
*
*
ft
FOR IMMEDIATE RELEASE
Contact: H. J. Hintgen
Extension 2427
March 31, 1976
FORMATION OF A TREASURY-FEDERAL RESERVE TASK FORCE
ESTABLISHED TO EXPAND THE BOOK-ENTRY PROGRAM
OF ISSUING GOVERNMENT SECURITIES
Secretary of the Treasury William E. Simon today announced the
formation of a Treasury-Federal Reserve Task Force, established to expand
the book-entry program of issuing Government securities. The Secretary
commented that the expansion of the book-entry program over the past
eight years has been most gratifying. At the end of February 1976, the
amount of United States Treasury bills, notes and bonds in book-entry
form reached a level of $299.1 billion or 79% of the total marketable
debt.
Initiated in 1968, the book-entry procedure eliminates the issuance
of engraved Treasury securities in favor of book-entries maintained at
Federal Reserve Banks for the accounts of commercial banks which are
members of the Federal Reserve System. The book-entry procedure is currently available to both individuals and institutions acting through such
member banks. The book-entry procedure offers substantial benefits to
investors, the financial community, and the Treasury. It reduces the
burden of paperwork created by the mounting volume of public debt
transactions; it protects against loss, theft, and counterfeiting; and
it substantially reduces the cost of issuing, storing and delivering
Treasury securities.
The Treasury-Federal Reserve Task Force will design and adopt an
expanded book-entry system with the ultimate objective of completely
eliminating the use of definitive securities in new public debt borrowings.
During the course of this effort, the views and comments of the financial
community and other interested parties will be solicited.
oOo
WS-756
FOR RELEASE ON DELIVERY
Statement of the Honorable William E. Simon
Secretary of the Treasury
Before The Senate Committee On
Banking, Housing and Urban Affairs
Thursday, April 1, 1976 at 10:00 AM
NEW YORK CITY'S FINANCIAL SITUATION AND OUTLOOK
Mr. Chairman and Members of this distinguished Committee,
I am pleased to provide you with the first formal report to
Congress on the administration of the New York City Seasonal
Financing Act of 1975. Much has occurred since the New York
City financial situation was last before this Committee and
later in my remarks today I shall summarize the key events.
But at the outset, let me provide you with an overview of
the situation as we see it today.
We presently have $1.26 billion of loans outstanding,
and we expect repayment of the first $270 million on April 20.
Repayment is in part dependent upon successful completion
of the New York State financing in April and I am pleased to
report that it now appears that the financing will be
completed. Accordingly, I am satisfied that there exists a
reasonable prospect that the entire $1.26 billion will be
repaid by June 30.
Looking at the balance of the three year period, there
is now basis for a degree of cautious optimism. Last week,
Mayor Beame responded forcefully to increased estimates of
the budget deficit by announcing a comprehensive and detailed
program of expenditure cuts designed to achieve a budget
surplus by fiscal 1978.
Carrying out this plan will not be easy for New York
City. Undoubtedly there will be those who will urge that it
is impossible, those who will claim that it can only be
accomplished over a longer period of time and those who will
urge that the price of achievement is severe human hardship.
In my experience in government, too often have I
witnessed an unfortunate tendency to allow the naysayers,
the purveyors of gloom and doom, to stifle sound and meaningful
WS-757
- 2 reform. Clearly it would be wrong to adopt a pollyanna
attitude and blithely assume that all the problems are
solved. But it would be even more wrong to deny New York
City, by our words and by our actions, the chance it so
clearly has earned by its progress in the past few months.
I believe the job can be done and done within the
allotted time frame. I believe the job can be done without
disrupting essential services. And most importantly, I
believe the rewards of doing the job well and properly are
potentially enormous.
Throughout this entire period, there has been much talk
about the question whether New York City will be in a position
to reenter the capital markets in 1978. I think itfs fair
to say that it has become fashionable in some circles to
assume that there exists no chance of reentry for many
years. But I would submit that such predictions are based
upon an incorrect factual perspective: an assumption that
New York City will not achieve the reforms it is on its way
to achieving.
I look at the situation quite differently. I ask
myself whether I, as a private lender, would be willing to
lend money to an entity which has
-- successfully weathered a severe financial crisis;
-- taken, within a 30 month period, firm actions to
correct more than a decade's worth of extreme fiscal and
financial neglect, including the permanent elimination of an
operating budget deficit of $1 billion;
-- established a sound and credible accounting and
financial reporting mechanism; and
-- developed a first rate financially oriented management
team.
Today these are still objectives. But if they become
reality, I believe New York City will be perceived entirely
differently by the credit markets in 1978. This is our
goal, and it now appears to be the City's goal as well. As
I said a moment ago, let's give them the chance to achieve
it.
I. Background
Before outlining New York City's current progress
toward fiscal reform, let me take a few moments recalling
- 3-
&?
certain key events that brought us to this point.
At the time I first testified before Congress on New
York City's financial situation in June 1975, it was on a
hopeful note, immediately following the creation by New York
State of the Municipal Assistance Corporation. MAC was
authorized to borrow $3 billion on New York City's behalf,
intercepting City sales and stock transfer tax revenues to
fund what it borrowed. Passage of the MAC legislation
prevented default in June, and provided, we then believed,
ample time through the summer to make the necessary corrections.
Our optimism was unwarranted. As June turned into July
without meaningful action on the fiscal front, the market
began to close to MAC as well. Its July issue sold sluggishly,
despite an "A" rating and a 9%% interest rate. Exploratory
efforts regarding an August sale indicated that investors
would not purchase MAC securities without solid evidence
that the City was making meaningful progress toward fiscal
and financial reform. On July 17, underwriters informed MAC
that its planned August issue could not be marketed unless
the City announced meaningful fiscal reform and spending
cuts.
In late July, the City and MAC announced plans to
reduce spending. Wage freezes, pay cuts for higher salaried
employees and layoffs were openly discussed. The announcements
were accompanied, however, by a public dispute about MAC's
authority to intervene in the City's financial affairs. In
addition, the City's labor unions denounced all talk of wage
freezes and layoffs of municipal employees.
It soon became clear that MAC could not raise the
$840 million needed to cover New York City's August cash
needs by public sales of its securities. Less than $300 million
was raised from the public despite a tax-exempt interest
rate of 11 percent. The remainder was sold to banks and
state employee pension funds. Perhaps more importantly, the
August sale marked, as a practical matter, the end of MAC's
utility as a viable and independent financing vehicle.
In September, New York State took the major step of
committing its own credit and resources to the problem.
This action was accompanied by a substantial restructuring
of the governmental relationship between City and State:
The Emergency Financial Control Board was established and
given virtually unlimited powers over the fiscal and financial
- 4 affairs of New York City. Moreover, the law mandated achievement
of a balanced budget in the fiscal year ending June 30, 1978,
and a showing of substantial progress toward a balanced
budget in fiscal years 1976 and 1977.
Under the legislation, New York City was required to
submit for Control Board approval a financial plan designed
to eliminate the budget deficit by fiscal 1978. The plan as
submitted on October 15 predicted a budget deficit of approximately
$700 million in fiscal 1978 and proposed to eliminate it in
three stages: $200 million in annual expenditure reductions
in fiscal 1976 and $262 million per year in both fiscal 1977
and fiscal 1978, thus achieving a small surplus in 1978. As I
shall discuss later in my testimony, this deficit estimate
proved too low. Much more in the way of expenditure cuts
was required.
As required by law, the plan also addressed the capital
budget. Total capital spending was cut from the approximately
$2 billion originally proposed for fiscal 1976 to $1.6 billion
in that year, $1.1 billion in fiscal 1977, and $900 million
in fiscal 1978. Operating items in the capital budget -nearly $700 million in fiscal 1976 -- were to be reduced at
a rate of $50 million per year. As I shall discuss later,
according to current projections, this target has already
been exceeded.
Two issues remained open. First, there was the question
of financing the deficits accumulated over the previous
decade that resulted in a multibillion dollar overhang of
short term debt. And second, in view of the fact that the
public credit markets were closed, New York City needed a
source of funds to finance operations and the capital
program during the 1976-1978 period.
In numerous appearances before this Committee and elsewhere, New York City and New York State officials insisted
that they had done all they could and demanded that Federal
taxpayers provide the funds to eliminate the overhang of
short term debt and meet all of the City's financial needs
during the 1976-1978 period. But these demands were seriously
questioned in Congress and flatly rejected by the Administration.
We believed that such deficit financing had to be provided
at the State and local level.
Finally, in late November, we were presented with a
financing plan that met the City's requirements. The package
consisted of the following elements:
5^
-- New and increased taxes designed to yield $500
million during the period December 1, 1975 through June 30,
1978. Included were higher taxes on personal income, increased
bank, estate and cigarette taxes, an increase in the minimum
corporate income tax and extension of the sales tax to cover
personal services.
-- Increased real estate taxes designed to yield $400
million.
-- Investment of $2.5 billion by the City's pension and
sinking funds.
-- Refunding of $1 billion of maturing City notes into
6 percent City bonds by the City's sinking funds, pension
funds and major banks.
-- Legislation imposing a moratorium on retirement of
the $1.6 billion of New York City notes which were held
privately and reducing the interest rate on such notes
to 6 percent. In lieu of the moratorium, holders of these
notes were given the option of exchanging the notes at
face value for ten year MAC bonds, bearing an 8 percent
interest rate. Despite the favorable exchange terms,' only
$500 million of the notes -- less than a third -- were so
exchanged.
-- A commitment by New York State to continue to advance
$800 million in welfare and education aid in the spring
quarter.
These steps were designed to result in a balanced cash flow
over the course of each fiscal year, eliminating the need
for deficit financing. However, because revenue collections
are not uniform throughout the year, seasonal loans remained
necessary to assure that payrolls Were met, vendors paid and
essential services performed in the months in which the
City's revenues fell short of its regular monthly expenditures.
Accordingly, to assure the continuity of essential services,
we asked the Congress for authority to make short-term
seasonal cash-flow loans. In early December, Congress
passed the New York City Seasonal Financing Act of 1975,
providing for up to $2.3 billion in seasonal loans.
II. The Seasonal Loan Program
The Federal Seasonal Loan Program began almost immediately
after passage and approval of PL 94-143. On December 18, 1975,
f7
the Federal Government loaned New York City $130 million
at an interest rate of 6.92%. As required by the statute,
the rate reflected the average rate on Treasury debt of
comparable maturity, plus a one percent premium. The loan
was secured by a pledge of $180 million in State aid to
education, and is scheduled to be repaid on April 20.
Credit Agreement
On December 30, 1975, after two weeks of extensive
negotiations, we entered into a Credit Agreement with New
York City, New York State, the Municipal Assistance Corporation
and the Emergency Financial Control Board. The Agreement, a
copy of which I shall submit for the record, provides a
number of specific protections to the Federal Government.
The principal requirements are as follows:
-- Certification by the Emergency Financial Control
Board that loans requested are consistent with the City
Financial Plan.
-- Agreement by the Mayor, City Comptroller, and Control
Board to take all actions necessary to insure that revenues
securing repayments are paid into a special repayment account,
controlled by the Secretary of the Treasury.
-- Power to require the Governor and State Comptroller
to prevent disbursement of State-funded repayment revenues,
except to the Secretary of the Treasury.
-- Submission of detailed analyses on a regular basis
to provide the flow of information needed to track and
monitor the City's performance and adherence to the Financial
Plan and Credit Agreement.
-- Right to audit and inspect the books and records of
New York City and New York State.
Subsequent to the signing of the Credit Agreement, we
loaned New York City $240 million on December 31, 1975, $140
million in January, $430 million in February, $250 million
on March 1, and $70 million on March 15. All loans are
scheduled to be repaid in full during the spring quarter.
Two hundred and seventy million dollars mature on April 20
$240 million on May 20, $250 million on June 20, and $500
million on June 30.
Let me focus on the security. As I have indicated,
each loan is directly secured by a specific revenue due New
- 7York City on or before the maturity date of the loan. These
encumbrances total $1,944 million and consist of $50 million
in City tax levy funds, $382 million in State revenue sharing
funds, $602 million in State aid to education and higher
education, $110 million in State welfare payments and $800
million of advances of fiscal year 1977 State welfare and
education aid. The Agreement provides that these funds cannot
be used for any other purposes until our loans are repaid.
Arthur Andersen Report
Prior to signing the Credit Agreement, I retained Arthur^
Andersen and Company to report to me on the Three-Year Financial
Plan and to evaluate New York City's financial reporting and
accounting systems. In addition, we asked them to help in the
preparation of a financial reporting package.
The Report provoked numerous concerns. I wrote to
Mayor Beame on January 20 and asked for his comments on six
specific questions raised by the Andersen Report. Chairman
Proxmire and Senator Stevenson wrote to me on January 23, asking,
in light of the Report, to be "apprised of the factors which
led (me) to conclude that there is nevertheless a reasonable
prospect of repayment by June 30, 1976," and, in addition,
for my answers to eight related questions. I am submitting
this correspondence for the record.
While we must be aware of the warnings in the Andersen
Report, it is equally important to understand its limits.
It did not comment specifically on the Federal loan program
or address the question of whether there was "a reasonable
prospect" of timely repayment by New York City of the Federal
loans which have been made to date.
It is not inconsistent to regard as tenuous the assumptions
and forecasts of the City's Three-Year Financial Plan, while
at the same time concluding that the City will repay the Federal
loans on time. The critical issue involves the aid and advances
that New York State is committed to provide New York City in
the spring quarter. If it receives the State aid and advances
that it is scheduled to receive, New York City's cash flow
will be sufficient to repay the Federal loans maturing
between now and June 30.
As suggested in the Andersen Report, some of the original
assumptions and forecasts in the Plan have already been
discarded. As predicted by the Andersen report, the estimated
deficit today is substantially higher than the October
- 8forecast. But, as Mayor Beame's recent proposal makes
clear, this does not mean the plan cannot work. If revenues
fall short of projected levels, or if expenditures are
higher, other revenues will have to be found, or expenditures
cut further. In the final analysis, targeted budget balances
can be hit and debts repaid on schedule, if there is a will
to cut spending.
In this regard, it is important to note that New York
City has little in the way of alternatives. Congress did
not contemplate and PL 94-143 does not allow the seasonal
loan program to become a vehicle for financing New York
City's deficits. And New York City can no longer finance^
elsewhere the level and diversity of programs and activities
they would like to provide but cannot afford. Accordingly,
without the prospect of either more Federal loans or funds
from other sources, revenues and expenditures must balance
by fiscal year 1978. As Mayor Beame recognized last week,
quoting Governor Carey's State of the State message,
"the days of wine and roses are over."
The Mayor's budget reduction proposal is clearly
the most significant indication that this important message
appears to be getting through. City officials now recognize
that major changes in the way the City conducts its affairs
have to be made. But before turning to the specifics of
Mayor Beame's new budget proposal, let me first outline the
progress in other areas.
Management
There is a new top financial management team on the
job. Mayor Beame has two new Deputy Mayors: Kenneth Axelson,
on leave from his positions as Senior Vice President of
Finance and Administration and Director of the J.C. Penney
Company; and John Zuccotti, formerly Chairman of the City
Planning Commission. The Mayor also has appointed Donald
Kummerfeld, formerly Vice President for Public Finance of
the First Boston Corporation, to be the City's Budget Director.
Comptroller Goldin has hired Martin Ives, formerly Deputy
State Comptroller, to be his Deputy. These are firstrate people.
Reporting and Record-Keeping
As I observed earlier, the Andersen Report concluded
that the City's present financial reporting, record-keeping
and controls systems are inadequate. We have been advised
- 9-
C&
by Mayor Beame that "a major effort is underway to correct
deficiencies in these systems." In that connection, ToucheRoss and Company and American Management Systems are designing
a new accounting and controls system to be in place by
July 1, 1977. By July 1 of this year, an interim obligation
encumbrance reporting system for all agencies will be in^
operation. This step will help tremendously in controlling
unbudgeted spending, which until now has been a serious
concern.
Monthly Reports
The Credit Agreement requires detailed monthly financial
reports to allow us to oversee the City's progress toward
budgetary balance. These reports also will enable City and
Control Board officials and staff to monitor progress, and
to spot any variances from the forecasts before they get out
of hand. The reporting package will be refined and improved
as time passes and we gain experience. Andersen personnel
are assisting us in this area, and we also are working
closely with City, Control Board and GAO staff to perfect
the monitoring formats.
Expenses
Expenditures are very close to target for fiscal
year 1976. Expenses through January were $12 million
higher than planned. Spending for social services and
education was $28 and $21 million above targeted levels.
Debt service, including MAC, was $34 million above forecast.
On the other hand, spending on health and hospitals was
$38 million below forecast and spending on police protection
and higher education was $9 and $10 million below targeted
levels.
Employment
Significant progress has been made in reducing
New York City's large payroll. In the first seven months
of fiscal year 1976 --'July 1, 1975 to January 31, 1976 -the payroll was reduced by the equivalent of nearly
35,000 full time employees. And when these gains are
added to progress made earlier in calendar 1975, the
total payroll reduction exceeds 40,000. In my view,
trimming a massive public payroll by 15 percent in one
year is a truly laudable accomplishment.
Capital Budget
New York City's most recent monthly forecast shows
total capital budget expenditures for fiscal 1976 at
- 10 -
6/
$1,597 billion, $3 million below the financial plan.
More importantly, the forecast shows a significant acceleration
of the removal of operating expenses from the capital
budget.
The original October plan included $697 million of
operating items in the fiscal 1976 capital budget and
forecast a $50 million annual reduction in both fiscal
1977 and 1978, reducing the total amount included in the
capital budget to $597 million in 1978.
The current forecast shows a further reduction of
$22 million to $675 million for this fiscal year. For
fiscal 1977, the amount eliminated will be almost double that
originally planned: a $95 million cut reducing the balance
to $580 million. Another $60 million will be cut in 1978,
leaving a balance of $520 million, $77 million better than
the original projection.
The Budget, the Financial Plan and Mayor Beame's New Proposals
Let me turn now to the highly complex, but critically
important, subject of New York City's budget deficit and how
it will be eliminated. In evaluating the current status,
let's begin with the forecasts of the October financial
plan.
The October plan forecast operating deficits of $1.19 billion
in fiscal year 1976, $932 million in fiscal year 1977 and
$693 million in fiscal 1978, before taking into account the
effect of the expenditure reduction program. In other
words, New York City predicted that its annual operating
deficit would decrease by some $500 million in the normal
course of events and thus premised its expenditure reduction
plan on the projected 1978 deficit of $693 million. According
to the plan, this amount was to be cut from the budget in
three steps: $200 million in fiscal 1976, $262 million in
fiscal 1977 and $262 million in fiscal 1978. Since the
program reductions imposed in 1976 and 1977 would of course
also result in savings in 1978, the gross savings in 1978
would be $724 million, generating a $31 million operating
surplus.
The $500 million "natural" decrease in the deficit was
suspect from the start, and data released by New York City
in February confirmed the error. The February forecast showed
that the deficit to be eliminated in fiscal 1978 -- again
5?oS r e M?? e f f e C t °t a n y s P e n d i n S cu ts -- is $986 million,
$293 million more than had been projected in October.
- 11 -
62,
For clarity, let me emphasize one point. Program
cuts imposed in 1976 and 1977 obviously have the effect of
reducing the operating deficits in those years. But in
evaluating the financial plan, we must keep in mind that
the target is a balanced budget in fiscal 1978. Accordingly,
all cuts -- irrespective of the year in which they are^
implemented -- should be viewed as reducing the $986 million
1978 deficit.
Until Mayor Beame's recent announcement, New York
City had not announced the details of any expenditure
reductions other than the $200 million announced and imposed
in the current fiscal year. Accordingly, the Beame Plan
must and does address the remaining 1978 deficit of
$786 million.
The Beame plan calls for deficit reductions of $379 million
in fiscal 1977 and $483 million in fiscal 1978. When added
to the $200 million savings anticipated this year, the total
savings are $1,062 billion, eliminating the projected fiscal
1978 deficit of $986 million and generating a $76 million
surplus.
The Beame proposals are incorporated in a detailed
document that was submitted to the Control Board on March 26.
I am submitting a copy for the Record.
FISCAL YEAR 1977
The Beame plan proposes reducing expenditures
by $379 million during the fiscal year ending
June 30, 1977. Fifty-four million dollars of this
reduction would result from proposed increases in Federal
and State funding. The remainder would be achieved through
the City's own efforts -- nearly all through reduction
in the scope and cost of services and programs currently
provided.
The City would cut $250 million by reducing existing
programs. Cuts in current programs and residual savings would
reduce the City's expenditures for education and higher
education by $84 million. Police expenditures would be cut
by $40 million, primarily through personnel reductions and
management improvements. Previously identified proposals
would reduce payments to the Health and Hospital Corporation
by $27 million. These proposals, and other means for reducing
the City program expenditures by nearly $250 million, are
spelled out in the Mayor's Plan.
- 12 The Plan provides considerable detail about how the
City plans to save an additional $75 million: reducing nonmandated welfare costs ($30 million), reducing fringe#
benefits ($24 million), and an anticipated reduction in
power costs ($16 million) are the key measures.
Finally, the City plans to receive approximately an^
additional $54 million in Federal and State revenues during
FY 1977. State assumption of court and probation costs on
April 1, 1977 would save the City $24 million. Increased
Federal subsidies for public housing and senior citizens ^
under existing programs is estimated to provide the remaining
$30 million.
FISCAL YEAR 1978
The largest saving in 1978 ($113 million) would result
from phasing out City support for the City University. In
addition, the City would expect to achieve $100 million in
savings through further program reductions, increased
productivity, greater management efficiency, and other
measures.
The remaining savings would be achieved through several^
measures: withdrawal from the Social Security system ($43 million
increased use of community development funds for tax levy
purposes ($50 million); and further reductions in nonmandated welfare costs ($30 million). Additional savings
would result from further reductions in power costs, and
other measures.
Finally, the Plan calls for an additional $128 million
in deficit reductions during fiscal year 1978 through increased
State and Federal funding. Most of this is attributable to
proposed assumptions by the State of additional court and
correction costs ($103 million). The remaining $25 million
would arise through proposed Federal assumptions of certain
costs for public housing and senior citizen rent increase
exemptions. It should be noted, however, that the plan
also includes contingency reductions in City programs
to be used in the event the State does not agree to
participate.
The Mayor submitted his Plan to the Control Board on
March 26 with a letter stressing the need for immediate
action. The proposal was generally well received and is
being intensively reviewed. A full Control Board appraisal
is expected by May 1.
- 13 Mayor Beame's plan plainly dispels two myths which have
permeated the year-long debate on New York City. How often
have we heard it said in some quarters that it was simply
impossible for New York City to balance its budget within
three years? And how often have we heard from others that
New York City officials simply were incapable of facing up to
the hard decisions and developing sound and credible
solutions?
Mayor Beame's plan shows that New York City's budget
can be balanced -- soundly and credibly -- within the alioted
time frame. And in so doing, it reflects a recognition
that hard measures must be taken and that detail
is required now. It does not attempt to avoid cuts in 1977
by unduly backloading them into 1978. It recognizes that some
assumptions are questionable and identifies contingency
measures in the event they prove too optimistic. All in
all, it reflects an unambiguous desire to deal with, not
evade, the problems New York City faces.
New York State's Prospects
To conclude my status report, let me briefly review the
financial situation in New York State. Our analysis indicates
that the state's financial condition is fundamentally sound,
and that its cash flow later this year will be adequate to
repay its borrowings this spring. These factors should
enable the State to raise the funds it needs. If it does,
New York City will receive the State aid and advances required
to repay the Federal loans.
In recent months, the State's leaders have directed
their efforts toward financing the state agencies, producing
a credibly balanced budget and obtaining financing for
seasonal needs. The first two jobs now have been done.
Substantial progress has been made toward completing the
third.
With the help of the State's retirement systems, a
$2.5 billion financing package was put together, allowing
the state agencies to refund short-term notes into bonds and
to finance completion of projects now in progress. No
further projects will be undertaken. And, most significantly,
moral obligation bonds are now prohibited by law.
Second, the State legislature adopted what appears to
be a credibly balanced budget. Significantly, expenditures
in the new budget are only $123 million higher than in the
- 14 fiscal year that ended yesterday. Investors are certain to
be reassured by this move to hold down spending.
As a result, the State now should be able to place the
$4 billion of securities it must sell before mid-June. As
of now, all but $1.7 billion has been tentatively placed
with various State funds and New York City's commercial
banks.
III. Long-Term Prospects
While the recent actions by New York City are clearly a
major step toward a solution to New York City's immediate
financial crisis, prior to June 1978 unforeseen events will
undoubtedly require more in the way of actions and responses.
However, while we should not be complacent in dealing with
the immediate situation, I believe the time has come to
address the longer term outlook as well. Accordingly, I would
like to devote the remainder of my time this morning to setting
the framework for what I hope will be a comprehensive review
of New York City's economic condition and outlook.
Let's begin by identifying the objectives. First,
and foremost, New York City must recreate an environment
in which economic activity can flourish. That in turn
requires a rational approach to business taxation and a
stable and satisfied labor force. As Mayor Beame and
Governor Carey have squarely recognized in recent weeks,
New York City's economic future depends upon its ability
to attract and retain business investment.
My remarks today are only a beginning. In the months
and years ahead New York City's leadership must mobilize
all elements of society -- the business and financial
community, organized labor and the citizenry at large -toward achieving this common goal. Without it, the
herculean efforts of the past months will be viewed by
future generations as an empty gesture.
To put this portion of the discussion into context,
let's first explore on a fundamental plane the problems
which led New York City into a unique dependency relationship
with the Federal Government.
New York City is bound by local and State Laws to
balance its operating expenses and revenues. Accordingly,
the first response to spending pressures was more and
higher taxes. Ultimately, the tax base was pushed beyond
u
- 15 its ability to generate more in the way of revenues and
deficit spending, hidden by accounting gimmicks, was the
inevitable option. As a consequence, New York City has run
operating deficits each year since fiscal year 1961. By
fiscal year 1975, these deficits totalled over $4 billion.
In addition, more in the way of past deficit spending is
forever buried in the capital program.
As a first step in a program of long-term economic
reform, the spending pressures which precipitated the problem
in the first place must be evaluated. If these pressures can
be moderated, then we will have made major progress in
creating an environment where business can invest and citizens
can settle.
I. Spending Pressures
Unique Services
New York City simply provides services that other
cities do not provide. The 1975-1976 fiscal year budget, as
originally submitted, provides, apart from pension costs,
$477 million for higher education, $890 million for City
hospitals, $586 for charitable institutions, most of which
consist of payments to private hospitals, $90 million for
activities of the Health Department, including mobile health
units and labs, $71 million for addiction services, $5 million
to administer mental health programs, $137 million for
various housing activities and $180 million in subsidies for
the transit system. State and Federal matching programs
account for a major share, but the City's taxpayers must
provide $1 billion to fund these activities.
Health and Hospitals
It must be determined whether New York City residents
could receive a satisfactory level of health care if public
outlays for this purpose were reduced. The operating
expense budget for New York City's Health and Hospitals
Corporation in fiscal year 1975-1976 called for total
expenditures of $1 billion, including pension costs; $390 milli
of this amount comes from city taxes. Of the City tax
funds, approximately $165 million is spent for medicaid and
other necessary programs. The remaining $225 million reflects
administrative costs and delivery of health care services
over and above those paid for by third party programs such
as medicaid, medicare, workmen's compensation, and private
- 16 insurance. Such extra services may be desirable, but it
must be asked whether they are affordable under present
conditions.
Progress clearly has been made in the health area. The
Beame plan provides for large cuts by the Health and Hospitals
Corporation. However, the possibility of similar cuts by the
Health Department and Addiction Services Agency, in the
budget for Charitable Institutions, and in mental health
programs must also be studied. Particular attention ought
to be paid to the possibility of eliminating unnecessary
administrative expenses.
Transit
Re-evaluation of the system of financing mass transit
is needed. Transit subsidies now cost New York City's
taxpayers $183 million per year. As we look into the future,
alternative approaches must be evaluated. An across the
board fare increase might hurt the poor; but if that is the
concern, why not explore the feasibility of a direct method
of helping the poor, while more affluent riders pay their
fair share.
Another area to explore is the fare structure. Many
cities have sucessfully experimented with a fare based on
distance travelled, and with off-peak discounts and rushhour premiums. The possibility of these innovations should
not be ruled out in advance.
Fringe Benefits
Everyone would agree that no long range study of New
York City's economy can ignore the question of public employee
fringe and retirement benefits. In the current fiscal year,
employee fringe benefits -- pensions, health insurance,
vacations and the like -- will cost New York City's taxpayers
more than $2 billion. Based on the 232,000 person full time
equivalent payroll at the end of January, this cost averages
more ^ than $8,600 per employee. In other words, New York
City's taxpayers spend more per employee on fringe benefits
than the annual income of the average American •
Clearly, ample fringe benefits are essential to an
efficient, productive and contented labor force. But given
the large costs, and the significant disparity between New
York City and other employers, a careful study is certainly
J
warranted.
Before turning to particular benefits, let's review the
overall level of benefits for certain key employee groups.
The cost of vacations and sick leave are excluded from these
L7
- 17 examples because of the difficulties in making precise
calculations. But these costs are well above average and
would add considerably to the level of disparity.
The base pay of a New York City patrolman first grade,
including the latest cost-of-living adjustment, now is
$16,800. Fringe and retirement benefits, excluding vacations,
equal $8,500 or 51% of the base. For a sanitationman,
benefits are 39% of the base. For a fireman first grade
they are 49%. For a teacher with a masters degree and eight
years of service they are 37%. For senior clerks, using
their median salary, benefits equal 34% of the base. All of
these percentages dwarf the national average of less than
20 percent.
Specific Benefits
The current costs of certain key fringe benefits are:
- Pensions $1,165 million
- Social Security 214 million
- Health and Hospitalization Insurance 170 million
- Union Welfare Funds 107 million
- Union Annuity Funds 36 million
- Uniform Allowances 19 million
- Training Funds 1 million
$1,712 billion
Social Security
New York City has announced that it is withdrawing from
the Social Security System as of March 1978. Given my
concern for the financial condition of the Social Security
System, I cannot be entirely sanguine about this development.
However, it may have been inevitable under the circumstances.
Ideally, Social Security benefits should be integrated
with pension benefits to provide a reasonable level of
retirement income. However, accomplishing such integration
in New York City is complicated by two factors. First, the
New York State Constitution has been interpreted to prohibit
reduction in levels of pension benefits already vested.
Second, a New York State law enacted at the time state and
- 18 local governments were made eligible for Social Security,
prohibits taking Social Security benefits into account in
collective bargaining regarding pensions. In light of these
factors, and given the anticipated savings of nearly $200 million
a year, New York City may have had little choice but to
withdraw.
Annuity Funds
New York City now pays $36 million per year into Union
Annuity Funds. These funds involve per diem contributions
toward the provisions of still more retirement benefits in
the form of annuities for certain employee groups.^ The
continuation of these payments should be assessed in light
of the overall level of retirement benefits employees now
receive.
Union Welfare Funds
The 1976 fiscal year budget provides for direct payments
of $107 million to municipal unions. These funds enable the
unions to provide both active and retired workers with still
more in the way of fringe benefits: free dental care,
eyeglasses, counseling and legal services. Certainly these
benefits are desirable for the employees. But their value
must be weighed against the burden imposed on New York
City's taxpayers.
Uniforms
Uniform allowances and training funds now are budgeted
at $19 million per year. Uniform subsidies can, of course,
be justified in the cases of policemen and firemen. But the
allowances also are given to marine engineers, aqueduct
captains, speech and hearing therapists, public health
nurses, nurses aides, ambulance technicians, food service
supervisors, bridge operators, deckhands, water plant operators,
and swimming pool operators. Uniform allowances should be
carefully studied to determine whether certain allowances
could be eliminated and whether cost savings could be
achieved by direct City purchases of essential uniforms.
Health Insurance
Like many private employers, and certain other cities,
New York City pays 100% of the cost of employee health
insurance programs. But most cities, and the Federal Government as well, require the employee to pay a fair share of
7o
- 19 the cost of providing health care protection for the employee
and his family. In light of the current fiscal and financial
realities, division of this expense between the City and its
employees warrants study.
Working Time
Additional areas of study include night shift pay
provisions, vacation benefits and working hours'. The night
shift pay differential is normal -- 10%. But night is
defined to cover 16 of every 24 hours. Cutting it down to
8 hours, or even 12 hours, would produce annual savings of
approximately $10 and $20 million.
Vacation and sick leave costs are quite high. For
example, such costs are estimated to exceed $4,000 per year
for patrolmen and $3,000 for sanitationmen. These high
costs are attributable to the fact that every employee is
entitled to 20 vacation days in the first year on the job^
and most have unlimited sick leave privileges. By comparison,
new Federal employees receive only 13 days vacation and do
not reach 20 days until their fourth year of service.
In the case of patrolmen, consideration should be given
to reducing the current work day from 8 and 1/2 hours to 8,
while increasing the work year by the equivalent number of
days -- 18, from 243 to 261. Little is gained by the 8 and
1/2 hour day, while the cost of the 243 day year (versus
261) is nearly 7 and 1/2% of total compensation, or $57 million
per year under the current contract.
Many other New York City employees now work only
35 hours per week. Others work 37%. In addition, under the
"summer hours" program, an even shorter work week-is the
norm in some cases. The possibility of moving to a 40 hour
week -- thus achieving substantial reductions in costs
without a loss in services -- should be examined.
Pensions
Quite appropriately, many aspects of the pension
situation are under careful review at present. I have
already noted one step New York City has taken: its planned
withdrawal from Social Security. In view of the substantial
disparity in net pension benefits between New York City and
other large cities, further actions might be considered.
- 20 For example, a married New York City employee who
retires at age 65, with 25 years of service, receives m net
after tax retirement income an amount equal to 125 percent
of his disposable income in his last year on the job. In
Atlanta the same worker receives 43 percent, Chicago 47 percent,
Dallas 52 percent, Los Angeles and Memphis 54 percent. Only
Denver and Detroit -- at 91 and 104 percent -- £re even
close.
* * *
Let me reiterate the spirit in which these areas for
discussion have been identified. I mean absolutely no
criticism of the creative plan Mayor Beame announced last
week. I do not mean to suggest that the plan as currently
proposed will not accomplish its intended objective. I
simply want to make clear that if New York City is to recapture
its proper leadership role the plan can not be viewed as
defining the outer limits of possible fiscal and financial
reform.
The Real Estate Tax Base
The heart of any great city is its real estate. Not
only does it provide the physical facilities for housing and
economic activity, but it is also an important financial
asset, since real estate taxation is the core of any city's
revenue stream. Accordingly, in providing for New York
City's future, we cannot avoid a careful look at the impact
on the tax base of the long and costly experiment with rent
controls and stabilization.
Like many of the programs we have discussed today, rent
control is a subsidy program and must be evaluated as such.
Simply stated, rent control provides a subsidy to a small,
largely middle class group, the members of which have occupied
apartments for a substantial period of time and are paying
rentals which bear no resemblance to current costs. Few
poor people benefit: typically, they have arrived too
recently or moved too frequently to qualify under the program.
But all poor people, indeed all citizens, pay for the subsidy
in the form of higher taxes, deterioration of the housing
stock and a general decline in the economic well-being of
the city.
Let's look at some specific costs. Since 1960, 300,000
rental units have been abandoned, and abandonments are now
running at an annual rate of 30,000 per year
- 21 From 1965 to 1975, New York Cityfs housing stock
increased only 2%, and the number of rental units declined
3.8%. The City's supply of rental units is old. Nearly
half were built before 1929. More than half are "walk-ups."
The aging, decay and decline of New York's housing
stock should come as no surprise. Rents have not been
allowed to increase as fast as operating costs. Landlords
have been compelled to absorb the larger part of the sharp
increases in fuel costs. Small wonder that maintenance has
been postponed and tax delinquencies and abandonments have
increased. Landlords cannot suffer losses endlessly.
But landlords are not the only ones to suffer. All New
Yorkers suffer in their capacities as taxpayers and users of
City services. Everyone suffers because property values
and, as a corollary, property taxes, decline. In this
regard, total arrears of real estate taxes are estimated to
be over $700 million, not including arrears in water rents
and sewer rents.
Because of the erosion of its real estate tax base, New
York City has had to resort to more taxation of business and
personal incomes. Such taxes tend to drive employers and
higher income workers out of town.
The ability to own one's own home -- one of the fundamental
goals of our society --is another frequent victim of the
rent control system. Applications to restore subdivided
brownstones to the original one or two family status can
take over a year to process through the rent control bureaucracy
and often are turned down, despite the neighborhood improvement
which would result. Clearly, the administrators of the
complex rent control laws do not recognize the direct relationship between the spread of urban blight and the flight of
middle-class families from New York City.
In short, rent control is inequitable as well as
uneconomic. If it were phased out, the following benefits
would accrue:
-- the existing housing stock would be better utilized,
reducing both over-crowding and under-occupancy;
-- new construction starts and rehabilitation work
would create thousands of jobs and provide New York City's
underemployed youth with a chance to learn a skill;
- 22 -- the real estate tax base would stop eroding and
start growing;
-- the need for public housing projects, which have
been a tremendous drain on the City's financial resources,
would decline;
-- business and personal taxes could be reduced and, as
a result, investment, jobs and income earners would return
to New York.
Welfare and Federal Aid
Before concluding, let me turn briefly to the role of
the Federal Government, particularly in the welfare area.
Mayor Beame's statement of last week reiterated a commonly
heard contention: New York City would not have a financial
problem if the Federal Government took over welfare. In
light of such contentions, it may be useful to outline the
large and growing Federal role in financing state and local
governments generally. But before I do, let me address
specifically the welfare question.
First, let me reiterate my conviction that we need a
comprehensive re-examination of Federal, State and local
relationships in the area of assistance to the disadvantaged.
I personally favor the simple, non-bureaucratic approach of
income maintenance. But whatever the outcome, we plainly
must assure ourselves that current policies are consistent
with the needs of the last quarter of the twentieth century.
As is clear from my remarks to this point, however, I
do not believe a change in welfare policy is itself a solution
to New York City's financial problems. To be sure, it is
factually correct to say that if the Federal Government
assumed all of New York City's welfare obligations, the
budget deficit would be substantially reduced since City
expenditures would fall by approximately $800 million. But
it is equally correct to say that the same effect would be
realized if the Federal Government took over responsibilty
for schools, for operating the police and fire departments,
or by paying for any of the other services which New York
City now provides. Accordingly, if the arguments regarding
welfare have any validity, they must be accompanied by a
credible showing that New York City's welfare problem is
somehow unique. And the facts simply don't bear that out.
- 23 The percentage of New York City's population which is
on welfare is 10-97o, a lower percentage than in Philadelphia,
Washington, D.C., St. Louis, Newark, or Baltimore. Median
minority family income is $8,108, almost $2000 more than the
national average. The proportion of families below the
poverty level fell by more than a third in the 1960's and is
well below the national average. These facts plainly belie
the allegation that New York City is a haven for the poor
and, as such, performs a service which Federal'taxpayers
must pay for.
The real financial problem presented by welfare in New
York City is a problem which has its roots at the State
level: specifically the division of responsibility between
the State Government and local governments for the nonFederal portion of the welfare payment. This Committee is
well aware of the burden New York State has traditionally
imposed on its local governments: 25 percent of total
welfare costs, as opposed to 1 percent in Illinois and 12
percent in California. But this Committee is also aware of
the fact that New York State is hardly in a financial position
to change this formula now.
Let me turn now more generally to the subject of Federal
aid. Federal aid to State and local governments has risen
steadily during the post-war period, and very rapidly since
the late 1960's.
In 1950, direct Federal aid to. state and local government
was $2.3 billion. Two decades later, in 1970, aid had
increased tenfold, reaching $24.4 billion. And this fiscal
year the figure will more than double again to $60 billion.
These are only direct grants. If other Federal expenditures -in the form of housing subsidies, transfer payments, Federal
employment and the like -- are included, the total benefit is
more than $100 billion higher.
Moreover, the growth in Federal aid to New York City
has outpaced even these rapid increases. In fiscal year 1965,
direct Federal aid to New York City was $228 million and
equalled 67o of the City's general revenues. By the current
fiscal year, direct Federal aid had grown to $2,437 billion:
22% of scheduled general revenues. This eleven fold increase
in aid is precisely double the nationwide growth rate over
the same period.
Federal aid has hurt New York City -- and every other
city -- in one respect. The bulk of Federal aid is in the
form of categorical grants. Of the total $2,437 billion
- 24 -
being provided to New York City in the year ending June 30,
1976, $2,174 billion, or nearly 90%, consists of categorical
grants. These grants are nearly always tied to matching
funds being provided from State and local sources. Matching
programs provide a clear and dangerous path to over-commitment
of local financial resources.
There is nothing more important that the Congress can
do to help New York City (and other municipalities as well)
than to enact the President's proposal to extend revenue
sharing, and to embrace the Administration's proposal to
substitute functional or block grants for large elements of
the present categorical matching grant system. We need to
let states and municipalities decide by and for themselves
the kinds of activities they want to support, and how much
of their own financial resources they want to put into these
activities.
Conclusion
I began my testimony today by suggesting that the
situation is much as we expected it to be. The financing
package and the Federal seasonal loan program have served
the purpose they were designed to serve: they have provided
New York City with ample time and ample opportunity to solve
its fiscal and financial problems.
At this time, no one can predict with complete confidence
whether the job will be done. Clearly the challenges are
great. But the potential rewards are even greater. New
York City has been given the opportunity to restore itself
to pre-eminence among our urban centers. And in so doing,
its accomplishments can serve as a model for all the cities
of the nation -- and for the Federal Government as well.
The question is very straightforward: what do the
people want from their Government and what are they willing
to pay for? Most political units *must answer this question
every day. Congress has given New York City two more years
to find the answer. It must use this time wisely.
oOo
F O R IMMEDIATE RELEASE
S T A T E M E N T O F WILLIAM M. GOLDSTEIN
D E P U T Y ASSISTANT S E C R E T A R Y O F T H E T R E A S U R Y
O N H.R. 12224
BEFORE THE WAYS AND MEANS COMMITTEE
APRIL 5, 1976, 10:00 a.m.
Mr. Chairman and Members of the Committee:
Thank you for inviting m e here today to discuss certain problems
that have arisen involving the taxation of transactions on a securities
option exchange. One of these exchanges, the Chicago Board Options
Exchange, has obtained a private ruling letter from the Internal Revenue
Service which has received extensive publicity in the securities field
and has been relied upon by some to promote a plan designed to convert
ordinary income into capital gains. H.R. 12224, which is before you
today, seeks to terminate this potential tax advantage. The Treasury
supports the bill, but we would like to suggest certain changes which,
we believe, will more effectively accomplish the purposes of the legislation.
BACKGROUND
The present rules governing the tax consequences of option transactions have been developed over the years through a series of Internal
Revenue Service rulings, which have been issued in the absence of
specific provisions in the Internal Revenue Code. Let m e note in passing
that there are proposals to codify the Service rulings, with some modifications. Such proposals, put forward by the American Bar Association,
seem worthy of further study and the Committee may want to consider
them at a later date.
WS-758
- 2As applied to a taxpayer who sells an option in direct dealings
with a purchaser ( as distinguished from an exchange transaction),
the rules are reasonably clear and produce results generally accepted
as fair. The seller's receipt of the premium for writing the option
does not result in the recognition of income until either the option
expires unexercised, the option is terminated through reacquisition
by the option writer, or the option is exercised. If the option expires
unexercised, the amount of the premium received upon writing the option
constitutes ordinary income. If the option is exercised, the premium
is considered part of the proceeds from the sale of the underlying
securities in the case of a call option and is applied as a reduction in
the basis of the purchased securities in the case of a put option. While
there is some controversy regarding the proper tax result when the
option is reacquired by the writer, such transactions occur infrequently.
The distinguishing feature of the options exchanges, which at present deal only in call options, is that the purchaser of an option does
not look to the actual writer of the call for delivery of the securities
named in the option. Instead, an option clearing corporation is the
primary obligor. Since there is no obligation on the part of the writer
to the purchaser of the option and since the options exchanges have
created secondary markets in options, a writer of an option in an exchange transaction can terminate his obligation merely by purchasing
on the exchange an option having the same teriris as the option he
had previously written. This so-called "closing transaction1' essentially
permits the writer to cancel his option contract.
If a call is written at the prevailing market price and the market
rises, the purchaser of the call will exercise the option in order to
realize the spread between the option price and the higher market price.
In the case of a face to face option (that is, one not traded on an options
exchange), the writer of the option adds the proceeds from the sale and
the option premium in determining his capital gain or loss on the transaction. In the case of an option traded on an options exchange, the
option writer instead engages in a closing transaction in which there is
no sale or exchange of securities. Thus, the creation of options exchanges
presented a novel situation for which there were no established tax rules.
<ir
-3The Service's letter ruling hplds, in part, that where the writer of
an option enters into a closing transaction he realizes ordinary income
or loss based upon the difference between the amount of premium received and the amount paid to repurchase the option. The rationale for
treating income from the lapse or termination of an option as ordinary
income is that in writing an option the writer merely has an obligation
to perform in the event that the holder exercises the option. He does
not have a capital asset-even though he m a y own stock with which he m a y
satisfy his contractual obligation if the option is exercised. Consequently,
it was held that a closing transaction does not constitute a sale or exchange and does not give rise to capital gain or loss.
POTENTIAL FOR TAX ABUSE
As an interpretation of the existing rules, we believe the letter
ruling reached a correct result. Nevertheless, because the exchange
separates the option from the interest in the underlying stock, an
opportunity has been created for writers of calls to adopts investment
strategies designed to create capital gains on one side of their investment position and orjdinary loss on the other. Thus,, in the case cited
by Congressman Mikva wh?n introducing H. R. 12720, an investor m a y
save tax by following this procedure:
(1) The investor purch^SQ^ 100 shares of IBM stock at $200 and
at the same time writes an IRM c^U for 100 shares at $200 for
a premiumof $2, 500.
(2) After six months, -when IBM goes up to $250, he seUs the IBM
stock and realizes a $5, OOOvlong-term capital gain and closes out the
IBM call at a cost of45, 000.
In economic terms, the consequence of these transactions is a net
gain of $2, 500, arising from the $5, 000 gain realized from the sale
of stock less the $2, 500 ordinary loss from the dealings in the option.
However, for tax purposes, these transactions can result in a "wash"
and the investor will-not pay any tax at all on the gain. Assuming a
taxpayer with a marginal tax rate of 50 percent, the tax on the $5,000
capital gain will be $1, 250 and the tax saving from the $2, 500 ordinary
loss will also be $1, 25Q* The net tax, resulting from offsetting the
long-term capital gain against the ordinary loss is thus zero.
-4Actually, there are a number of variations on this theme. For
example, similar advantages are available in cases where investors
have useless capital loss carryovers which they want to convert into
useable ordinary losses. W e also understand that additional opportunities for manipulation will arise when the national options exchanges
begin dealing in puts at some date in the future.
It should be noted, however, that there is a substantial tax detriment to the investor who follows the above-described plan in the event
the market goes down and he suffers an economic loss. For example,
if the value of the I B M stock in the previous example had declined to
$150, the investor would have sustained a $5, 000 capital loss if he
had sold his stock and a $2, 500 ordinary gain from the lapse of his
option. While in economic terms he would have sustained a$2, 500
out-of-pocket loss, for tax purposes he will offset only $2, 000 of his
capital loss against $1, 000 of ordinary income, carry over a capital
loss of $3, 000 to the next taxable year and pay tax on $1, 500 of
ordinary income.
ANALYSIS O F BILL
H. R. 12224 would amend section 1234 of the Code to provide that
gain or loss from any closing transaction shall be treated as a shortterm capital gain or loss. A closing transaction is defined as a purchase of a put or call in stock or securities or commodities to
terminate, in whole or in part, the taxpayerTs obligation under the
existing put or call in substantially identical stock or securities
or commodities.
Under the proposed statutory change, the tax system would assume
a neutral stance with respect to these transactions. That is, our investor
m the example cited will now have a short-term capital loss ($2, 500)
from the closing transaction which will reduce his long-term capital
gain ($5, 000) from the sale of stock and he will pay a tax on a $2, 500
long-term capital gain. On the other hand, in the event the value of
the investor's stock decreases, and he enters a closing transaction to
terminate his interest in the option, he will be able to offset his $2, 500
short-term capital gain from the writing of the option against his longerm capital loss of $5, 000 from the sale of stock. Since the tax law
limits the offset of capital losses against ordinary income to $1, 000
appTy S h6 ^ haVe-a $2' 0°° ^g-term capital loss to
apply against $1, 000 m ordinary income and a $500 long-term capital
ieutrSit%^T"?VeKi
H R
12:224
t0
d6Slrable
^^^
' and
taxable
f o r that
^ear-
We belleve such tax
r ^ s o n w e support enactment of
fd
- 5You will note, however, that in order to obtain the benefit of this
new provision in the situation where the market falls, the investor must
go through the formality and expense of a closing transaction. This is
in contrast to the normal procedure where the value of stock decreases;
in such event, the holder of a call will allow the option to lapse and the
seller will retain the premium. But H. R. 12224, as drafted, does not
extend to lapsed options. Therefore, we suggest that it would be
desirable to amend the bill so that it applies not only to closing transactions but also to lapses of options. Failure to make this change
would give rise to discrimination between those investors who are
sophisticated enough to enter into a closing transaction and those who,
through ignorance of the tax laws or otherwise, permit their options
to lapse. W e recommend that the income realized upon the lapse
of an option be treated as short-term capital gain in all events.
The proposed new rules will require some elaboration, either
in the bill or in the Committee report. The Internal Revenue Service
has ruled in Rev. Rul. 66-47, 1966-1 C.B. 149, that premium income
received by a tax exempt organization from the writing of "covered"
call options that is, call options respecting stock owned by the organization is subject to unrelated business income tax where the options
lapse without being exercised and the writing of options is regularly
carried on by the organization. The Service has also ruled in Rev.
Rul. 63-183, 1963-2 C.B. 285, that amounts derived by a regulated
investment company from writing put and call options which are not
exercised do not constitute "gains from the sale or other disposition
of stock or securities" within the meaning of section 851(b) (2) of the
Code. Accordingly, a corporation will not qualify as a regulated
investment company for income tax purposes if more than 10 percent of its gross income consists of such premium income.
In each ruling the Service has taken the position that the premium
received by the writer upon the lapse of the option is not associated with,
and has no relevance in, fixing the amount of gain or loss from the disposition of any particular stock or securities. Nor, in the view of the
Service, can the premium be viewed as gain from the sale or other disposition of the option itself. This is because the writer is viewed as
being compensated for assuming an obligation and the income he receives
upon the lapse of the obligation is in no way attributable to a sale or
other disposition.
- 6If the bill is amended as we propose, it might be interpreted as reversing the principle enunciated in these rulings since gain or loss
from lapsed options and closing transactions will now be treated as gain
or loss from the sale or exchange of a capital asset. Such an interpretation,
if applied to all options, might encourage undesirable speculative activities
on the part of exempt organizations and regulated investment companies.
With respect to exempt organizations, this Committee, after separately
considering the question, has decided to favorably report H. R. 3 052.
That bill, which has the Treasury Departments support, would exempt
from the unrelated business income tax, income of exempt organizations
from the writing of covered call options.
An exempt organization which writes covered call options is writing
options as an incidence of its investment activities in order to maximize
the yield from its securities portfolio, and exemption from the unrelated
business income tax is appropriate. Different questions would be raised
respecting the proper sphere of exempt organization activities if the
present bill were to be interpreted as also exempting income from the
writing of naked options, that is, where the exempt organization does
not own the underlying stock.
Similar considerations may apply in the case of regulated investment
companies. W e believe this question should be further studied and that
the views of industry representatives and the Securities and Exchange
Commission should be obtained to determine what is the appropriate
policy to follow in this area.
Accordingly, we recommend that it be made clear that the present
legislation does not affect the application of the unrelated business
income tax to exempt organizations and section 851 of the Code to regulated investment companies, leaving the special problems of such
organizations to be resolved by specific legislation tailored to meet
their special circumstances.
Another modification which we recommend is to add to the bill a
provision excluding gains or losses realized by traders dealing in options
in the ordinary course of their trade or business from short-term capital
gam or loss treatment. A similar provision is contained in present-law
section 1234(c)(2).
^
We would also like to draw the Committee's attention to the impact
this provision would have on foreign investment in option markets. At
present there is some uncertainty regarding the tax treatment of nonresident aliens and foreign corporations who desire to engage in option
writing transactions. The uncertainty, involves first, the question whether
- 7the foreign investor will be considered engaged in a trade or business
in the United States and, second, whether the United States withholding
taxes apply to the receipt by a foreign investor of premium income.
The Foreign Investors Tax Act of 1966 was enacted to stimulate
investment by foreign investors in the United States securities markets.
However, neither section 864(b)(2)(A)(ii) of the Code, which provides
that a foreign investor engaged in "trading in stocks or securities for
the taxpayers own account" will not be deemed to be engaged in a
United States trade or business, nor the Treasury regulations under
that provision are clear that the writing of options constitutes "trading
in stocks or securities".
Under the Code, foreign investors generally are subject to withholding
tax on their gross income which is "fixed or determinable annual or
periodical gains, profits, and income", unless such income is "effectively
connected" with a United States trade or business, in which case it is
generally subject to regular United States tax. If a call option written
by a foreign investor is exercised, there is no withholding tax owed since
the premium is deemed to be part of the gain realized on the underlying
stock and there is no witholding tax imposed upon the sale or exchange
of property by a foreign investor. It is not clear under present law
whether ordinary gain or loss realized upon the lapse of an option or in
a closing transaction will receive similar treatment.
Under H. R. 12224, however, gain or loss arising from a closing
transaction (or upon a lapse of an option if the Committee decides to
so amend the bill) will be treated as gain or loss from the sale or
exchange of a capital asset. Such treatment should make it clear that
premium income is not subject to United States withholding tax. W e
believe that this is the appropriate result. It is consistent with the
policy adopted by Congress in the Foreign Investors Tax Act of 1966
and with the Administration's policy to encourage foreign investors to
trade in the United States securities markets.
Finally, we note that the bill contains a March 1, 1976, effective
date. W e suggest that the bill, as amended, apply only to options
written after the date of the Committee's decision on the bill.
Adoption of an earlier effective date m a y be unfair to taxpayers who
entered into transactions in reliance upon existing law and in ignorance
of the introduction of H. R. 12224.
- 8-
CONCLUSION
In conclusion, the Treasury supports H. R. 12224 and recommends
that the Committee adopt the modifications proposed relating to the
lapse of options, the exclusion of tax-exempt organizations and regulated investment companies from the application of the bill's provisions,
and the effective date rule. While we feel that the Committee should
also consider the codification of all consequences of option transactions,
as they apply to both investors and regulated investment companies,
we do not think that action upon H. R. 12224 should be delayed pending
the consideration of such matters.
o O o
FOR IMMEDIATE
RELEASE
REMARKS OF THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE
THE COLBY INSTITUTE FOR MANAGEMENT
COLBY COLLEGE
WATERVILLE, MAINE
APRIL 2, 1976
Thank you, Governor Jim Longley, President and Mrs. Robert
Strider, Ben Haug, and ladies and gentlemen:
It is indeed a pleasure to be your guest on this
distinguished campus and in a corner of the country where
individualism, independence and self-reliance are not just
handy catchwords, but a way of life -- today no less than in
the early years of your rugged, vital state.
I am honored to be introduced by your outstanding
Governor, my good friend Jim Longley- Jim offered to put me
up for the night, just so long as I reimburse the State of
Maine for any heat electricity, or running water that I may
use while staying at the Executive Mansion. Well, I'm
perfectly willing to go along with any reasonable economy drive
because I believe in saving the taxpayers money, too — and I
plan to congratulate him on his many efforts to reduce spending
as we hitchhike back to Augusta after the banquet tonight.
It is also a special pleasure to be included in this
excellent program sponsored by Colby College. I am impressed
not only by the scope of your deliberations but by their strong
accent on long-range solutions rather than just short-range
problems. Fred Webber -- one of your workshop leaders and an
outstanding Assistant Secretary of the Treasury until recently -can vouch for the fact that if you were holding these sessions
in Washington, you would be committing one of the cardinal sins
of that city: asking people to look beyond November in an
election year. And yet the need for long-term vision in this
country has never been greater, and we will all benefit from
these efforts by you leaders in business and the professions
to meet the challenge — in the words of your conference theme -of a post-recession economy.
WS-759
-2Finally, it is heartening to see a joining of the
academic and business communities in this endeavor. Too
often, our society tends to split up into neat and selfcontained compartments rather than combining forces to
work toward common goals. The Colby Institute for
Management, with a generation of experience and service
behind it, sets an example that should be emulated throughout the nation.
I intend to follow your lead tonight and also look
beyond the recession, .but first Ifd like to take a moment
to itemize our progress in recovering from this most severe
economic slowdown since World War II.
The decisions we have
had to make in the past year or so, I believe, are instructive
as we chart our course for the future.
Economists generally agree that the recession hit bottom
last April, that the recovery began sooner than expected, and
that it has been stronger than expected. Only a few months ago,
we began to see light at the end of the tunnel. Today, we are
nearly out of the tunnel and on our way to recovering a full
head of steam. For example:
— 1975 opened with inflation raging at nearly 13 percent.
That rate has been cut to approximately 6 percent, and February's
consumer price index showed only a microscopic rise, the
smallest in over four years. There will be ups and downs, but
I believe the decline in inflation will be steady, overall.
— Last spring, unemployment had reached nearly 9 percent.
It has now dropped to 7. 5 percent and our forecasts indicate
a continuing downward trend — perhaps falling below 7 percent
by the end of the year.
— Other signs point to an economy that is regaining its
vitality: Real GNP, the stock market, personal income,
industrial output, housing starts, retail sales — all are
registering gains and this reflects a rising public confidence
about the economy that contrasts sharply with the deep pessimism
reported by polltakers only a few months ago.
But although we made considerable headway in 197 5 and we
are making even more in 1976, this is no time for complacency.
Inflation is not yet under control and the jobless rate is
still too high. Right here in Waterville, unemployment is
running at, or a little above, the national average — and
this translates into hardship and suffering for many families.
Many other areas of Maine are far above that average and we
will not be content until the rising vigor of the economy
nationally is reflected in communities hit by long-term
unemployment.
e^
-3That is why the Administration is urging Congress to
adhere to a broad-gauged plan to further nurture and stimulate
the natural forces of growth in our private enterprise
economy. An essential element of this plan is to put the
brakes on the dizzying momentum of Federal spending — to slow
the rate of increase to about 5 percent this fiscal year,
contrasted with 40 percent the past two fiscal years. This
will allow us to continue to make progress on inflation and,
at the same time, will make additional tax cuts possible for
businesses and individuals and set the stage for a balanced
budget within three years.
Further, the President has urged tax measures designed
to stimulate job creation generally, encourage the building of
sorely-needed electric power facilities, and increase
construction of plant and equipment in areas where unemployment
has topped 7 percent, which includes virtually every major job
market in Maine and many other parts of New England.
Finally, the Administration has proposed elimination
of the unfair double taxation of dividends that retards
capital formation. This is the only major proposal I know
about that seeks to correct the imbalance between corporate
debt and equity. As you well know, we must redress this
imbalance to allow the financial markets to channel society's
savings more efficiently to the more promising investment
opportunities. And, as you also know, improving our lagging
capital investment picture is absolutely essential to meet
our long-term goals of more jobs, higher incomes, greater
productivity, lower inflation and sustained growth.
These steps and the balanced program we have pursued thus
far are designed to fight inflation and unemployment simultaneously and strengthen the private sector of our economy.
We firmly believe that this course is working, that
it is right for the nation, and that it is leading us back
to the position of robust growth and expanding opportunities.
And yet you will hear a mournful chorus of rhetoric out
of Washington, especially as the election campaign draws closer,
claiming that we aren't spending enough, aren't pressing hard
enough, aren't pushing enough panic buttons to solve our
problems. Despite our steady gains, many of these critics
assume there must be a basic flaw in the system and they cast
about for other remedies: governmental control over economic
planning — guaranteed jobs for everybody at government
expense — a new round of wage and price controls — and other
encroachments on the market place which were discussed in one
of your workshops this afternoon.
-4Frankly, I believe that many of these critics suffer
from what Mark Twain called "loyalty to petrified opinions."
They fail to see that efforts to strengthen the public
sector at the expense of the private sector are a large part
of the problem, not part of the solution. They refuse to
recognize that the same excessive government fiscal, monetary
and regulatory policies they call for today have led to abuse
of our economy and helped trigger, first, a storm of inflation
in the early 1970s and, second, the severe recession from
which we are now recovering. And they fail to comprehend
a gathering mood in this country against the further expansion
of big government. They suffer from the economic variety of
Potomac Fever — the delusion that all economic cures must
originate in Washington with the Federal government. As
President Eisenhower once remarked> "there are a number of
things wrong with Washington, and one of them is that
everybody has been too long away from home."
However, public disenchantment with big government does
not mean that all Americans are necessarily immune from the
superficial appeal of quick-fix government programs whose
short-term benefits are well publicized but whose long-term
impact in terms of inflation and economic stagnation is
carefully masked from view.
It may seem strange, and it is certainly ironic, but
at a time when the vast majority of Americans are enjoying
such abundance and opportunity, too many of us have lost
sight of the principles and institutions that have made our
way of life possible.
This is certainly not true in many countries abroad. I
was reminded of this fact during my recent two-week trip to
the Middle East. Israel and the Arab states have sharp
differences, of course. But on one thing they are agreed.
They all have a profound admiration for the achievements and
performance of the American economy. The leaders of the Middle
East believe, as I do, that the United States has developed
the most dynamic and efficient economic system ever devised.
Largely because of this, they see the United States as the
major source of strength and stability in today's unstable
world.
But here in the United States, somewhere along the line
there seems to have been a dangerous breakdown in communication.
Your fellow New Englander, Secretary of Commerce Elliot
Richardson, put it succinctly the other day when he said that
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-5Too many Americans — especially those born into an
affluent society which seemed to have no beginning or end,
no cause and no effect — have lost sight of, or have never
been taught, the actual dynamics of prosperity in a free
society.
Today, when nearly everybody takes the fruits of the
free enterprise system for granted — the abundance, the
opportunities, the freedom of choice, and the chance for
learning, travel and general upward mobility — not everyone
understands the basic economic facts of life that have
produced these benefits.
Because of this, I believe that the time is ripe for an
economic heart-to-heart talk with the American people. And I
believe that the men and women who make up our free enterprise
economy — in business, in the professions, in the factories —
must do even more than they are now if such a national dialogue
is to succeed.
What is at stake is not simply the future of this or
that company, or even this or that industry. At stake is the
survival of the private sector, and, because of the interlocked
nature of our freedoms, the survival of the individual liberties
which can never long endure after the collapse of a society's
free enterprise system.
This problem of communications exists, as I have had
ample opportunity to observe in my job as Secretary of the
Treasury, and it is getting worse, not better. It is a
question of both policy and perception, for a faulty view or
understanding of the economy makes faulty economic policymaking almost inevitable.
Part of the problem is a matter of image. Frequently,
those who support bigger government spending and more
government domination of the private sector are perceived
as concerned and socially progressive individuals who "care",
who are champions of the persecuted underdog.
And I don't have to remind those of you on the firing
line that people who warn, on the other hand, that the
government should not and cannot effectively solve every
new problem that comes down the pike, and who advocate instead
the strengthening of the free enterprise system, are seen as
either outdated ideologues or a new generation of economic
exploiters — indifferent to human suffering and only out to
make a fast buck for themselves or their companies.
-6This stereotype wouldn't matter if it were not so
misleading — so blatantly phoney. My experience in Washington
has convinced me that almost every man and woman in a
position of high public trust cares deeply about the wellbeing of our citizens, especially those who are impoverished
or face disadvantages because of artificial barriers of sex
or color or national origin.
The central question if not who cares the most — we all
care. It is rather the method we choose to broaden prosperity,
reduce human hardship and meet our other national goals
without sacrificing our freedoms or destroying the most
successful economic system that man has ever known.
We can talk about the free enterprise system until we are
blue in the face, but it still won't mean much to those who do
not understand what it really menas and what makes it work.
It's like trying to discuss the birds and the bees sensibly
with somebody who unshakable in his belief that babies are
delivered by the stork.
People who have never seen what happens to countries with
state-controlled economies simply have no standard for comparison,
They have never witnessed the long lines of workers and
housewives who have to cue up for hours to buy a poor selection
of over-prices food and state-manufactured clothing and
merchandise.
They don't realize what a miracle of variety, economy
and productive competition an average shopping center found
anywhere in the U.S. would represent to most of the world's
people.
They have never asked themselves why a country like the
Soviet Union, with some of the richest grain land in the world but with an agricultural system owned and operated by the
government — cannot even feed its own people without turning
to American farmers who own their own land, make their own
decisions and feed not only their fellow Americans but millions
of others as well.
They have never lived in countries where the seemingly
idealistic dream of a society without private property or
profits has turned into a nightmare reality: where the state
and the state alone dictates what kind of education you will
receive, whether or not you will be allowed to travel, what
kind of job you can have, what you will be paid, what you can
buy with your own earnings, where you will live and, ultimately.
where you will be buried.
76
-7The truth is that regimented societies inflict upon
their citizens not only a political regime that reduces the
individual, in Churchill's phrase, to a mere fraction of the
state, they also inflict an economic regime that smothers
enterprise and breeds inefficiency. Let's face it: Without
the individual profit motive, people simply do not work as
hard, produce as much, or bother to come up with as many
fresh ideas and new improvements. Whether we like it or not,
this is an immutable law of human nature.
Unfortunately, like clean air, economic freedom is
something most people don't really appreciate until it begins
to run out — and then it is often too late.
So I submit to you tonight that if America continues
down the road toward greater governmental spending and
greater governmental control over our economy and over our
lives — a road that we have been traveling for several
decades — then all of us will be condemned to an economy
riddled by chronic inflation and incurable unemployment and
those who come after us will be robbed of their personal and
economic freedoms. That is really what is at issue underneath
the semantics and the misleading labels.
Let me be specific about how our private enterprise
economy has been undermined by excessive government policies.
Just before the New Deal, government spending at all
levels — Federal, State and Local — was about 10 percent
of our total national output. Today, because budgets have
mushroomed, government accounts for almost 4 0% of the GNP,
and if recent trends prevail, the government's share of the
total economy will reach 60 percent before the end of this
century.
Let's put present spending in dollar signs. Today, and
every day during this fiscal year, the Federal Government will
spend $1 billion. And this week and every week this fiscal
year it will go into debt an additional $1 billion. Since
1962, when the federal budget hit the $100 billion mark, it
has almost quadrupled, and has been in the red for all but
one of those years.
The interest on the federal debt alone by the end of
fiscal 1976 will have climbed to $36 billion. The amount in
fiscal 1977 will reach $45 billion. That's more than we spent
in any one year on the war in Vietnam. It is almost half of
what we will be spending on total national defense next year.
And it is money, I'm sure you will agree, that could better
be spent on improvements in health care, public transportation,
rebuilding our cities or any of a dozen other national needs.
-8As business and professional people you know that it
spells disaster to borrow and spend more than you take in
for too long. You know that heavy government borrowing has
fueled inflation and driven up interest rates so that
strains have developed in money and capital markets. Many
of you may have felt these strains as you have tried to get
loans to expand your businesses and create new jobs, or even
to buy a new home without paying an arm and a leg in mortgage
interest.
Throughout the nation, we see signs that taxpayers, who
have so long borne the burden of heavy government spending,
are close to open rebellion. In the 1974 elections, for
example, voters across the country turned down more than 75
percent of all bond issues on the ballot. And eight state
legislatures, fed up with rising national debt, have now
adopted resolutions calling for a constitutional amendment
requiring a balanced national budget. As one state representative put it: "I don't want the government spending my
grandchildren into a poorhouse."
So our major concern as we work our way to a sound and
durable recovery is to avoid another dose of the same poison
which brought on the recession in the first place: rampant
inflation fed by runaway federal spending.
But spending isn't the whole problem. As government
spending has grown by leaps and bounds, so too have government
controls, regulation and red tape.
Did you realize that government regulatory agencies, with
an army of 100,000 on the payroll, exercise direct control over
10 percent of everything bought and sold in the United States
and indirect control over almost every other sector of the
private economy?
The avalanche of paperwork required by this regulatory
network is a tremendous burden on small and big businesses
alike. Business spends an incredible $18 billion a year just
to fill out government forms. General Motors recently
calculated that it spent more than $1.3 billion in 1974 just
to comply with existing government regulations or get ready
for new ones. This is more than it cost to run the entire
Federal Government for all of the first 75 years of our historyand that includes the Louisiana Purchase.
Some of these regulations are, of course, necessary and
in the public interest. But many more of them are counterproductive, wasteful, and obsolete. And as President Ford
has repeatedly stated, those regulations and regulatory
bodies that no longer serve a useful purpose should be
abolished, before we strangle in our own red tape.
7TI
-9Speaking in 1865, Lincoln said, "I have faith in the
people... the danger is in their being misled. Let them
know the truth and the country is safe."
What I have been trying to emphasize here tonight is
the need to hammer home the truth — the economic facts of
life — to the American people, including the young Americans
who must lead us in the years ahead. Much of that task is,
and should be, up to individuals like yourselves who are most
knowledgeable in the everyday practices and strengths of a
free economy.
It is a story that cannot be vividly portrayed on
television like the war in Vietnam or the urban riots of
the sixties. Yet it is the one thing that affects every
aspect of our lives.
And I am convinced that the American public has not
irrevocably closed its ears to this story. The polls tell us
that businessmen themselves rank low in public confidence,
and yet the principles of private enterprise rank high. A
majority of Americans say they want more regulation of
businesses, and yet business is the most popular major field
of study among college students -- above education, science
and the humanities. We can strike a responsive chord in
telling this story to the American people if we tell it in
human, comprehensible terms.
For when we talk about our free enterprise economy we
are talking about food on the table, goods on the shelves
and services at the counter. We are talking about medical
breakthroughs that have added 10 years to our lives in the
past generation. We are talking about labor-saving devices
that have freed millions of women for productive careers and
the pursuit of self-enlightment. We are talking about five
out of every six jobs in America and wages and benefits that
stagger the imagination of the rest of the world. We are
talking about a productive base that pays for government
support of the elderly, the jobless, the poor, the dependent
and the disabled. And we are talking about basic freedoms;
to choose a career, to choose what and where we buy, to choose
where and how we live, and yes, to swim against the tide -as did Fulton and Ford and Edison — things you could never
do living in the gray shadow of conformity under a regimented
society.
And finally, those who are part of our private enterprise
economy have the crucial responsibility of making sure the
business community keeps its own house in order.
-10American business is being rocked by news of illegal
corporate political contributions, payments of millions of
dollars in bribes to help influence business decisions in
foreign countries, and other questionable or downright illegal
practices that have rightly shocked the majority of our
citizens. Congressional committees have reacted strongly
and many businessmen are calling for a voluntary business
code of ethics and internal reforms.
I would applaud this mood of reexamination that is
beginning to reveal itself in the business community. After
all, no one has more to lose from corrupt practices than the
vast majority of honest businessmen, and no one has more to
gain from wiping out corporate corruption before it endangers
the whole free enterprise structure, which would be a tragedy
for each and every citizen.
And I would respectfully suggest that this reexamination
be extended to include other practices that are perhaps less
dramatic but which also create a gap between business principles
and performance — taking subsidies and bailouts and other forms
of government intervention or protection — resist regulatory
reform solely to avoid competition in the marketplace — putting
high quantity above high quality in the manufacture of products
and misrepresentation above truth in selling them to the public.
Once people begin to roll all these abuses together in their
minds it can mushroom into a general, unreasoning indictment
of the system itself.
I would urge all of you who are part of our mighty private
sector — the real source of the vitality of our economy and the
vitality of our society — to place your convictions and your
energies in the service of this cause of improving, and
telling the facts about, our private enterprise system.
In this Bicentennial year, if we keep alive the spirit
that infuses our national character — the spirit of free
enterprise that each of you personifies — then we can be
certain that it will endure for another 200 years and more.
But, if we let free enterprise wither away, we may be
sure that our other freedoms 0O0
and individual liberties will
expire as well. We must not, we will not, allow this to happen.
N
\e Department of theTR[/[$URY VJ
JHINGTON, D.C. 20220
TELEPHONE 964-2041
FOR IMMEDIATE RELEASE
April 1, 1976
The Treasury Department today unveiled the official
portrait of former Secretary of the Treasury, John B.
Connally. Governor Connally served as the 61st Secretary
from February 11, 1971 to June 12, 1972.
Addressing Governor Connally and other officials,
Secretary of the Treasury William E. Simon cited Governor
Connally's "deep human resources, his sense of adventure
and commitment, and his amazing capabilities that perhaps
no painting — however great — can fully capture."
The portrait was painted by Everett Raymond Kinstler
one of America's outstanding portrait artists. Mr. Kinstler
also painted the official portraits of former Treasury
Secretaries David Kennedy and George Shultz.
Governor Connally is also past recipient of the
Alexander Hamilton Award, the highest honor the Treasury
Department bestows.
oOo
WS-760
April 2, 1976
NOTE:
Attached is a preliminary analysis on "Tax Treatment
of Allowances Paid to U. S. Government Employees," prepared
by the Office of International Tax Affairs of the Treasury
Department, for consideration by the House Ways and Means
Committee Task Force on the Taxation of Foreign Income.
The analysis does not represent an Administration
position and does not contain recommendations.
0O0
WS-761
Tax Treatment of Allowances Paid
to U.S. Government Employees
Department of the Treasury
April 1976
PREFACE
Ihis preliminary analysis was prepared by Marcia-Field and
Brian Gregg of the Office of International Tax Affairs for consideration
by the House Ways and Means Committee Task Force on the f axation .pf
Foreign Income. The analysis does not represent an Administration position and does not contain recomnendations.
tr
Table of Contents
I.
ISSUE
II. PRESENT LAW
1. Explanation
2. Legislative history
III. ANALYSIS
1. Scope of the exclusion
2. Justification for the exclusion
a. Personal benefit vs. reimbursed costs
b. Costs must be borne by employers
c. Tax exemption vs. higher pay
d. Practical considerations: exemption
vs. higher pay
e. Distinguishing overseas government
employees from other employees
3. Other considerations
a. Official expenses
b. Education expenses
c. Housing costs
IV. OPTICNS
1. Retain present law
2. Repeal Section 912 exclusion entirely
3. Substitute for Section 912 a tuition expense
deduction and an exclusion for the value of
employer-provided municipal type services
4. Allow a deduction for housing costs in excess
of comparable U.S. housing in addition to the
duductions listed in option 3
5. Make Section 912 inapplicable to employees
serving in Alaska and Hawaii
I.
ISSUE
The issue is whether the allowances paid to U.S.
civilian government employees, primarily for overseas
employment, which are now tax exempt under Section 912 of
the Internal Revenue Code, should be made taxable. 1/
A related consideration is the extent to which the tax
treatment of these allowances should parallel the treatment
of income earned abroad by private sector employees.
Under Section 912 of the Internal Revenue Code, U.S.
citizens employed outside the continental United States by
the U.S. Government in a civilian capacity may exclude from
their gross income certain allowances which supplement
their base salary.
The allowances in question are designed
primarily to cover certain living expenses.
In a number of
cases, such as moving expenses, the expenses would generally
be deductible as employee business expenses under current law.
But other allowances, notably those for housing, cost-ofliving differentials, education expenses and home leave
travel, would be taxable income in the absence of the special
exclusion under Section 912.
In 1974 the Ways and Means Committee voted to phase out
both Section 912 and Section 911, which excludes certain
foreign earned income of private sector employees.
Both
1/ This paper deals only with allowances paid to civilian
government employees. Military allowances are treated under
different provisions of the law.
- 2 sections would be phased out over four years and with limited
exceptions.
That bill (H.R. 17488) was not acted on by the
House before Congress adjourned.
Many of its provisions
concerning foreign source income were incorporated into
H.R. 10612, including the phase out of Section 911.
However,
the Ways and Means Committee deferred consideration of
Section 912 pending receipt of the report of an interagency
committee which was reviewing the entire structure of overseas
government, allowances.
Completion of that report in final
form is expected to require another year, but in view of the
Ways and Means Committee's interest, the interagency group
has completed the portion of the report dealing with tax
questions and has transmitted that portion to the Task Force
as an interim report. 1/
1/ Interim Report of the Interagency Committee on Overseas
Allowances and Benefits for U.S. Employees, (Chairman, John M.Thomas,
Assistant Secretary of State for Administration) January 1976.
- 3 II.
1.
Explanation.
PRESENT LAW
Section 912 of the Internal Revenue
Code provides an exclusion from gross income for certain
allowances paid to civilian government employees.
The
section refers to three categories of allowances, citing in
r
each case the statutes which authorize their payment.
a.
Foreign areas allowances.
Section 912)
(Paragraph (1) of
The first category enumerated in Section 912
comprised the various allowances paid to government employees
in foreign areas.
There are about 50 such allowances, which
fall into eight major groupings:
living quarters, cost-of-
living differentials (by comparison with Washington, D.C.),
education of dependents, travel, expenses associated with
transfers, expenses associated with separation from the
foreign service, representation expenses, and residences
(limited to certain officials).
Table 1 gives an abbreviated
description of the types of costs the allowances are intended
to cover.
b.
Cost-of-living allowances.
Section 912)
(Paragraph (2) of
The second category excluded from income by
Section 912 is cost-of-living allowances paid in accordance
with regulations approved by the President to employees
stationed in the U.S. territories and possessions or in
Alaska or Hawaii.
The statute refers to employees stationed
outside the continental United States, which for this purpose
Table 1
PRINCIPAL CATEGORIES OF ALLOWANCES
OF U.S. GOVERNMENT EMPLOYEES IN FOREIGN COUNTRIES
Housing - Quarters provided or payments to cover rent and utilities.
Extraordinary Living Costs - "Post Allowance" for higher cost of living and
"Separate Maintenance Allowance" where dependents must be living away from
post of duty.
Education - Government provided schools or payments to cover tuition.
Educational travel where appropriate schooling is not available at post of
duty.
Community Services - Commissary privileges, medical care or reimbursement
for medical expenses, after death services, personal transportation.
Hardship Incentives - "Post Differential" (presently taxable), Rest and
Recuperative Travel, Unhealthful Post Credit
Relocation - Moving expenses (including auto), temporary lodging expenses,
foreign transfer allowance for miscellaneous expenses, per diem while moving,
home leave expenses, family visitation travel, emergency visitation travel,
evacuation payments.
- 4includes only the 48 states which were part of the United
States in 1944, when the Revenue Act of 1943 was enacted, and
the District of Columbia.
To qualify for the exclusion,
cost-of-living allowances paid to employees in the territories, possessions, Alaska and Hawaii must meet the second
condition of being paid in accordance with regulations approved
by the President.
Those regulations authorized the payment
of allowances to employees whose basic compensation is fixed
by statute (Executive Order 10,000, 3 CFR 1943-48 comp., 792).
If the basic compensation is paid from nonappropriated funds
or is established by administrative order, the employee may
not exclude under Section 912 any cost-of-living allowance
he may receive.
c.
Peace Corps allowances.
(Paragraph (3) of
Section 912). The third category mentioned in Section 912
covers certain allowances paid to Peace Corps volunteers and
their families.
This paragraph, added in 1961, is essentially
limited to travel expense allowances and living allowances
which do not constitute basic compensation.
Termination pay-
ments and leave allowances for such individuals are specifically
excluded from Section 912.
Section 912 specifically does not apply to another category
of allowance, namely post differentials or "hardship11 allowances.
Post differentials are a percentage of base salary, up to 25
percent, paid to employees in locations where living conditions
I"
- 5 are uncomfortable.
The Internal Revenue Service ruled in
1953 and 1959 that such payments were not excludable
(Rev. Rul. 53-237, C.B. 1953-2, 52 amplified by Rev. Rul
59-407, C.B. 1959-2, 19').
That position was incorporated
1/
into the statute in I960.2. Legislative History. The predecessor to Section 912
(Section 116(j) of the Internal Revnue Code of 1939) was
enacted in the Revnue Act of 1943 as an amendment introduced
by the Senate Finance Committee.
The exclusion covered cost-
of-living allowances of employees and officers of the Foreign
Service, and cost-of-living allowances of other U.S. Government
employees stationed outside the continental United States, if
received in accordance with regulations approved by the
President.
The reasons for excluding the allowances was
that wartime inflation was seriously reducing their value,
particularly for foreign service personnel in Europe, that
increases in allowances were partly nullified by the increase
in tax, resulting from the Revenue Act of 1943, and that the
State Department did not have the funds or authority to compensate the recipients for the added burden of the tax.
1/ In 1973 a new allowance was introduced to cover the additiona
housing and utilities costs incurred by U.S. Government employee
stationed at U.N. headquarters in New York City who have entertainment responsibilities. Not more than 45 employees may
claim the allowance at any one time. The amount is set to
approximate the excess cost of housing and utilities in the
neighborhood of the U.N/ headquarters over the average of such
costs in the metropolitan New York City area. The tax status
of this allowance is not clear.
- 6The Foreign Services Act of 1946 expanded the.allowances
....
V"
and benefits authorized for foreign servicje officers, and
employees.
The additional allowance included amounts pay-
able for housing, cost-of-living, representation costs, travel
expenses (for moving, home leave, and sick leave).
That Act
also added Section 116(k) of the 1939 Code.to provide an
exemption for such additional allowances.
Section 912 of the Internal Revenue Code of 1954 was
identical to Section 116(j)(k) of the 1939 Code.
»
In 1960,
4
the 1954 Code was amended to add an.exemption for allowances
authorized under other Acts and to confirm the IRS .position
that post differentials are not excludable.
In 1961, certain Peace Corps allowances were added to
the list of exclusions.
The Treasury Department at that time
expressed concern at expanding the list of benefits excluded
from income.
The excluded Peace Corps allowances do not
include leave or living allowances which represent £asic
compensation, or allowances to family members of volunteer
leaders training in the United States,
- 7 1.
Scope of the exclusion.
There are about 100,000
civilian government employees who receive one or more allowances
that are excluded from income under Section 912.
About 40,000
are employed in foreign countries, 20,000 in U.S. territories
and possessions and 40,000 in Alaska and Hawaii.
About 60
percent of the total are civilian employees of the Department
of Defense (see Table 2). The allowances for foreign areas
are administered by the State Department and those for nonforeign areas by the Civil Service Commission, but each of
the 38 participating agencies may make its own variations in
determining the amounts and conditions of allowances.
Table 3
identifies the principal foreign countries where civilian U.S.
Government employees are located.
The aggregate amount of allowances is not reported, nor
does each agency report allowances separately in its budget.
For example, the Defense Department, the largest single employer
of personnel covered by Section 912, reports some civilian
allowances with those of the military.
The estimated total
for all allowances in 1975 is $350 million, up from about
$250 million in 1972 (see Table 4). The revenue cost in 1975
of excluding the allowances from taxable income was roughly
$100 million, estimated on the basis of salary, location, and
assumed family size.
This is a gross figure relating only to
the revenue side of the budget, and it does not take into
account that the tax exemption of the allowances is in part
TABLE 2
Number of Federal Civilian Employees Eligible for Section 912 Benefits by Area and Agency, 1968, 19 72 and 1975-£/
Total
1968
Dept.
:Dept.
of
: of
Defense :State
64,791
12,259
35,587
12,259
Other
Agencies
27,211
14,567
Total
TTTT
Dept.
:Dcpt.
of
: of
Defense :State
58,652
8,733
32,145
8,733
T«ltal
1/
104,261
95,626
(Overseas:
62,413
55,082
Foreign
41,887 25,671
12,240 3,976 33,134 21,817
countries
U.S. terri20,526 9,916
19 10,591 21,948 10,328
)
tories
41,848 29,204
12,644 40,544 26,507
M a s k a and
Hawaii 2/
Office of the.- Secretary of the Treasury
Office of Tax Analysis
Other
Agencies
28,241
14,204
iy/b
: Dept.
: Dept. :Other
: of
: of
:AgenTotal : Defense : State : cies
7,299
28,263
98,397 62,835
7,299
14,263
58,397 36,835
8,732 2,585 38,041 28,886
7,299 1,856
1 11,619 20,356 7,949
12,407
14,037 40,000 26,000
14,000
March 24, 1975
e/ Estimated
1/ Calendar year averages were used for foreign countries and U.S. territories for 1968 and 1972. The 1975 figures are
averages for the first six months of the year.
2/ Figures for Alaska and Hawaii for 1968 and 1972 are as of December 31. The 1975 figures are estimates.
M
Table 3
Principal Locations of Civilian U.S. Government
Employees in Foreign Countries, FY 1975
T7
All foreign countries
38,592
Germany
13,,493
5,,271
Japan
1,,521
Korea
1,,399
The Philippines
1,,357
The United Kingdom
1,,094
1 ,066
Italy
714
Thailand
25,,915
Spain
Subtotal
12;,677
All others
Selected other countries:
Mexico 321
Canada
201
Belgium
405
France
410
The Netherlands
129
Barbados
274
Bermuda
255
Office of the Secretary of the Treasury March 22, 1976
Office of Tax Analysis
1/ Excludes about 20,000 employees in the territories and
possessions and 40,000 in Alaska and Hawaii who also
qualify for some benefits under section 912.
Source: U.S. Department of State, Office of Personnel Reports,
U.S. Citizens Residing in Foreign Countries - FY 1975"
bt
TABLE 4
Federal Civilian Employees Eligible for Section 912 Benefits;
Estimated Salaries, Allowances Excludable under Section 912/
and Associated Revenue -Loss" by AVeia, 1968, 1972, and 1975
(Dollars Millions)
HT73"£/
Wff
TFZ
Salaries
Total
Overseas
Foreign countries
U.S. territories
Alaska and Hawaii
$880
577
431
146
303
$1,246
773
510
263
473
$1,555
1,020
740
280
535
Allowances
Total
Overseas
Foreign countries
U.S. territories
Alaska and Hawaii
179
156
131
25
23
244
209
165
44
35
343
303
256
47
40
Revenue Loss
Total
Overseas
Foreign ,countries1
U.S# territories
Alaska and Hawaii
51
45
39
6
6
76
66
50
11
10
100
89
77
12
11
Office of the'Secretary of the Treasury
Office of Tax Analysis
e/ Estimated
March 24, 1975
- 8 reflected in lower salary or lower allowances.
If the
allowances were subject to tax there would have to be some
offsetting increase on the expenditure side of the budget in
the amounts paid.
There are some 50 different allowances.
Some of those
would not be taxable in any case because they reimburse
expenses which would be deductible (e.g., moving expenses),
or because they are excluded from taxable income under other
section of the Code (e.g., the government contribution to
employee health insurance plans).
Even within this group,
there are several instances where the tax regulations for
claiming allowable deductions were drawn up with domestic
employment in mind and may not adequately take into account
the requirements of overseas employment.
The limit under the
moving expense deduction of 30 days for household storage
is one such example.
Thus, if Section 912 were repealed,
equitable treatment of overseas employees suggests a need
to review present regulations.
There are four principal allowances, accounting for
a substantial portion of the total, which would become taxable
income if Section 912 were repealed, those for cost-of-living
differentials, housing, education, and home leave travel.
As already mentioned, post differentials or "hardship11
allowances are specifically excluded from Section 912 and
would not be affected by its repeal.
- 9 2.
Justification for the exclusion.
When it introduced
the exclusion of living allowances of U.S. Government employees
outside the United States, in 1943, the Senate Finance Committee
stated,
"Payment of allowances to meet the extra
cost of living at individual posts is
indistinguishable from the payment of
allowances to defray expenses of operation
of the establishment..."
The Committee went on to conclude that since the State Department
had neither the funds nor the authority to increase the allowances enough to offset the tax on them, tax exemption was the
appropriate solution.
This line of reasoning continues to serve as the justification for the Section 912 exclusion.
cation is as follows:
In brief, the justifi-
(a) the expenditures covered by the
allowances do not represent a personal benefit to the recipient,
but solely a reimbursement for costs incurred as a result of
the employment assignment, (b) these expenses must, therefore,
be borne by the employer, (c) the employer can either increase
the payments to cover the tax on them, or exempt them from tax,
(d) tax exemption is the only practical alternative for
government employees, where the ability to alter compensation
levels is limited, and (e) this case is distinguishable from
that of private sector employees overseas and from U.S. Government employees in the United States.
the justification
sections.
Each of the elements in
is discussed in detail in the following
- 10 (a) Personal benefit vs. reimbursed costs.
The Section
912 exclusion specifically does not apply either to post
differentials paid to compensate for environmental conditions,
or to living allowances paid to Peace Corps members as basic
compensation.
These exceptions are consistent with the
general case for excluding government allowances, which
usually rests on the argument that the allowances are not
additional compensation to the employee, but simply reimbursement for costs necessitated by the conditions of employment,
and therefore do not properly constitute taxable income of the
employer.
In other words, the allowances are designed to
leave the overseas government employee in the same net position
in terms of disposable income as his counterpart in the United
States.
Indeed, much of the recent criticism of exempting the
allowances is directed at cases where allowances are excessive
and do confer personal benefit, leaving the recipient better
off than his domestic counterpart.
Two recent studies, one by
the Office of Management and Budget in 1973, and one by the
General Accounting Office in 1974, called for an overhaul of
the entire system of measuring and paying allowances to remedy
the lack of uniformity and the excessive allowances.
While in general the allowances are designed to cover
only extra living costs, there are some cases where the amounts
paid go beyond that standard.
The principal example is the
housing allowance, which provides free housing, including
utilities, and does not cover just the excess of the cost of
- 11 housing and utilities at the particular post over what the
employee would have paid in the United States. The State
Department recognizes that this allowance confers a personal
benefit:
"As a financial inducement to overseas service, Government employees
stationed abroad are furnished
either with free Government acquired
housing or an allowance to cover the
cost of privately rented quarters.
This provides the employee with additional income, equal to what he would
have spent on housing in the United
States, that is available for spending on other goods and services." 1/
Another example of an allowance which covers more than the
additional cost necessitated by overseas in contrast to
domestic employment is payment of home leave travel for the
whole family to any point in the United States.
If the rationale for the tax-free allowances is merely
to equalize the positions of foreign and domestic employees,
it would seem to follow that there should also be some provision for a reduction in base pay where foreign living costs
(for example, household help or food) are lower than in the
United States.
1/ U.S. State Department, "Indexes of Living Costs Abroad, tt
April 1975, published by Labor Department, Bureau of Labor
Statistics (underscoring added).
Ill
- 12 Some observers would argue that exclusion from income
is appropriate only for those allowances which reimburse the
overseas employee for living costs above what he would incur
in the United States and that exemption of that part of the
allowance which exceeds the living cost differential provides
a windfall to the recipients and leaves them better off than
their counterparts in either the private or the public sector.
Others would contend that, with very limited exceptions, ±/
the allowances are basically all income, whether or not they
represent a reimbursement for excess costs, and that any
exemption represents a windfall to the recipient.
The case for tax exemption is weakest in those instances
tfhere the allowance is for costs which the employee would incur
in any event.
In fact, the existence of windfalls within
the allowances structure and the difficulty of eradicating
-hem may be a reason for taxing all of the allowances; there
nay be less resistance to paying tax on the allowances than
:o reducing them, and at the same time the absence of tax exemption
zould remove the incentive to overstate the allowance portion
)f total compensation.
/ Nearly all observers would make an exception for allowances
esigned to cover evacuation and funeral expenses.
- 13.(b) Cost must be borne by employer.
Other things being
equal, an employee will not accept the same pay for the same
work in two different places if living costs are much higher
in one place than in the other.
seldom equal.
Other things are of course
Different work, pleasant surroundings, useful
experience and other elements of "psychic" income may induce
an employee to accept a lower real income in one post than he
could get in another.
But on the whole it is fair to say that
higher living costs must be.reflected in higher compensation
to attract the same quality of personnel.
Assuming that government employees will accept overseas
assignments only if their real Income can be maintained at
the same level as when they were employed in the United States,
and assuming that the allowances were revised so that they
covered only the extra living costs incurred as a consequence
of employment outside the United States, then taxation of the
allowances would result in a reduction in their after-tax
and would presumably have to be made up by higher government
salaries or allowances.
Unlike private sector employees over-
seas, government employees are not subject to foreign tax on
their earnings. An increase in U.S. tax, therefore, would be
felt in full by the employe^ since there
is no foreign tax
credit to offset the U.S. tax.
(c) Tax exemption vs. higher pay.
If overseas livine
allowances were made taxable, the ultimate result in most cases
would be an increase in cost to the employer, the U.S. Government.
Whether the increases in compensation would be the same
lib
- 14 or less than the increase in tax costs would depend in part
on whether the allowances are for total costs of living abroad
or only for the excess over the costs of living in the United
States.
As the Finance Committee noted in introducing the fore-
runner of Section 912 in 1943, tax exemption is one method of
bearing the cost, a substitute for increasing the allowance
directly.
Tax exemption of a particular group is a cost borne by
taxpayers in general, but when the U.S. Government is the
employer, paying higher salaries is also a cost to taxpayers
in general.
Therefore, in one sense, taxing the allowances
would amount to taking money from one pocket and putting it
in another.
But this argument leads to the conclusion that
no government employee should be taxed on his salary.
in this light, the logic is questionable.
Considered
If government
salaries were generally made tax exempt as a cost-cutting device,
the result would be highly deceptive budgeting.
Government
agencies would have an incentive to use more labor than necessary because its cost would appear lower than it really was.
Moreover, the tax free status of government salaries would
appear highly inequitable to the vast majority of Americans.
These considerations also apply to the case of overseas
allowances.
The exemption is an incentive to paying higher
allowances than are necessary, and to hiring more persons than
is necessary.
The actual cost incurred by each agency is
understated since part of the personnel budget is reflected
Ill
- 15 in lower tax collections by the Treasury Department.
In fact,
as mentioned earlier, the allowances themselves are not
adequately reported, so that it is difficult to determine the
gross pay of U.S. Government employees in different locations.
Finally, the exemption of government allowances ,may seem
inequitable to persons who, for one reason or another, incur
high living costs which are not recognized in computing taxable
income.
A problem caused by the taxation of allowances may occur
in the case of an employee with a substantial amount of income
in addition to his government salary, by comparison with a similar employee having no outside income.
If the allowances are
treated as marginal income and are subject to tax, then under
the progressive U.S. tax system the net benefit of the allowance
to the employee with outside income would be less than to the
employee with no outside income.
If the allowances are not
taxable both would benefit equally.
It may be argued that if
the allowances simply reimburse the employee for differential
costs of overseas employment the present exemption system gives
the appropriate result.
It is more difficult to sustain this
argument when allowances exceed these cost differentials.
This issue highlights the general question of recognition
in the tax law for differences in the cost-of-living between
different locations or oyer time.
U.S. tax law does not generally
take such differentials into account.
Making tax adjustments
would be very complex, and would appear highly inequitable to
those taxpayers not favored by the adjustments.
-16 (d) Practical consideration: exemption vs. higher pay.
If the allowances now exempt under Section 912 were to become
taxable, the gross or budgeted cost to the government agencies
of maintaining their foreign staffs would have to be increased
in order to maintain a necessary level of disposable income for
the employees. Additional appropriations would be required for
the employing agencies. This would require special attention
to alleviate statutory or administrative restraints on additional
spending.
Under present appropriations procedure, Congress might not
adequately take into account the offsetting additional tax on
the increased allowances. For example, if an employee whose
marginal tax rate is 33-1/3 percent has $6,000 of allowances
and the U.S. Government wants to reimburse him fully for the
tax liability on those allowances, it would have to increase
the allowances from $6,000 to at least $9,000, an increase of
50 percent, or more if he is pushed to a higher marginal tax
bracket. The net cost to the U.S. Government would be zero
in this case since the added tax of $3,000 matches the added
allowance of $3,000; but the tax revenue is not credited to
the agency which must pay the allowance.
To the extent that certain allowances tend to overcompensate the employee (e.g., housing, home leave, travel, rest and
recreation), there could be a net budgetary gain if the allowance
is not raised by the full increase in the tax. In the example
mentioned above, the Government might increase the allowances
from $6,000 to only $7,500, so that the after-tax amount would
- 17 be $5,000 instead of $6,000; then the increased cost of
$1,500 would be more than offset by the increased tax of
$2,500.
But again the net revenue gain will not be reflected
in the employing agency's budget requests which must be approved
by Congress.
Under present law, the personnel budgets of employing
agencies are understated since they do not reflect the appropriate
tax costs.
A change from tax exemption of allowances to taxation
as ordinary compensation would correct this situation.
But such
a change should be accompanied by adjustments in the budget
process necessary to make this policy practical.
(e) Distinguishing overseas government employees from
other employees.
The principal reason for paying the allowances
is to compensate for increased living costs in certain locations.
Differential living costs are also encountered by private
sector employees overseas and by U.S. Government employees in
the United States, and are similarly reflected either in varying
amounts of compensation or in difficulties filling positions
in certain locations.
The argument for exempting the allowances
from tax is basically an argument that part of differential
living costs should be borne by taxpayers in general rather
than by the particular employee.
This argument has fundamental
shortcomings, as noted earlier.
If tax adjustments for differential living costs are not
made as a matter of general policy, the question remains whether
adjustments should be made for a particular group, such as
- 18 overseas government employees. Part of the answer to this
question depends on whether such adjustments seem inequitable
by comparison with the tax treatment of similar groups.
In deciding to phase out the foreign earned income
exemption of private sector employees, the Ways and Means
Committee said:
"Your Committee notes that some of
the same reasons for repeal of the
exclusion for private industry
employees might be equally valid
to the exclusions for governmental
employees." 1/
The comparison between overseas government employees
and government employees stationed in the United States is
in many respects better than the comparison with private
sector employees overseas. The only relevant tax for overseas government employees is the U.S. tax, whereas overseas
private sector employees are affected by the foreign tax liability and foreign tax credit. However, where a government
and private sector employee work side by side in a foreign
country and receive the same gross pay, it is difficult to
justify exempting the living allowances of one and not the
other.
3. Other considerations.
(a) Official expenses. Some allowances may be viewe
as representing reimbursement for official expenses. As such
they may be either excluded or included in income and allowed
1/ House of Represenatative Report 94-658, November 12, 1975,
page 200.
- 19 as a deduction.
However, those expenses which are business
expenses under current law would not include many important
allowances, such as the cost of living, education or housing
allowances.
To broaden the limits of deductibility would
raise a serious problem of where to draw the line for overseas
government employees as well as for government employees based
in the United States and private sector employees based overseas.
(b) Education expenses.
The situation of government
employees is parallel to that of private sector employees
with respect to expenses incurred in providing elementary
and secondary schooling for dependents: publicly financed
schooling might be inadequate, and the families may have to
rely on private schooling.
The State Department regulations
provide allowances to cover the cost of transportation, room
and board, and tuition and other school expenses at a private
school where the local facilities are judged inadequate.
H.R. 10612 provides for a duduction of $1,200 per year per
child (up to 19 years old) for tuition expenses paid by private
sector employees when both the taxpayer and the dependent are in
one or more foreign countries for 330 days in a 12 month period.
The 330 day requirement for the taxpayer may be strict for those
employees, both private sector and government, who have to return
to the United States on business frequently or for extended
periods.
The amount of the deduction deserves further review
as well.
The problem is to balance the extra burden borne by
private and government employees abroad against the considerations that: (a) they may not pay U.S. state and local taxes,
- 20 which finance most U.S. public education at the elementary
and secondary levels; (b) many U.S. residents who do pay
state and local taxes nevertheless use private schools for
their children without being allowed a deduction for the
added costs; and (c) some of the schools used by foreign
service employees are church-sponsored.
(c) Housing costs.
Government and private sector employees
face the same problems of high cost housing in many foreign
cities.
However, government employees have their full housing,
including utilities, provided by their employer, and are not
required to report any part of that as taxable* income.
Table 5
gives some examples of housing allowances in various foreign
cities.
Private sector employers frequently pay part of the
housing and utility costs of overseas employees, typically the
excess over the estimated U.S. cost or the excess over some
percentage of the salary, but the employer-paid portion is
considered taxable income to the employee.
Some argue that housing provided by the U.S. Government
for overseas employees serves the convenience of the employer
and therefore should not be taxable to the employee.
The
standards for determining when housing is for the convenience
of the employer are fairly stringent under current law.
Section 119 of the Internal Revenue Code provides that if
lodging is to be excluded from gross income on the grounds that
it is furnished for the convenience of the employer, then the
employee must be required to accept lodging on the business
premises of the employer as a condition of his employment.
/t3
Table 5
Examples of State Department Housing Allowances,
as of January 1976
Frankfurt
Annual allowances for an
employee with dependents
earning basic salary
of $15/000-$26,999
$4 300
Tokyo, (city)
4 500
Seoul
4 400
Manila
3 800
London
5 100
Rome
7 200
Bangkok
4 400
Madrid
6 500
Mexico City
6
400
Ottawa
5 600
Brussels
8 500
Paris
9 400
the Hague
6 900
Barbados
5 500
Iran
400
Kuwait
000
Office of the Secretary of the Treasury
Office of Tax Analysis
Source:
March 26, 1976
U.S. Department of State, Allowances Staff
/JY
- 21 The regulations explain that to be a condition of employment,
residence in that lodging must be necessary to proper
performance of the duties of employment and that the lodging
must be furnished in kind with no option to take a cash allowance in lieu of that lodging (Reg. 1.119-1(d)(6) and (c)(2)).
There are numerous rulings and court decisions interpreting
these rules; but clearly in its present form the statutory
tests would be difficult for the average foreign service
employee to meet.
The Ambassador's residence presumably
would qualify as being for the convenience of the employer.
Revenue Ruling 75-540 states that a Governor's mansion does so
qualify.
The cases where lodging furnished by the employer
meets the statutory tests of being for convenience of the
employer follow more from the nature of the employment than
from the location of employment.
In short, if Section 912
is repealed, free housing of overseas employees will almost
always be taxable income to the government employee.
Congress could legislate special relief for the added
burden which would result if foreign employee housing allowances
were reduced by subjecting them to tax.
One question then
would be whether such relief should be made available to
private sector employees in similar circumstances.
In both
cases, the principal beneficiary would be employers with overseas staff.
- 22 One possibility would be to allow a deduction for the
portion of housing costs incurred for business purposes, such
as official entertainment.
Such a rule,however, would be
difficult to administer and complicated for the taxpayer who
would have to pro-rate rent and utilities by hours.
Another possibility would be to allow a deduction for
the cost of foreign housing in excess of the cost incurred by
similar employees in the United States.
employees do not enjoy
Since domestic
tax relief for high housing costs,
it might be desirable to limit any such relief to costs above
a reasonably high U.S. base, and perhaps to provide an upper
limit to minimize any incentive to acquire lavish housing by
Americans overseas.
In addition to determining the amount of
such a deduction, there would have to be rules on what is
included in housing costs (utilities, telephone, cable TV?);
who is eligible (should government employees in the possessions,
Alaska, Hawaii, New York be eligible?; if private sector
taxpayers qualify, does this include self-employed persons,
employees of foreign firms, corporate directors?);and the
conditions on which housing is furnished (must it be available
to all employees?). Rental value would have to be imputed in
many cases.
Such a relief provision would be complex and difficult
to administer.
But the governmen allowances and the Section
911 exclusion are already complex and difficult to administer.
Furthermore, there is precedent in the Code for allowing
deductions for extraordinary personal expenses (e.g., medical
- 23 expenses in excess of 3 percent of adjusted gross income).
special deduction for "excess" housing costs would have the
advantage of focusing relief on a particular expense related
to the location of the employment and would be limited to the
portion of that expense which exceeds the cost of comparable
housing for employees at the U.S. headquarters.
/Jf7
- 24 IV.
OPTIONS
!•
Retain present law.
This option would put the least
strain on employing agencies and affected employees.
The
present system of exempting from tax allowances paid to
government employees outside the United States, and in some
cases in Alaska and Hawaii, reduces the cost to the employing
agency of maintaining U.S. citizens in those posts.
It has
been argued that most allowances just offset the higher living
costs entailed by an overseas assignment.
However, the
exemption can amount to preferential tax treatment for a certain
group of government employees compared to government employees
in other locations and compared to private sector employees in
the same locations.
2.
Repeal the Section 912 exclusion entirely.
This option
would subject to tax all of the allowances now excluded under
Section 912.
Some of the allowances would not be taxable,
due to offsetting expense deductions permitted under other
sections of the Internal Revenue Code, but many allowances,
including those for education, cost-of-living increases, and
housing would become taxable.
need increased appropriations.
The employing agencies would
If private sector employees
overseas are allowed a deduction for tuition expenses of
dependents, as provided in H.R. 10612, government employees
in the same posts would be put at a disadvantage.
- 25 3.
Substitute for Section 912 a tuition expense deduction
and an exclusion for the value of employer-provided municipal
type services.
This option would put government employees in
essentially the same position as private sector employees
in foreign posts if the provisions of H.R. 10612 are enacted
with respect to Section 911.
It would put government employees
in a worse position than under present law and would require
increased budgets for salaries or allowances to attract qualified
persons to fill such posts, although the necessary increases
would not be as great as under option 2.
Specific statutory relief should be considered for
several of the. minor allowances which, though they might be
treated as taxable income in the absence of Section 912,
might none-the-less be considered as justifiably excludable
from income or deductible.
This category might include
allowances for emergency evacuation from a post and allowances
for preparation and transportation of remains of a deceased
employee.
4.
Allow a deduction for housing costs in excess of the
costs of comparable U.S. housing, in addition to those listed
in option 3.
A deduction for "excess" housing costs above
those which the employee would have incurred if employed in
the United States might be appropriate to deal with the principal
component of extraordinary living costs associated with foreign
employment.
It would significantly reduce the added tax liability
of employees in areas where desirable housing is scarce, and
would, therefore, relieve the budget burden on the employing
0
- 26 agencies. At the same time, taxing the other allowances
would reduce the windfall element and- permit more accurate
accounting of the costs of the overseas operations.
On the
other hand, there would be a problem of drawing the line,
particularly with respect to private sector employees overseas who encounter the same high costs in certain posts. 1/
The net revenue cost of such a deduction for government
employees would be small, since housing allowances in excess
of the permissible deduction would be taxable, and since in
the absence of the deduction the government would have to
increase the allowances to attract the same quality of personne
The revenue cost of such a deduction for private sector employe
would be greater since there would usually be no offsetting
effect on outlays (there could be some offset where the allowance is a deductible expense for U.S. tax of a U.S. employer).
Government employees would have an added tax liability with
respect to other allowances, and salaries or allowances would
have to go up by part of that increased tax liability.
5.
Make Section 912 inapplicable to employees serving
in Alaska or Hawaii.
Although employees in Alaska and Hawaii
constitute about 40 percent of Federal employees eligible for
1/ If a distinction between private and public sector employees
is not justifiable, then a deduction for extraordinary housing
costs (applicable to all overseas employees) might be inappropriate. The reason is that the revenue loss from such a deduction for all employees may significantly outweigh the cost of
increasing allowances to compensate Federal employees for the
additional tax burden in the absence of such a deduction.
- 27 the Section 912 exemption, the revenue loss attributable to
their allowances is relatively small.
Nevertheless, the
distinction between employees serving abroad and those
serving at domestic posts (both groups encounter variable
living costs) is confused by applying the exemption to
Alaska and Hawaii.
The increased burden on government
employees in Alaska and Hawaii might be a necessary price to
pay for justifying any continuation of the exemption for
employees assigned to foreign countries.
0O0
L
7'00/>
- 8 -
)S/
ACT
June 30, 1974
88 Stat. 285
increased sec. 21 limitation by
$95 billion during the period
beginning June 30, 1974 and
ending March 31, 1975
$495,000,000,000
Feb. 19, 1975 increased sec. 21 limitation by
89 Stat. 5
$131 billion during the period
beginning February 19, 1975 and
ending June 30, 1975
531,000,000,000
June 30, 1975 increased sec. 21 limitation by
89 Stat. 246
$177 billion during the period
beginning June 30, 1975 and
ending November 15, 1975
Nov. 14, 1975 increased sec. 21 limitation by
89 Stat. 693
$195 billion during the period
beginning November 14, 1975 and
ending March 15, 1976
March 15, 1976 increased sec. 21 limitation by
$227 billion during the period
beginning March.15, 1976, and
ending June 30, 1976
577,000,000,000
595,000,000,000
627,000,000,000
ie Department 0/ r/ie
NGTON, D.C. 20220
TREASURY
TELEPHONE 964-2041
April
1976
/32
BIOGRAPHY
W3S a
United State; I f
PP oin ted a Special Agent of the
fSld office
? h f ^ ? T r V 1 C e ° n J U n 6 2 9 ' 1 9 7 0 ' i n t h e Chicago
07071fflce'
. T h e . following year he was transferred to the
Intelligence Division at Secret Service Headquarters in
the p S ^ n M a i ' p ^ f
i
" . D e c e m b - "72, he wa? reassigned to
tne Presidential Protective Division. During the 1972
Campaign for President and Vice President of the United
States, Agent Buendorf was assigned to security for the
Born in
Wells,
MinnesotaCandidate
on November 18, 1937 Buendorf
Democratic
Vice
Presidential
received a bachelor of science degree from Mankato State
College
U S Navv
L
fu^equently he served as a pilot with the
Ear^h M?»
I9 s c * ° o 1 business teacher and coach in Blue
a
Service
' " * a S p e C i a l A g e n t o f t h e N a v ^ Institute
*During
* , his career with the U.S. Secret Service Aaent
beSn
Gi
ient
Awlrfln
i
?
?
,
/
^
P
°f the Expert M a r k f m a S p
in 1973,
in 1975.
1973. and the Distinguished Expert Marksmanship
Award in
On September 5, 1975, while providing crowd security
B u e n d ^ f 1 ^ ^ G ^ a l d R- F ° r d i n S*cramento, California" Agent
reaatTL? H 6 ^ a W e a p ° n a i m e d a t t h e President. Without
i n X r n o S uXS P ? ^ s ° n a l safety, Agent Buendorf immediately
seiJS ?hf J i m S e l f between the assailant and the President,
indfvffl,^? f ? ; r e a r m a ? d assisted in the apprehension of the
individual who was attempting to use it.
n
November 25, 1975, Secret Service Director H. Stuart
Kn. °
n
Buend f, s
actiSn ^77
0 .
and exemplary
with777^77±
the presentation
of theefficient
Secret Service
Valor Award.
oOo
Contact; Herbert C. Shelley
Extension: 8256
April 5, 1976
FOR IMMEDIATE RELEASE
TREASURY DEPARTMENT ANNOUNCES
COUNTERVAILING DUTY INVESTIGATION OF
CERTAIN SCISSORS AND SHEARS FROM BRAZIL
Assistant Secretary of the Treasury David R. Macdonald
announced today the initiation of a countervailing duty investigation against certain scissors and shears from Brazil.
A "Notice of Receipt of Countervailing Duty Petition and
Initiation of Investigation" will be published in the Federal
Register of April 6, J.976.
Under the U.S. Countervailing Duty Law (19 U.S.C. 1303)
the Secretary of the Treasury is required to assess an additional customs1s duty which is equal to the amount of the
"bounty or grant" that has been found to be paid or bestowed
on imported merchandise.
The investigation of imports of certain scissors and shears
stems from a petition received on February 9, 1976 from the
National Association of Scissors and Shears Manufacturers alleging that certain scissors and shears (those valued at over
$1.75 per dozen) are benefiting from possible bounties or
grants within the meaning of the Countervailing Duty Law. The
Treasury has until August 9, 1976 to issue a preliminary
determination as to whether a bounty or grant exists. A final
determination must be rendered by no later than February 9,
1977.
During calendar year 1975, .imports of the subject merchandise from Brazil were valued at approximately $1.2 million.
*
WS-762
*
*
/Jr
FOR IMMEDIATE RELEASE April 5, 1976
LARRY M. BUENDORF
RECEIVES TREASURY MERITORIOUS SERVICE AWARD
Secretary of the Treasury William E. Simon today presented
Secret Service Special Auent- Larr^ M. Buendorf with the Treasury
Department's Meritorious Service Award.
Special Agent Buendorf received the award for his
"outstanding bravery and unusually competent action" beyond
his required duties in the deterrence of an attempt on the
life of President Ford in Sacramento, California, on September
5, 1976.
In presenting the award, Secretary Simon cited Buendorfs
"efficient and exemplary action" when "without regard for his
own safety, he immediately interposed himself between the
assailant and the President, seized the firearm and assisted in
the apprehension of the individual who was attempting to use it."
In recognition of his actions, Special Agent Buendorf
received a silver medal and lapel emblem, a certificate and a
miniature Treasury flag.
Mr. Buendorf was appinted a Special Agent of the U.S. Secret
Service on June 29, 1970. He was born in Wells, Minnesota on
November 18, 1937, and received a B.S. degree from Mankato State
College in 1959. Special Agent Buendorf served as a pilot with
the U.S. Navy and also as a Special Agent of the Naval Investigative Service.
oOo
WS-763
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V
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7^(9
H71$1 d
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0P-93
epartmentoftheTREASURY
ON, D.C. 20220
TELEPHONE 964-2041
IN
ft
/
FOR IMMEDIATE RELEASE
&
April 5, 1976
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $2.7 billion of 13-week Treasury bills and for $3.5. billion
of 26-week Treasury bills, both scries to be issued on April 8, 1976,
were opened at the Federal Reserve Banks today. The details are as follows:
RANGE OF ACCEPTED
13-week bills
COMPETITIVE BIDS: maturing J^Y 8, 1976
Price
High
Low
Average
Discount
Rate
Investment
Rate 1/
4.933%
4.969%
4.957%
5.06%
5.10%
5.09%
98.753a/
93.744
98.747
a/ Excepting 1 tender
b/ Excepting 1 tender
Tenders at the low
Tenders at the low
26-week bills
maturing October 7, 1976
Price
97.333 b_/
97.313
97.324
Discount
Rate
5.275%
5.315%
5.293%
Investment
Rate 1/
5.
5.54%
5.51%
of $1,000,000
of $650,000
price for the 13-week bills were allotted 18%.
price for the 26-week bills were allotted 46%.
TOTAL TENDERS RECEIVED AND ACCEPTED BY FEDERAL RESERVE DISTRICTS:
District
Received
82,270,000
$
Boston
,120,790,000
New York
21,630,000
Philadelphia
87,705,000
Cleveland
50,610,000
Richmond
49,885,000
Atlanta
622,115,000
Chicago
69,150,000
St. Louis
63,985,000
Minneapolis
36,530,000
Kansas City
36,620,000
Dallas
San Francisco 355,865,000
T0TALS$5,597,155,000
Accepted
$
37,170,000
1,954,080,000
20,810,000
36,750,000
34,610,000
45,580,000
336,235,000
29,150,000
39,985,000
30,490,000
16,620,000
118,925,000
Received
$
47,310,000
4,697,155,000
44,970,000
87,380,000
151,415,000
40,220,000
258,785,000
62,180,000
59,720,000
24,245,000
36,505,000
220,615,000
$2,700,405,000 c/$5,730,500,000
Accepted
$
30,070,000
2,859,455,000
24,970,000
67,380,000
97,085,000
32,420,000
152,245,000
35,180,000
54,720,000
19,745,000
26,005,000
100,975,000
$3,500,250,000 d/
c/ Includes $ 403,690,000 noncompetitive tenders from the public.
d/ Includes $223 580 000 noncompetitive tenders from the public.
1/ Equivalent coupon-issue yield.
WS-764
TREASURY
TELEPHONE 964-2041
FOR R E L E A S E A T 11:45 A . M .
April 5, 1976
TREASURY OFFERS $2.5^BILLION OF TREASURY BILLS
The Department of the Treasury, by this public notice, invites tenders for
$2,500,000,000, or thereabouts, of 14- day Treasury bills to be issued
April 8, 1976, representing an additional amount of bills dated October 23. 1975,
maturing April 22, 1976 (CUSIP No. 912793 ZD 1 ) .
The bills will be issued on a discount basis under competitive bidding,
and at maturity their face amount will be payable without interest. They will
be issued in bearer form in denominations of $10,000, $15,000, $50,000, $100,000,
$500,000 and $1,000,000 (maturity value), and in book-entry form to designated
bidders.
Tenders will be received at all Federal Reserve Banks and Branches up to
1:30p.m., Eastern Standard time, Wednesday, April 7, 1976. Tenders will not be
received at the Department of the Treasury, Washington. Wire and telephone
tenders may be received at the discretion of each Federal Reserve Bank or
Branch. Tenders must be for a minimum of $10,000,000. Tenders over $10,000,000
must be in multiples of $1,000,000. The price on tenders offered must be
expressed on the basis of 100, with not more than three decimals, e.g., 99.925.
Fractions may not be used.
Banking institutions and dealers who make primary markets in Government
securities and report daily to the Federal Reserve Bank of New York their
positions with respect to Government securities and borrowings thereon may
submit tenders for account of customers provided the names of the customers
are set forth in such tenders. Others will not be permitted to submit tenders
except for their own account. Tenders will be received without deposit from
incorporated banks and trust companies and from responsible and recognized
dealers in investment securities. Tenders from others must be accompanied by
payment of 2 percent of the face amount of bills applied for, unless the tenders
are accompanied by an express guaranty of payment by an incorporated bank or
trust company.
Public announcement will be made by the Department of the Treasury of the
amount and price range of accepted bids. Those submitting tenders will be advised
of the acceptance or rejection thereof. The Secretary of the Treasury expressly
reserves the right to accept or reject any or all tenders, in whole or in part,
and his action in any such respect shall be final. Settlement for accepted
tenders in accordance with the bids must be made at the Federal Reserve Bank
or Branch on April 8,1976, in immediately available funds.
IVS 76 5
Under Sections 454(b) and 1221(5) of the Internal Revenue Code of 1954 the
amount of discount at which bills issued hereunder are sold is considered to
accrue when^the bills are sold, redeemed or otherwise disposed of, and the bills
are excluded from consideration as capital assets. Accordingly, the owner of
bills (other than life insurance companies) issued hereunder must include in his
Federal income tax return, as ordinary gain or loss, the difference between the
price paid for the bills, whether on original issue or on subsequent purchase,
and the amount actually received either upon sale or redemption at maturity
during the taxable year for which the return is made.
Department of the Treasury Circular No. 418 (current revision) and this
notice, prescribe the terms of the Treasury bills and govern the conditions of
their issue. Copies of the circular may be obtained from any Federal Reserve Bank
or Branch.
NOTICE TO CORRESPONDENTS:
ApriJ 5, 1976
George Dixon, the recently confirmed Deputy Secretary of the
Treasury, will be available for a "get acquainted" meeting v;ith
reporters in his office, room 3326, at 10 a.m. Thursday April 3.
While no specific announcements will be made, the meeting will
be on the record.
Bill Rhatican
Special Assistant to the Secretary
(Public Affairs)
oOo
he Department of the'fREASURY
\SHINGT0N, D.C. 20220
TELEPHONE 964-2041
April 5, 1976
/ / /
GEORGE H. DIXON OF MINNEAPOLIS, MINNESOTA, SWORN IN
AS DEPUTY SECRETARY OF THE TREASURY
George H. Dixon, former Chairman and President of the
First National Bank of Minneapolis, was sworn in today as
Deputy Secretary of the Treasury by William E. Simon,
Secretary of the Treasury. Mr. Dixon succeeded Stephen
Gardner who is now Vice Chairman of the Federal Reserve
Board.
Born on October 7, 1920, in Rochester, New York, Mr.
Dixon received his B.S. degree from Wharton School of
Finance at the University of Pennsylvania in 1942. He attended
Harvard University Graduate School of Business and received his
M.B.A. in 1947, He served in the United States Army during
World War II as a Captain.
In 1947, Mr. Dixon joined the Brown Brothers Harriman 5
Company of Boston, Massachusetts. He became a Partner in the
firm of Davis and Davis of Providence, Rhode Island in 1950.
From 1956 to 1968 he was the Vice President-Finance and
Treasurer of Sperry § Hutchinson Company of New York, New York.
He joined the First National Bank of Minneapolis as President
and Chief Administrative Officer in 1968.
Mr. Dixon is married to the former Marjorie Freeman and
they have three children.
oOo
WS-766
770
April 1976
GEORGE H. DIXON
DEPUTY SECRETARY OF THE TREASURY
George H. Dixon was sworn in as Deputy Secretary of the
Treasury on March 3, 1976. As Deputy Secretary, Mr. Dixon
is responsible for the general supervision of all day-to-day
functions of the Department and for acting for the Secretary
in his absence, sickness, or unavailability.
Prior to becoming Deputy Secretary, Mr. Dixon served as
Chairman, President, and Chief Executive Officer of the First
National Bank of Minneapolis,which he joined in 1968. He was
Vice President Finance and Treasurer of the Sperry & Hutchinson Company of New York from 1956 to 1968, and a general
partner in the investment firm of Davis and Davis of Providence,
Rhode Island from 1950 to 1956. He began his business career
in 1947 with Brown Brothers Harriman & Company in Boston,
Massachusetts.
Mr. Dixon has served as a director of the following
Minnesota-based companies: First National Bank of Minneapolis,
First Bank System, Inc., First Computer Corporation, Soo Line
Railraod Company, International Multifoods Corporation, Donaldson Company, Inc., Fingerhut Corporation, and Honeywell, Inc.
He was also a director of Brown Harriman and International Banks
Limited of London, England. His professional affiliations included membership on the Federal Advisory Council representing
the Ninth Federal Reserve District and serving as a director
of the Association of Reserve City Bankers and as trustee of
its Banking Research Fund. He is a trustee of Carleton College
in Northfield, Minnesota, and was active in numerous civic and
community endeavors in the Minneapolis area.
Mr. Dixon was born October 7, 1920 in Rochester, New York.
He was educated at the University of Pennsylvania's Wharton
School of Finance where he received a B.S. degree in 1942 and
at Harvard University's Graduate School of Business where he
earned a M.B.A. degree in 1947.
He is married to the former Majorie Freeman of Providence,
Rhode Island and they have three children. Mr. Dixon and his
wife presently reside in Washington, D.C.
0-n^l
DEPARTMENT OF THE TREASURY
OFFICE OF NEW YORK CITY FINANCE
Introductory Statement of Robert A. Gerard
Deputy Assistant Secretary (Capital Markets Policy)
Department of the Treasury
For Presentation to the Senate and House
Subcommittees on Appropriations
April 6, 1976
I am pleased to describe for you this morning the
activities of the Department of the Treasury under the New
York City Seasonal Financing Act of 1975.
Our appropriation for fiscal 1976 is $1 million. These
funds cover the six month period from enactment to June 30,
1976. For the transition quarter (June 30, 1976 to September 30,
1976) our appropriation is $315,000.
We are now requesting that you appropriate $1,250,000
to enable Treasury to carry out its responsibilities under
the Act during fiscal 1977. This amount is more than the
current appropriation of $1 million but substantially less,
on an annualized basis, than the current year's appropriation.
The amount requested is approximately equal to the annualized
rate for the transition quarter.
The Act
The New York City Seasonal Financing Act of 1975 was
enacted on December 9, 1975. It reflects Congress' findings
that: "It is necessary for the City of New York to obtain
seasonal financing from time to time because the City's
revenues and expenditures, even when in balance on an annual
basis, are not received and disbursed at equivalent rates
throughout the year." Furthermore, Congress found that such
financing, while necessary to maintain essential government
services, may not be available from customary sources.
To maintain essential services, the Act authorizes the
Secretary of the Treasury to loan up to $2.3 billion to the
City of New York. Each loan must be repaid by the end of
WS-768
0
- 2 the City's fiscal year. If, and only if, such loans are
repaid, they may then be renewed for the following fiscal
year. Loans may be renewed through fiscal 1978. At that
time, the loan must be repaid and the Act expires.
The interest rate on these loans is fixed at one percent
above the interest rate paid by Treasury for loans of
comparable maturity. As a result of this interest differential,
the Federal Government will obtain revenue from the loan.
After subtracting the $1 million appropriated to Treasury
for administrative costs, the net revenue to the Federal
Government in fiscal 1976 will be approximately $3.3 million.
In fiscal 1977 and 1978, revenues will be substantially
higher since the average amount and duration of the loans
wilL increase « sharply.
We are responsible for ensuring that the loans are
repaid. To do this, we may insist upon whatever terms and
conditions he considers necessary. We intend not only to
seek the best collateral reasonably available, but also the
maximum amount of relevant information about the financial
condition of the borrower -- the City of New York. It is
the task of securing, analyzing, and verifying the financial
condition of the City which is the single greatest cost
envisioned. I shall describe this task after describing
actions which have been accomplished to date.
The Loans
We have $1.26 billion in loans outstanding. The first
loan -- $130 million -- was made December 18, 1975 and will
be repaid on April 20. Since then, we have made 5 loans
which mature on various dates between April 20, and June 30, 1976.
On a monthly basis, the schedule calls for repayment of
$270 million on April 20, $240 million on May 20, and a
total of $750 million on June 20 and June 30.
At the time these loans were made, and at this time, it
is our view that there is a reasonable prospect that these
loans will be repaid in accordance with their terms and
conditions.
The objective of the Act was to help the City to maintain
essential services and deal with seasonal cash flow problems
while it is implementing its Plan to eliminate its budget
deficit. The Act has accomplished this. Essential services
have been maintained and the City is carrying out the budgetary
measures which were promised.
0
The Fiscal Plan
The seasonal funding provided by the Act is an integral
part of the Financial Plan devised by City and State officials.
The Plan!s objective is to eliminate the City budget deficit
by June 30, 1978 and to provide sufficient cash to allow the
City to operate during the interim period when it cannot
obtain financing in the public credit markets.
In September 1975. the State of New York decided to
commit its own credit and resources to assisting the City,
but it also mandated certain changes. The City was required
to eliminate its deficit by June 30, 1978, and to submit a
detailed three year plan outlining the steps it would take
to this end. Furthermore, the Emergency Financial Control
Board was established, chaired by the Governor, and given
virtually unlimited powers over the financial affairs of the
City.
In late November, we were presented with a financing plan
that financed New York City's past and future deficit financing
needs. It is detailed in Secretary Simon's April 1 testimony,
a copy of which I am submitting for the record.
In addition, however, financing was required for meeting
seasonal cash flow needs. Although the financing plan was
designed to eliminate the deficit over the course of the fiscal
year, revenues and expenditures did not balance on a monthly
basis. Accordingly, we asked Congress for authority to make
short-term seasonal cash flow loans. Such authority was
granted early last December with the passage of New York City
Seasonal Financing Act of 1975.
A New Resolve
It is, of course, too early to tell whether the measures
taken last fall will be accompanied by all of the actions
necessary to restore New York City to fiscal and financial
viability. But on March 26, Mayor Beame took an important
step in that direction.
He presented a detailed plan to eliminate the $986 million
deficit which the City now projects for fiscal 1978, and to
generate a $76 million surplus that year. While the plan
relies on some assumption of costs by the State, and a
$55 million increase in Federal aid under existing programs
by 1978, most of the cuts are to be accomplished by the City
itself.
- 4The plan does not postpone the hard decisions by unduly
backloading them into 1978. It is a serious plan and -- in
the context of a city which has already pared its payrolls
by 40,000 persons in the last year -- it is a realistic
plan.
Even more heartening is that the plan not only proposes
to make the cuts which the critics last October said could
not be made, but it also identifies additional cuts. The
reason for these additional cuts is that the City continued
to review its data since October and concluded that its
original deficit estimates were too low. The City did not
try to bury the revised estimates nor plead for major new
infusions of Federal funds. Instead, it frankly acknowledged
that the facts now tell a different story, and promptly
revised its plan to deal with them. This forthright response
reflects a new spirit of resolve in the City today.
This new spirit is the result of several changes:
primarily the realization that the public, as well as the
capital markets, will no longer tolerate financial gimmickry
as a solution to real problems. It is a result of the new
team of financial experts that Mayor Beame has assembled.
And, most importantly, it is a result of the Mayor's own
determination to face up to New York's problems.
These developments are grounds for cautious optimism
about the City's future. I say "cautious" because we are
not yet home, not even half way home. But we now know what
many previously doubted; the preconditions for fiscal recovery
exist. There are clear signs that the City recognizes it
must deal with its own problems and is resolved to do so.
Congress contributed materially to this process by
imposing the firm conditions which encouraged the City to
put its own house in order. But I hope that those of you
who believe this prognosis too optimistic will be encouraged
by the fact that we do not propose to let our guard down.
The commitments have been made. That, in itself, is an
important accomplishment. But the task is to make sure they
are carried through.
Credit Agreement
On December 30, 1975, with the assistance of the law
firm of Ropes and Gray and the accounting firm of Arthur
Andersen, we completed negotiations with the City, State,
Municipal Assistance Corporation, and the Emergency Financial
Control Board and executed a Credit Agreement with these
parties.
record.
I am submitting a copy of this document for the
Our first requirement was that all the parties -- the
City the Comptroller, the Control Board and, where necessary
the State -- must agree to stand by the spirit of the Agreement
and the reports they make. Furthermore, they pledged in the
Agreement to inform us of adverse developments, of changes
in the plan, and to use maximum efforts to protect our
interests.
We then insisted that each Federal loan be secured not
only by the general obligation of the City but also by the
pledge of a specific revenue. Furthermore, when this revenue
comes due, it must be paid into a specific bank account for
the benefit of the Secretary of the Treasury. To date the
City has pledged $1,944 billion in revenues, nearly all
tunds due from the State, to cover the $1.26 billion in
loans outstanding. Each Federal loan, therefore, is secured
both by specific revenues and by the general obligation of
a
the City.
Finally, the Credit Agreement allows us to develop
something which has not previously been available -- accurate
financial information. By law, the City is required to
develop an auditable accounting system by July 1, 1978.
But, to assist us in assessing the prospects for repayment,
we must have the best available information about what is
happening in the interim. Consequently, the Agreement
provides that the City must prepare -- and the Control Board
must approve -- detailed reports, designed with the assistance
of Arthur Andersen. Perhaps the most important of these is
a report covering virtually every significant financial
aspect of the City's activities -- revenues, expenses, cash
flow, employment, etc. This report -- 65 pages filled with
statistics in its latest version -- is due each month.
In addition to the protections I have enumerated, the
Credit Agreement also confirms our power under the Act to
audit books and records, and it provides numerous additional
protections.
The Arthur Andersen Report
In the best of times, municipal finance is a complex,
specialized, and difficult field. As you know, there are no
disclosure requirements in municipal finance comparable to
those imposed on corporations. Nor are cities required to
- 6produce a financial statement which is auditable by an
independent accountant. In short, our dilemma was simple:
we had neither the information, nor the expertise required
to analyze it. Yet we needed such background to carry out
our responsibilities.
Let me describe some of the facts known in December 1975
which led us to believe that we needed immediate expert
advice to carry out our responsibilities under the Act:
The Municipal Assistance Corporation, established
in June 1975 to assist the City in borrowing
money, found itself unable to float loans on the
public market by July.
The City had never issued a report certified by an
independent public accountant.
A State law requires that the City balance its
budget. And, each year, the City had duly
certified -- in accordance with its accounting
system -- that its budget was balanced. Nevertheless,
its short term debt load had risen since 1961,
resulting in a multimillion dollar deficit.
On December 12, 1975, we retained the accounting firm
of Arthur Andersen and Company to advise us on several
matters. First, we needed an overview of the City's financial
situation. Second, we needed a reporting system to allow us
to monitor the City's financial conditions and progress ^
toward eliminating its deficit. Third, for both the City s
benefit and ours, we needed to know the potential problems
in the City's financial plan, and the state of the systems
by which the City's financial data is generated.
Andersen received the complete cooperation of the City
in undertaking its study, and submitted a report, as of
December 29, to the Treasury. The final report was released
to the public on January 14. I am submitting a copy for the
record.
Later I shall discuss some of the numerous specific
findings, but three points highlight the scope of the task
that we faced in monitoring the City's financial condition:
The City does not have an auditable accounting^
system; it is essentially unable to determine its
actual accounts payable or receivable on a current
basis.
- 7Consequently, it is unable to prepare a consolidated
statement of financial position.
It will take a substantial period of time to
implement an auditable accounting system.
Since December, the City has made a major effort to
remedy this situation, but it is a long-term process and it
would be unrealistic to expect immediate cures.
Progress Since December
Since January, we have made the loans which I described
earlier, and focussed our efforts on improving the monthly
reports. There are still many uncovered areas left, many
qualifications and many inconsistencies which suggested that
the City was either unable to provide key parts of the
report, or did not understand their purpose.
We went back to the City. We discussed the omissions,
pointed out the inconsistencies, and tried to indicate where
the information supplied was not what the report called for.
The second monthly report, received on March 15 and
covering the month of January, was a distinct improvement
over the previous one. But it had some of the same problems
on a smaller scale. We went back and discussed them again.
By March, we had enough experience to request Arthur
Andersen to revise the monthly reports so as to provide
better information. At the same time, we asked them to
review the revised Financial Plan and the City's procedures
for improving the systems. Andersen is presently conducting
these reviews, and will submit a report to us this month.
In revising these reporting requirements, we have
worked closely with the staff of the Emergency Financial
Control Board in order to develop reports that will serve
our joint requirements. This will simultaneously reduce the
reporting burden on the City and expand the scope of our
coverage.
In the course of our work, we have already learned a
great deal about the City's cost and revenue structure. The
Act does not authorize us to decide which action the City
should take in meeting its Plan, but we felt we would be
remiss in not making available our analyses about areas
where costs might be cut over both the near- and long-term.
- 8The Task Ahead
The Act has already accomplished part of its objective.
The Beame Plan is a milestone, evidence that the City is
able, willing, and determined to take the steps necessary to
eliminate its deficit by June 30, 1978.
But the task ahead is made more difficult by the fact
that, as each month passes, we must obtain better and more
reliable information about the status and prospects for the
City. If we cannot do this, it will become increasingly
difficult to authorize loans.
More reliable data is needed because each month the
margin for error grows thinner. We can confidently conclude
that there is a reasonable prospect for repayment of the
loans we have made this year, despite known problems with
the data, because there is a comfortable margin for error.
If the City finds that it has incorrectly estimated revenues
or expenses, there is still more than two years to correct
it. In this first year of the Plan, there is still enough
flexibility in the three-year financing plan to cushion
these errors while the corrections are being instituted.
But as time passes, it will become increasingly difficult
for the City to make whatever corrections are necessary.
Consequently, complying with statutory conditions precedent
to making the loan will become increasingly difficult without
greater confidence in the reliability of the facts.
To ensure that future data is sufficiently reliable to
make the judgments the Act requires, we must be confident of
the facts and the forecasts. We must have evidence that
their reliability is improving -- and this means audits and
independent analyses.
The task of auditing the nation's largest city is
enormous. Apart from the City's own financial staff, the
State has some 85 auditors assigned to this job. In addition,
the Emergency Financial Control Board has currently established
a staff of some 50 professionals, most of whom are auditors
and accountants.
Even a very limited review of the City's economic
progress can be time consuming in view of the complexity of
the issues. In testifying before the Senate Committee on
Banking, Housing, and Urban Affairs on April 2, Comptroller
General Elmer Staats indicated that even the limited "oversight
0
role envisioned for the GAO is likely to require 12-14
staff-years annually.
Nevertheless, we believe it will be possible to carry
out our responsibilities under the Act with the funds we
have requested. We intend to keep the office small by
relying on outside expertise for assistance during peak
periods and in specialized studies. Furthermore, we will
coordinate our work with the State, Control Board, and the
GAO so as to take maximum advantage of the studies they are
undertaking.
But our greatest asset in attempting this monitoring
agreement with very limited staff is the Credit Agreement
and the reports which the City must prepare in compliance
with this Agreement. The Credit Agreement provides all the
reports which the Secretary will normally need to authorize
a loan, and allows him to request others. The job is to
assure that the facts and forecasts contained in these
reports are accurate.
To oversee this task, and to carry out the other
administrative and monitoring functions required by the Act,
we have recently established a separate organizational unit
within Treasury to be known as the Office of New York Finance.
We estimate that it will be composed of approximately a
dozen persons under the direction of a Deputy who reports
directly to the Assistant Secretary.
To verify the factual accuracy of the reports we receive,
the Office will assemble a staff of professionals capable of
undertaking direct audits in limited areas as well as working
with outside accountants and the other auditing groups on
more extensive reviews.
Our first target will probably be review of the expense
reduction program. This is perhaps the single most critical
area if the City is to meet its plan. We know that there
has been some slippage at this point in view of the City's
limited ability to enforce cuts on a monthly -- as opposed
to annual -- basis. At this time, we believe that the most
meaningful time to conduct a full review during the current
fiscal year will be in May or June.
The December Andersen report has identified certain
other areas where inadequate controls suggest that in-depth
analyses may be useful. For example, the time lags in
recording accounts payable, the adequacy of the reserve for
uncollected real estate taxes, and the progress in reducing
capital expenditures are among the key candidates for more
intensive review. It would be difficult to specify the
order at this time, however. We will make the decision on
priorities after we receive the Andersen report due this
month, and have a more precise idea of the audits which the
Control Board staff plans to undertake.
The remaining staff in the office will principally be
devoted to analyzing forecasts and other data which is too
judgmental to be characterized as factual, but is nevertheless
critical to the success of the Plan. Again, the Andersen
report provides an excellent framework. Among the key areas
for study, in our view, are the accuracy of the general
revenue forecasts, the soon-to-be-released Shinn Commission
review of pension cost adjustments, the question of welfare
cost claim disallowances, and the City's projected savings
from withdrawing from the social security system.
Several of these issues have implications for other
cities as well. We will undertake especially detailed
analyses in these areas: How New York resolves its pension
funding, the benefits it derives from withdrawing from the
Social Security system, the interpretation of welfare regulations
affecting New York's claim for reimbursement, and other
questions will be watched closely by other cities. Their
resolution may well set precedents which will endure long
after the last seasonal loan has been repaid.
We are requesting appropriations for the period September 30
1976, through September 30, 1977. In terms of the administration
of this loan, there is no more critical period. It encompasses
the last billion of financing in 1977, under the current
schedule, and the first financings in fiscal year 1978.
With the amount we have requested, $1.25 million to oversee
a $2.3 billion loan, we believe we can carry out this task.
oOo
FOR RELEASE AT 4:00 P.M.
April 6, 1976
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites tenders for
two series of Treasury bills to the aggregate amount of $6,100,000,000 >
thereabouts, to be issued April 15, 1976,
or
as follows:
91-day bills (to maturity date) in the amount of $2,700,000,000* or
thereabouts, representing an additional amount of bills dated January 15, 1976,
and to mature July 15, 1976
(CUSIP No. 912793 ZY 5) , originally issued in
the amount of $3,403,500,000, the additional and original bills to be freely
interchangeable.
182-day bills, for $3,400,000,000, or thereabouts, to be dated April 15, 1976,
and to mature October 14, 1976
(CUSIP No. 912793 B5 4) .
The bills will be issued for cash and in exchange for Treasury bills maturing
April 15, 1976,
outstanding in the amount of $6,094,635,000, of which
Government accounts and Federal Reserve Banks, for themselves and as agents of
foreign and international monetary authorities, presently hold $2,854,980,000
These accounts may exchange bills they hold for the bills now being offered at
the average prices of accepted tenders.
The bills will be issued on a discount basis under competitive and noncompetitive bidding, and at maturity their face amount will be payable without
interest.
They will be issued in bearer form in denominations of $10,000,
$15,000, $50,000, $100,000, $500,000 and $1,000,000 (maturity value), and in
book-entry form to designated bidders.
Tenders will be received at Federal Reserve Banks and Branches up to
one-thirty p.m., Eastern Standard time, Monday, April 12. 1976.
Tenders will not be received at the Department of the Treasury, Washington.
Each tender must be for a minimum of $10,000.
multiples of $5,000.
Tenders over $10,000 must be in
In the case of competitive tenders the price offered must
be expressed on the basis of 100, with not more than three decimals, e.g., 99.925.
Fractions may not be used.
Banking institutions and dealers who make primary markets in Government
WS-769
(OVER)
-2-
'
securities and report daily to the Federal Reserve Bank of New York their positions
with respect to Government securities and borrowings thereon may submit tenders
for account of customers provided the names of the customers are set forth in
such tenders.
Others will not be permitted to submit tenders except for their
own account., Tenders will be received without deposit from incorporated banks
and trust companies and from responsible and recognized dealers in investment
securities.
Tenders from others must be accompanied by payment of 2 percent of
the face amount of bills applied for, unless the tenders are accompanied by an
express guaranty of payment by an incorporated bank or trust company.
Public announcement will be made by the Department of the Treasury of the
amount and price range of accepted bids.
Those submitting competitive tenders
will be advised of the acceptance or rejection thereof.
The Secretary of the
Treasury expressly reserves the right to accept or reject any or all tenders,
in whole or in part, and his action in any such respect shall be final. Subject
to these reservations, noncompetitive tenders for each issue for $500,000 or less
without stated price from any one bidder will be accepted in full at the average
price (in three decimals) of accepted competitive bids for the respective issues.
Settlement for accepted tenders in accordance with the bids must be made or
completed at the Federal Reserve Bank or Branch on
April 15, 1976,
in cash or
other immediately available funds or in a like face amount of Treasury bills
maturing
ment.
April 15, 1976.
Cash and exchange tenders will receive equal treat-
Cash adjustments will be made for differences between the par value of
maturing bills accepted in exchange and the issue price of the new bills,
Under Sections 454(b) and 1221(5) of the Internal Revenue Code of 1954 the
amount of discount at which bills issued hereunder are sold is considered to
accrue when the bills are sold, redeemed or otherwise disposed of, and the bills
are excluded from consideration as capital assets.
Accordingly, the owner of
bills (other than life insurance companies) issued hereunder must include in his
Federal income tax
return, as ordinary gain or loss, the difference between
the price paid for the bills, whether on original issue or on subsequent purchase,
and the amount actually received either upon sale or redemption at maturity
during the taxable year for which the return is made.
Department of the Treasury Circular No. 418 (current revision) and this notid
prescribe the terms of the Treasury bills and govern the conditions of their
issue.
Copies of the circular may be obtained from any Federal Reserve Bank or
Branch.
oOo
he DepartmenTS^REASUR Y
(VSHINGTON, D.C. 20220
TELEPHONE 964-2041
I
/ *
Contact: Herbert C. Shelley
Extension 8256
April 6, 1976
FOR IMMEDIATE RELEASE
TREASURY ANNOUNCES FINAL MODIFICATION OF
DUMPING FINDING ON LARGE POWER TRANSFORMERS
FROM THE UNITED KINGDOM
Assistant Secretary of the Treasury, David R. Macdonald,
announced today a final modification of the dumping finding
on imports of large power transformers from the United Kingdom.
This decision revokes the finding with respect to three U.K.
firms. The dumping finding was published on June 14, 1972
pursuant to the provisions of the Antidumping Act of 1921,
as amended. Notice of the final modification will be published
in the Federal Register of April 7, 1976.
The tentative modification of the dumping finding was
published on November 14, 1975 after it was determined that
three firms, Hawker Siddeley Electric Export, Ltd., London,
England; Ferranti, Ltd., Manchester, England; and Parsons
Peebles Power Transformers, Ltd., Edinburgh, Scotland, had
had no sales to the United States at less than fair value
since the dumping finding. These firms additionally provided
assurances that no future sales would be at less than fair
value.
In addition to the announced modification of the finding,
Mr. Macdonald indicated that a new policy concerning revocation of dumping findings had been established. Assistant
Secretary Macdonald stated that petitioners for revocation
of dumping findings would be notified that if sales at less
than fair value were demonstrated subsequent to a revocation,
a new investigation would be initiated. In the new investigation, however, unlike current Treasury policy, serious
consideration would be given to making any withholding of
appraisement issued retroactive from the date of such
withholding.
Mr. Macdonald noted that "this measure will ensure our
continued even-handed and equitable administration of the
Antidumping Act.11
JU JU J/\
WS-770
/v
/*
>„rL,L. n,^A
Department
of the Treasu^/
Office of the Fiscal
ibbm:aa!5_date: 4/2/76 Assistant Secretary
The attached Fact Sheet has been
revised to broaden the third sentence of
paragraph 11 to reflect all local
financial organizations -- not only
banks. We plan to meet with all financial
organization groups.
J.T. Spahr
0
FACT SHEET ON CLOSING OF CASH ROOM
For Use by Office of Public Affairs
1. The Cash Room was established in 18 69 and was a part of the
so-called "Independent Treasury System" consisting of the
Treasury building in Washington, D,C, and nine Subtreasuries
located in principal cities throughout the United States.1/
2. The function of the Cash Room and the Subtreasuries was to
provide for the receipt and payment of public moneys, Thus,
they accepted deposits from Government disbursing officers,
redeemed and issued United States currency and coin, and
cashed checks, warrants and drafts drawn on the Treasury.
3. From the time of establishment of the Independent Treasury
System in 184 6 until the National Banking System was established in 1863, the Subtreasuries served to decentralize
the Treasuryfs transactions with the public — at a time
when the Charter of the Bank of the United States had been
revoked and during a period when State banks were not
capable of serving the Federal Government's financial needs,
4, With the advent of the National Banking System in 1863, the
Treasury began to cooperate more closely with banking
interests for economic and practical reasons, but retained
the Independent Treasury System at arm's length from the
banking'system. With the establishment of the Federal
Reserve System in 1913, the Independent Treasury System
became obsolete for all practical purposes and the Subtreasuries
were discontinued by legislation in 1920 t
5. The Cash Room has continued operation, howeverr providing
some of the services provided to the public generally by
commercial banks: cashing checks drawn on the Treasuryf
exchanging currency and coin, issuing and .redeeming U t S t
Savings Bonds, and redeeming coupons on U*St bearer obliga^
tions,
6. The services provided at the Cash Room — principally cashing
checks and receiving deposits of collections from Government
agencies — are no longer economically justifiedr and the
operation is targeted to be discontinued on June 3C, 1976,
1/ These cities were Boston, New York, Chicago, San Francisco,
New Orleans( Baltimorer St. Louisr Philadelphia, and Cincinnati,
-2The Treasury does not perform these services at any other
location in the United States, and the cost is too great
merely to maintain a tradition stemming from the earlier
Independent Treasury era.
. With respect to agencies now depositing collections with the
Cash Room, arrangements are being made for such deposits to
be made with commercial banks in the area.
. Over half of the checks cashed at the Cash Room are Federal
salary checks for local Government employees, some 9,000
checks each-month. These employees can elect to participate
in either the Government's direct-deposit system or the
savings allotment program and have their salaries credited
in whole or in part to accounts in financial organizations
of their choice.
. Another 20 percent of the checks cashed, about 3,000, are*
District of Columbia welfare and unemployment checks,
prepared for the D.C. Government by the Treasury's Washington
Disbursing Center. When the District's home-rule charter
is fully effective, these payments will be drawn on depositaries other than the Treasury and would not be cashable at
the Cash Room in any event.
. The remaining 25 percent of Cash Room encashments, or about
3,700 monthly items, are for social security and veterans
disability and pension benefits; and tax refund and other
Federal payments. They * represent only a small portion of the
checks issued under these programs to all D.C. residents -an indication that other check-cashing facilities are widely
available. Social security recipients may elect to participat
in a recently installed nationwide system of direct deposits
to financial organizations, and others may make similar
arrangements.
The Treasury will make every effort to encourage local
financial organizations to make alternative check-cashing
arrangements available for affected individuals. For those
individuals with chronic check-cashing problems, we will
provide for individual consultations in order to be of all
assistance possible. Discussions will be held with officials
financial organizations in the District of Columbia to request
their organizations to encourage individuals not now having
accounts to establish them for purposes of having a financial
organization relationship for their financial needs -including check-cashing privileges. All present users of
\ *
1
the check-cashing services at the Cash Room will be individuals
notified, beginning in April 1976, of the move to discontinue
the service. That announcement will also discuss possible
alternative arrangements and offer the Treasury's assistance
Office of Fiscal Assistant Secretary
March 197 6
STATEMENT OF THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE THE SUBCOMMITTEE ON AVIATION OF
THE SENATE COMMERCE COMMITTEE
WEDNESDAY, APRIL 7, 1976
Mr. Chairman and Members of This Distinguished Committee:
It is a pleasure to appear before you today to discuss
legislation which I believe to be of the utmost importance:
S. 2551, The Aviation Act. As the Committee is aware, the
reform of government regulation is a principal goal of the
Administration and, I am pleased to note, of a growing
number of Members of Congress as well. In recent months,
government officials and the general public have become
increasingly aware of the problems created by a regulatory
system which no longer serves the needs of today's dynamic
economy. Many Americans have come to recognize that government
regulation too often stifles the creativity and productivity
of the competitive market place resulting in both lower
quality of service and higher prices.
The rapid development of the U.S. economy over the
years has resulted from the favorable combination of the
Nation's natural resources, our productive labor force, the
efficient provision of needed capital and a form of business
organization which has emphasized reliance on competitive
market forces and profit incentives to stimulate growth and
efficiency. The allocation of human and material resources
has generally been left to the market to determine rather
than relying on unwanted government controls although such
intervention has unfortunately increased. The resulting
decisions about prices and output are not the result of
central planning; instead, they reflect the long-term balance
between what we want and what can be supplied. While this
balance can become distorted —sometimes grotesquely as we
are now witnessing in some industries — the market system
has served us well and it remains the key aspect of our
productive economy.
The policies of the Federal Government have a direct
influence on the private economy. It is a major purchaser
of goods and services. It promulgates numerous legislative
and administrative rules. Its allocation of funds to
projects often determines the future course of private
sector decisions. Whatever its reasons for involvement in
the economy, the Government has a responsibility to encourage
WS-771
reduce
resources,
efficiency
unnecessary
or
and increase
fairness.
demands
output
To
for
the
using
limited
degree human
that and
efficiency
material
can
-2the same resources, inflation pressures can be moderated.
Unfortunately, Government involvement in the economy
too often restricts efficiency. Regulatory practices
become obsolete as the functions originally required fail
to adapt to changing economic and industry conditions.
The transportation industry is a classic example. In
responding to special interests the general interests may
suffer. Government policies cannot be based on such
fragmented reactions. We must develop a more comprehensive
set of guidelines which will be more consistent with our
dynamic economy. Bureaucratic enforcement of legislative
and administrative rules may become unnecessarily burdensome.
It is useful to periodically review Government activities to
identify specific actions which can improve the efficient
use of resources. The Administration and Congress have
jointly recognized the great need to review the extensive
regulatory functions of government. Universal agreement
exists that widespread modification of regulatory practices
is required to correct the many individual abuses now
recognized and to provide a healthy environment for the
future development of the U.S. economy which must create
more jobs and become more productive to moderate inflation
and use our resources more efficiently.
What are some of the ingredients of a competitive
market? In a free enterprise system, companies vigorously
compete with one another. As long as new businesses are
able to form and enter markets and as long as there is no
collusion among competitive firms as to pricing, every
company will strive to maximize its efficiency in the
production and marketing of goods and services to gain a
competitive advantage. The incentive for such actions is
potential profitability. A record of profitable operations
is the fundamental factor in enabling a business enterprise
to attract necessary financial capital from lenders and
investors for further development.
In order to attract financial capital, a company must
demonstrate an acceptable level of profit potential relative
to the risk involved. Private savings are channeled
directly, or indirectly through a financial institution,
to investment opportunities on the basis of expected risk
ana return. it is the profit motive on the part of companies
Z*lt l~Sx K l n t h e c o n t i n u a l search for more efficient
o ™ L ^ ? ° ^ m e s s . Consumers benefit from the intense
J S 1 ? " f m ° n g companies by being able to purchase a
n
or wfth ?i«C
° f P r o d u c t s and services at a lower price
or with less inconvenience than would otherwise be the case.
-3In the commercial airline industry, many of the basic
characteristics of competitive markets are missing. Price
competition is virtually nonexistent because rates, schedules
and specific route structures essentially are set by government
regulation. As a result, we see competition taking the form
of more flights, special meals, splashy colors and costumes,
piano bars and what have you. In the final analysis, the
consumer pays a significantly higher price than he need pay
for air travel because of the lack of meaningful competition
and the absence of consumer choice as to the travel services
desired- The price mechanism is the focal point for competitive
markets and efficiency in most industries. Unfortunately,
the prevention of price competition in the airline industry
restricts the efficiency and responsiveness of companies
and leads to deteriorating service even as prices continue
to rise sharply. During the last five to six years the
airline industry has received eight regulated fare increases
totalling 33 percent but this rapid surge of prices has not
solved the basic financial problems of low profitability
and strained financial positions. Increasing operating
costs — particularly fuel, labor and airport fees — have
created severe financial pressures. But airlines have not
been able to seek increased volume through price competition
so the increasing fares tend to be counter-productive by
driving customers away.
A basic variable in promoting price competition is
the absence of agreements among companies. Yet in the
airline industry we witness various anticompetitive
agreements dealing with such things as pool revenues, capacity
limits, the price of headsets and drinks, and so forth. It
is not that these agreements are illegal; the Civil Airenautics
Board specifically permits them. Nonetheless, in most
instances they are anticompetitive and the marketplace for
air travel is compromised further.
Competitive markets also require freedom of entry.
If competition truly exists then companies cannot earn
excessive profits for very long before other firms will
enter the market. The entry of competing firms and the
resulting price competition tend to eliminate unusual
advantages and cause profits to return to levels which
more realistically reflect demand and supply relationships.
In the process, the consumer benefits from lower prices
than would otherwise prevail. The possibility of new
entrants also assures innovation and new ideas. It keeps
companies already established in the market on their toes
so that they continually improve efficiency and service. In
short, free entry is the very essence of competitive markets.
-4When barriers to entry are erected, as they are in
the airline industry, the consumer does not have the benefit
of "new blood." Existing carriers are protected from the
driving forces of competition and, to a degree, can afford
to be less concerned with innovation and efficiency.
Barriers to entry influence not only the distribution of
routes but other rigidities in the services provided.
Such rigidities are completely contrary to the basic
operation of free enterprise; they inevitably lead to
less efficiency, less creativity, and higher prices.
It is easy to see that government regulation produces
higher fares when we compare fares of CAB regulated
carriers with intrastate carrier fares — for example
Southwest Airlines which operates only in Texas. In
these markets, intrastate carriers which are not subject
to Federal economic regulation have been allowed to enter
new markets. The lower-cost service they provide has
generated additional demand for air travel, permitting
these carriers to fly with more passengers per plane and
to offer lower prices. For example, the interstate fare
from New York City to Washington, D.C, a distance of
about 215 miles is now $36 according to CAB regulations.
For a flight from Dallas to Houston, a comparable distance
of 222 miles, the fare of Southwest Airlines is $25 on
weekdays and $15 for evening and weekend travel.
In the 1930fs, the "infant industry" argument was
used for the economic regulation of airlines so as to
give them a period of protection. After forty years,
however, the industry is no longer an infant. If we
keep in place present regulations well past the time
an industry is an infant, a youth, or even a young adult,
as we did with the railroads, the results are predictable.
There will be subsidy after subsidy followed by deteriorating
service and rising prices.
In the end, the government itself may have to intervene
directly to prop up the entire airline industry just as it
has had to pass legislation to sustain the operation of many
railroads. The evidence of the disastrous impact of regulation
fcy the Interstate Commerce Commission in disrupting the
railroad industry is clear. We must not let this happen to
™ ^ r i l n e ^ n d u s t r y- It is time to allow the forces of
competition to provide better service at lower costs to the
consumer.
-5Now this is not to say that the airline industry
should be entirely free of regulation. It is clear to
all of us that the public interest must be protected in
having high safety standards, continuity of certain route
service and perhaps other things of this sort. However,
the public interest is not served by inefficiency, rigidities
in the services offered and by higher prices than are
necessary. Areas other than those clearly identified to be
in keeping with the public interest should be left to the
marketplace. The cleansing forces of competition will
assure greater efficiency and lower prices to the public
than can be accomplished by the government.
The bill before you calls for the gradual introduction
of pricing flexibility in the airline industry and the
gradual relaxation of barriers to entry. It also calls
for prohibiting anticompetitive agreements. These changes
will not cause sudden dislocations in the industry, but
rather a steady movement toward more competition, more
innovation, better service, and lower prices. If ever a
time was ripe for such a bill, what with the inflation we
have experienced, it is now.
The Administration believes that the survival and
growth of our airline system depdnds upon the industry's
ability to adjust more rapidly to changing economic
conditions. We have designed a program of gradual, phased
reduction of government regulation as a means of achieving
this goal. Specific transition measures have been built
into the bill to reduce uncertainty and to permit the
airlines to gradually adjust to a changed regulatory
environment.
As with any fundamental change in public policy, our
proposal has met with mixed reactions. Interestingly
enough, airline management and aviation interest groups
are among the strongest defenders of the status quo. They
claim that The Aviation Act will disrupt airline service and
cause public inconvenience and confusion, reduce or eliminate
service to small communities, and produce market chaos which
will destroy the "finest air transportation system in the
world." I grow uneasy whenever the regulated grow too
comfortable with the regulations imposed upon them.
163
-6The same sort of hue and cry arose last summer when
competition in commission rates charged by stockbrokers
was permitted for the first time in two hundred years.
They were convinced thatcthe removal of government
regulation would ruin the securities industry and reduce
service to the small investor. Nearly one year later, we
find that the stock market is up and that the industry is
strong. The rates on large institutional trades have been
cut nearly in half. And the "unbundling" of rates for
brokerage services has permitted the small investor the
flexibility to purchase only those services which he
wants and for which he is willing to pay.
I cannot believe that airline executives really want
to continue a system which affords them little or no
opportunity to run their own business and which has rendered
them essentially unable to attract needed investment capital.
And I am sure that no one in Congress, the Administration,
or the public at large is willing to stand by and watch our
airlines in the 1980 's suffer the same problems as passenger
railroads have experienced. We all have a tremendous stake
in the future of this vital industry. We must overcome the
natural tendency to concentrate on short-run needs at the
expense of long-range consequences. The Aviation Act and
these hearings
provide us an opportunity to get at the substance
Thank you.
of the matter of economic efficiency in concert with the public
interest.
01
Contact: Donald Cameron
Extension 2951
FOR IMMEDIATE RELEASE
April 7, 1976
TREASURY ANNOUNCES TWO ACTIONS UNDER
THE ANTIDUMPING ACT
Assistant Secretary of the Treasury David R. Macdonald
announced today the issuance of a six-month withholding of
appraisement in the antidumping investigation of AC Adapters
from Japan, pending a determination as to whether the subject
merchandise is being sold at less than fair value within the
meaning of the Antidumping Act, 1921, as amended.
Under the Antidumping Act, the Secretary of the Treasury
is required to withhold appraisement whenever he has reasonable
cause to believe or suspect that sales at less than fair value
may be taking place.
A final decision in this case will be made on or before
July 8, 1976. Appraisement will be withheld for a period
not to exceed six months from the date of publication of the
"Withholding of Appraisement Notice" in the Federal Register.
Under the Antidumping Act, a final determination of sales
in the United States at less than fair value requires that
the case be referred to the U.S. International Trade Commission,
which then considers whether an American industry is being, or
is likely to be, injured. Both sales at less than fair value
and injury must be shown to justify a finding of dumping under
the law. Upon a finding of dumping, a special duty is assessed.
During the period of May 1975 through October 1975,
imports of AC Adapters from Japan were valued at approximately
$142,000.
Mr. Macdonald also indicated that he was issuing an
"Antidumping Proceeding Notice" on clear sheet glass from
Romania following a summary investigation conducted by the
U.S. Customs Service after receipt of a petition alleging that
sales at less than fair value are occurring in the United States.
WS-772
(Over)
- 2 -
The petition also provided sufficient evidence of injury
to the domestic industry to warrant an investigation.
Imports of clear sheet glass from Romania during the period
of January 1975 through November 1975 were valued at
roughly $2 million.
Notice of these actions will appear in the Federal
Register of April 8, 1976.
~~
*
*
*
0
FOR RELEASE UPON DELIVERY
APRIL 8, 1976
STATEMENT OF THE HONORABLE GERALD L. PARSKY
ASSISTANT SECRETARY OF THE TREASURY
FOR INTERNATIONAL AFFAIRS
BEFORE THE SUBCOMMITTEE ON FOREIGN OPERATIONS
OF THE SENATE APPROPRIATIONS COMMITTEE
APRIL 8, 1976 at 10:00 a.m. EST
Mr. Chairman, last year the four international development banks made commitments Tor new loans totalling $8.5
billion for 377 projects in 84 countries. This total is far
more than the bilateral economic development program of the
U.S. or any other country. For most developing countries
outside the Middle East the programs of the international
development banks have become the core of their external
financing. Most aid donors from both Europe and the Middle
East build their bilateral programs around, and in cooperation
with, the banks' programs. The U.S. contribution to this
truly mammoth development effort requires appropriations of
a little over a billion dollars in FY-77. About $300 million
of this total is for callable capital which is unlikely to
result in any outlays ever from the U.S. Treasury. Callable
capital is a guarantee facilitating the sale of bonds by the
banks in the capital markets of the world.
Mr. Chairman, Treasury has testified each year about
these banks and I would presume not to repeat the basic details
on their creation and growth which you and the committee know
so well. I shall try to focus on a few of the key reasons why
continued support for the banks at the level requested is in
the national interest, despite the many competing domestic
demands for funds, and review the current funding situation
and recent developments in each bank. Detailed statements on
the International Development Association (IDA), the International Finance Corporation (IFC), the Inter- American DevelopWS-773
ment Bank (IDB), the Asian Development Bank (ADB) and the African
Development Fund (AFDF) are annexes to this statement.
- 2 I shall do my best to answer questions on any of these
institutions as well as any general questions you may have
on the banks. Mr. Charles A. Cooper U.S Executive Director
for the World Bank Group, Mr. John M. Porges, U.S. Executive
Director at the IDB and Mr. John A. Bushnell, my Deputy at
the Treasury for Developing Nations Finance are here with me
today and are also available for questions.
We believe that the World Bank Group and the three regional
banks provide important extra dimensions to development
assistance. Economic development is not primarily a matter
of external funding. While money is needed, the key factors
determining the success of development efforts are the
policies and priorities followed by each country. The
development banks make important contributions in precisely
such areas by encouraging the adoption of sound economic
policies, by assisting in institution building, and by supporting
successful development efforts made by the countries themselves.
The banks have developed highly competent professional
international staffs which help the developing countries with
the complex problems of priority setting and institution
building. These international staffs bring together outstanding
professionals from both developed and developing countries.
In both the World Bank and the Inter-American Development
Bank there are more Americans than any other nationality,
and overall Americans make up about 25 percent of the development bank staffs.
The banks are cost efficient institutions. For example,
the combined administrative budgets of the banks in 1975
accounted for only 3 percent of the $8.5 billion lent out
that year. Moreover, included in the administrative budgets
are expenses for technical assistance, training centers,
etc. which are not directly associated with the cost of
making loans.
From the U.S, national point of view, these banks
encourage development along lines compatible with our own
economy. They stress the role of market forces in the
ettective allocation of resources and the development of
outward-looking trading economies. Through contact with
tne international development banks, developing countries
f f f ^ a r i \ l n g t0, " d m i n i s t e r l a r 9 e Procurement programs
? " f C t I V f l y a n d h o n e s " y . These programs will result in
increased procurement of goods and services in the United
i i n ^ 3 f f U t U r e m a r k e t * for our products, thus
! S
S. e n , P < ? y , n e ? t i n ° U r c o u "try. Our participation
m the international development banks will also provide
- 3 -
7
more assured access to essential raw materials, and a better
climate for U.S. private investment in the developing world.
There is clear evidence that in all of the international
development banks increasing attention is being given to,
and a greater volume of loans are being made for, the direct
benefit of the urban and rural poor. Assistance is being
directed increasingly to the poorest countries and to low
income groups in all borrowing countries.
About 92 percent of IDA credits are made to countries
with per capita incomes below $200, and the ADB makes loans on
concessional terms only to member countries with per capita
incomes of less than $300; About 50 percent of IDB's concessional loans are being made to the nine poorest countries
in Latin America, and this percentage is expected to continue
rising steadily in the future.
All of the international development banks are increasing
their lending for projects which directly assist the rural
and urban poor. In recent years the banks have placed greater
emphasis on agriculture, the family farm, and cooperatives —
an emphasis we have encouraged and supported. The IDB has
been the leader, for example, in lending for integrated rural
development, cooperatives, farm-to-market roads, and rural
water supply. The World Bank and IDA have made several loans
for population projects and for sites and services to improve
living conditions for the poorest groups. The IDA, as well
as the African Development Fund, have made loans for the
drought-stricken Sahel region of Africa. The ADB is taking
the lead in loans involving light and intermediate technology
which benefit the poor.
I would emphasize that the change in emphasis toward
direct assistance to the poor is slower than some of us would
like and we continue to press within the banks for a greater
concentration to reach directly the poorest groups in each
borrowing member. We must also not lose sight of the fact
that basic infrastructure projects — roads, ports, electric
power and major irrigation — are still necessary to provide
the basis for overall growth of the developing country economies.
The development banks are part of an international
structure in which the developed and developing countries
work together to solve problems. The development banks
are not debating societies which engage in seemingly
endless rhetoric about restructuring of the world economy —
they are working institutions that get things done. By
cooperating with other developed countries in funding these
institutions we improve the effectiveness of our own efforts.
- 4 Other donor countries strongly support this cooperative
approach and multilateral institutions are being used for
an increasing share of the total development assistance of
other industrial donor countries. The United States is no
longer the leader in directing assistance through the development
banks; the constraints on our support are a principal limitation
on their growth as other countries, in general, are prepared
to multilateralize a greater part of their assistance.
Bilateral aid remains, of course, of major importance.
There are special aspects of economic assistance that require
bilateral programs, especially where we have special techniques
or products to impart, where we have special interests in
individual projects or programs, or where security considerations are heavily involved. But U.S. support for the multilateral institutions is essential if we are to meet today's
and tomorrow's challenges of improving the prospects for the
millions in developing countries which our bilateral programs
do not reach.
In our contributions to the international development banks,
we have been trying to reduce U.S. budgetary outlays by making
relatively less available to the soft loan windows of these
institutions and relying more on U.S. contributions of callable
ordinary capital. Callable capital does not involve budgetary
outlays; thus, emphasizing callable capital fits in well
with the Administration's strong efforts to achieve budgetary
constraint. Moreover, since our private capital market
is a major source of borrowing by the international development banks, it is appropriate that the United States provide
an increased proportion of its overall contributions to
these banks in the form of callable capital, while other
donors with less well-developed capital markets undertake
a greater share of funding for the soft loan windows of
the banks. This shift in burden-sharing is illustrated
by the recent trends in U.S. contributions to the concessional
funds of the banks. Our contribution to the Fourth Replenishment of IDA is one-third of the total, as compared with
43 percent m our initial contribution in 1961, 42 percent
of the First IDA Replenishment, and 40 percent of both IDA
II and IDA III. i n the case of the new IDB replenishment,
our contribution to the Bank's concessional resources would
be reduced to $600 million, or 57 percent of the total,
tn ? h m P ? o ^ W i t h $ i b i l U o n ' or 67 percent of the total
in the 1970 replenishment.
rpn^i?chlie lF(Z' °Ur Share in the Proposed total capital
a^comiarp^^, f H^o Y 1 9 7 7 ~ 7 9 w o u l d f a l 1 t o * b °ut 25 percent
as compared with 32 percent m the initial capitalization.
- 5 -
'
And in the Asian Fund the U.S. share will also decline, although
we want to maintain our share of the ordinary ADB capital
through full appropriation of the amount requested for FY-77.
One of the advantages to the United States of burdensharing in the international development banks is that it
provides us with substantial leverage in the use of our foreign
assistance funds. Thus our appropriations request of about
$1 billion in FY 1977 will be associated with nearly $10
billion of total lending by these banks.
Because of burden-sharing by the other donor countries,
and their consequent sharing of the role in the decision-making
process as members of these institutions, we do not — as we
do in our bilateral aid programs — have complete control
over the activities of the banks. These institutions, as you
know, are clearly not part of the U.S. Government. What we
have to weigh, therefore, is whether, on balance, the international development banks generally perform in ways which meet
U.S. objectives even if, for example, they make some loans
or lend to some countries that do not meet with our approval.
In this connection most of the total lending by the international
development banks is to countries — such as South Korea, the
Philippines, Pakistan, Tunisia, Brazil, Egypt and Colombia
— where we have strong interests nd where we now have or
recently have had substantial bilateral aid programs.
Appropr iations Requests
To provide for continued U.S. support of the international
development banks in FY-77 we are requesting appropriations
of $1,030.6 million of which $734.1 million will require
Treasury outlays and $296.5 million is callable capital —
guarantees unlikely to require expenditures. The Administration
is seeking:
— $375 million for the second U.S. installment of
the fourth replenishment of IDA;
— $45 million as the first U.S. installment in the
first replenishment in twenty years for the International
Finance Corporation;
— $240 million for the second installment of the fourth
replenishment of IDB ordinary capital ($40 million of
paid-in capital and $200 million of callable capital);
— $200 million for the first installment of the
replenishment of the resources of the IDB's soft loan
window, the Fund for Special Operations (FSO);
- 6 $120.6 million for the third installment of the
first capital replenishment of the ADB ($24.1 paid-in
and $96.5 callable);
$50 million for the initial U.S. contribution to the
first replenishment of the resources of the soft loan
window of the ADB, the Asian Development Fund (ADF).
In addition, the President has just transmitted to the
Congress a request for supplemental appropriations for FY
1976. In this supplemental request the Administration is
seeking:
— $240 million for the first installment of the fourth
replenishment of IDB ordinary capital ($40 million of
paid-in capital and $200 million of callable capital);
— $15 million for the initial U.S. contribution to the
African Development Fund (AFDF).
These U.S. contributions are part of the multilateral
effort in funding the international development banks in which
the U.S. contributes only a part — and an increasingly smaller
part as can be seen in the table attached to this statement.
If other donors are to continue supporting these banks, we must
do our part by delivering on the amounts we agree to contribute
The Administration is not seeking a contribution for the
"Third Window" of the World Bank which lends at an interest
roughly half way between that of the World Bank and that
of IDA because we believe priority should be given to IDA
and IFC appropriations.
Our participation in the Fourth IDA replenishment was
authorized by Public Law 93-373 and our participation in
the replenishment of the capital resources of the Asian
Development Bank in Public Law 93-537. Authorizing legislation
for participation in the replenishment of the IDB passed the
House of Representatives as HR 9721 on December 9, 1975, and
the Senate on March 30. A conference, necessitated by
differences in the House and Senate versions of the bill is
expected to be held soon. Legislation authorizing U.S.
participation m the replenishment of the IFC and ADF was
transmitted to the Congress in February,
™nf HK V21 provides for the United States to make three
contributions of >400 million per year to the replenishment
? ,n *-?? P
! "sources of the IDB beginning in FY 1976 and
11
oroSiSii fo n'i1 C a l l a b l e » ^ FY 1979. The bill also
provides for U.S. membership m the African Development Fund
with an appropriation in FY 1976.
v
f
In the IDB a new class of shares, known as inter-regional
capital, will be created to facilitate the entry of nonregional members. We are not requesting appropriation of
the callable inter-regional capital because covenants limiting
IDB borrowing to the amount of appropriated U.S. ordinary
callable capital would not apply to inter-regional callable
capital. This matter is explained in more detail in Annex 3
on the IDB.
We signed up for IDA IV in January 1975 without appropriations because we knew that, while other donors had made advanced
contributions to allow IDA to continue making commitments, they
would contribute no additional funds until the United States
formally agreed to the replenishment. Such action by the other
donors would have forced IDA to stop lending to the world's
poorest countries. By agreeing to contribute one-third of
the funds for IDA IV we assured that others would contribute
the other two-thirds of the funds and IDA has continued
to make commitments for projects and programs in the poorest
countries.
The nature of our current arrangements concerning IDA,
frankly, give me a great deal of concern. We should be aware
of the implications of the procedure under which we are
beginning our contributions one year late and spreading our
contribution to IDA IV over four years while IDA commits the
funds in three years. Under the present schedule IDA will
have committed all IDA IV resources three months before the
end of FY-77. Yet we shall have half of our contribution still
awaiting appropriation in FY-78 and FY-79.
As you know, the Conference Committee on April 1 recommended
$320 million for the first installment of the U.S. contribution to IDA IV. We will need to have the $55 million appropriated
in FY 1977 in addition to the full $375 million requested if we
are not to fall further behind other donors in providing funds
to IDA.
To complicate matters, negotiations have already started
on the next IDA replenishment. IDA hopes that the fifth replenishment will take effect by July, 1977, so that there is
no period during which IDA commitments must stop. Some of
you have suggested that we provide commitment authority to
IDA subject to appropriation. This procedure would mean that
in FY-78 appropriations would be necessary to meet not only
the $375 million third payment for IDA IV but also for the
first payment for IDA V. Such appropriations would total
more than double the current request even if the
/0
U.S. share of IDA V is substantially reduced. Although I would
welcome your views on this problem, I do not believe we can
resolve it this morning. However, this situation does emphasize
the great importance of full appropriation of the $375 million
plus any shortfall from FY 76 in FY-77 if the United States
is to continue as an active supporter of IDA's key development
role in the poorest countries. The Administration believes
that for the United States to turn its back on IDA is unthinkable.
The need for funds in the other banks is also urgent.
The IDB ran out of commitment authority to make new loans in
late 1975 and would have had to cease lending except for a
change in its regulations that allowed it to make new commitments against loan reflows and certain reserves on a temporary
basis until the new replenishment becomes effective. Even
after doing this the IDB had only $73 million in remaining
commitment authority from ordinary capital at the end of 1975;
these funds have already been allocated for a couple of pending
loans. Thus the IDB is now unable to make new ordinary
capital loans. The supplemental FY-76 appropriations which
are obviously urgently needed will be used in part to reverse
this temporary accounting change made last year. Thus the
Bank will again have exhausted its commitment authority by
about the beginning of FY-77. The FSO will also run out of
commitment authority by the beginning of FY-77.
The Asian Development Bank has only $41 million of
commitment authority remaining for soft funds, and these funds
remain only because it reduced its soft lending in CY-75 to
$166 million from $173 million in CY-74. The Bank has made
no soft loans so far in 1976. During 1975, the United States
participated in negotiations on an ADF replenishment but
did not commit itself concerning the specific timing or amount
of any U.S. contribution. Last December, the ADB Governors
approved a resolution providing for an $830 million replenishment
with a suggested U.S. share of $231 million. The United States
abstained on the resolution and no final decision has yet
been taken on the full amount to be requested from the Congress
for a 3-year U.S. contribution. We are, however, requesting
$50 million as the U.S. contribution to the ADF for FY 1977
to continue the level of U.S. support of the ADF in recent
years.
The pipeline of available funds for concessional lending
has been reduced below minimum levels by the delays in U.S.
contributions. Soft convertible funds of the regional banks
available for commitment declined from $285 million at the
beginning of 1975 to only $100 million by the end of the year.
11
- 9 The inability to make new commitments not only delays the
financing of good projects but also weakens the morale and
dedication of the banks' staffs.
The $45 million appropriation request for the IFC is
part of a $480 million capital increase for the Corporation.
The total U.S. share is about $112 million.
We regard the IFC expansion as a major element in our
program for aiding the developing countries. IFC, a member
of the World Bank Group, is the only multilateral agency
specifically designed to encourage private sector growth in
the developing countries. It is unique among international
development institutions in that it purchases equity and
operates without government guarantees.
The U.S. has taken the lead in publicly supporting a major
expansion of IFC capital through statements made by Secretary
Simon at the annual meeting of the IBRD/IMF in September 1975
and by Secretary Kissinger at the UN Seventh Special Session in
the same month. The proposal has since received widespread
support from other countries and international negotiations
are expected to be completed soon.
The U.S. has always stressed that the development process
involves a cooperative effort between the public and private
sectors --.domestic and foreign. The task is too big and
resources too scarce to permit a dependence on one or the other.
A high level of private investment has been a common factor
behind the growth experience of three of the most successful
LDCs — Brazil, South Korea and Taiwan. Low rates of private
investment have tended to be associated with low rates of
economic growth. Public investments in infrastructure yield
low returns if not followed up by further investment in more
directly productive activities. The private sector has proven
its effectiveness relative to the pubiic sector, both in seeking
out the investment opportunities that are most profitable and
in using available resources efficiently.
IFC taps the private sector, both domestic and foreign,
for the bulk of the investment capital in its projects, while
applying a development orientation to the utilization of that
capital.
The country shares of IFC's current capital represent
the relative economic strength of the members in the 1950s
when the Corporation was established. By using an up-to-date
formula reflecting conditions in the 1970s the relative
share of the United States subscription declines while those
of Germany and Japan, as well as of the newly rich OPEC countries,
rise.
jp
This capital increase is the first since IPC's founding in 1956. The proposed increase is ambitious -- more
than quadrupling the IFC's small capital base of $108 million.
IFC's small capital base has impeded its equity operations,
restricted its ability to borrow IBRD funds for relending,
and resulted in IFC becoming a much more junior member of
the World Bank than was contemplated when it was established
20 years ago. The capital increase will enable the IFC to
play a more substantial role in the development process in
association with private capital. The U.S., as the largest
private enterprise economy in the world, is expected to be
the leader in support of the IFC. Frankly, I wonder if we
have done justice to our strongly held beliefs in the
advantages of private enterprise by delaying a replenishment
of the IFC in recent years while giving priority to the
organizations lending mainly to governments. It is time to
put the IFC at the top of our priority list.
Mr. Chairman, I must take note at this point of the
actions of the Conference Committee of the Senate and House
on April 1. The Committee has reduced our requests by
$130 million. I should state for the record that it is present
Administration thinking that we would amend the FY-77 request
to include this $130 million requested but not appropriated
in FY 1976. This procedure would also apply to the supplemental
requests in FY 1976 for the IDB and for the African Development
Fund recently submitted to the Congress.
Before closing I would like to address briefly five
additional issues which are of interest to the Congress
and the Administration. First, let me comment on why it
is important for the United States to contribute to four
international development banks.
Our past experience with the regional banks leads us
to believe that smaller institutions with a predominance
of local citizens can do a better job of meeting certain
requirements than the much larger World Bank Group. Countries
in the regions — Latin America, Africa and Asia — concur
in this belief, since the regional institutions give them
more control over the course of their own development. Moreover, the work of these institutions and that of the World
Bank Group are complementary. The World Bank concentrates
on larger, more complex projects utilizing expertise gained
from worldwide operations. The regional banks focus on smallerscale projects and call upon the first-hand knowledge and
experience of their staffs to meet problems unique to their
areas.
- 11 -
fjlfi
Let me now address the effect of the international development banks on our balance of payments. Excluding short-term
funds held by the development banks in U.S. financial markets,
the total of all inflows and outflows of dollars resulting from
transactions from their inception through December, 1975,
has resulted in a net deficit of only about $200 million
for the U.S. balance of payments. Moreover, the banks
maintain substantial investments in U.S. short-term financial
assets.
The absolute magnitudes of the various types of flows
are of course much larger; the total net outflow of capital
(subscriptions paid-in plus net sales of bonds, loan participations, etc. in the U.S.) totaled almost $11 billion as
of end 1975, while the development banks' purchases of
U.S. goods and services, direct expenditures and long-term
investments in the United States totaled over $10 billion.
Because of our overall favorable payments situation in
1975 we opened our capital markets freely to the banks for
the first time in several years. As a result they raised
$1.8 billion in net long-term capital. Consequently the
cumulative effect on U.S. international payments was less
favorable at the end of 1975 than at the end of 1974. However,
at the end of 1975, the banks held about $5 billion in
short-term U.S. financial assets, which, if included in
the above figure, would make the effect on total inflows
and outflows from the U.S. positive by a large margin.
Let me turn now to procurement. One of the major
benefits we derive from our membership in the international
development banks is the opportunity it affords U.S. exporters
to compete for procurement financed by the banks. The rules
of the banks require international competitive bidding and
other safeguards which give our exporters a fair chance
to compete for business in the developing countries. One
of the advantages in joining the African Development
Fund is that U.S. companies will become eligible to compete
for contracts financed by the AFDF and thus will have a
greater incentive to compete for business in Africa, which
has not been a traditional market for many U.S. suppliers.
We have increased efforts in the last year to obtain
a larger share of procurement in the development banks.
During the past ten months Treasury has had on loan from
the State Department a senior foreign service officer who
has concentrated on improving the U.S. procurement record
at the banks. This record, I might add, is not bad at all.
- 12 Although the U.S. share of world exports of goods and services
in recent years has been approximately 17 percent, our share
of bank-financed procurement has been running at 25 percent.
Every $1 billion of procurement in the United States for bankfinanced projects generates 47,500 man-years of employment
in this country.
I know you are also interested in the foreign assistance
activities of the oil-exporting countries as they relate to
the international development banks. The vast increase in
oil export earnings of the OPEC countries has made it possible
for some of them to take on part of the development financing
burden and to borrow substantially less from the international
development banks thus permitting more lending to the poorer
developing countr ies.
OPEC countries have provided co-financing totaling some
$1 billion to complement 36 IBRD and IDA projects in 16
countries — most of them over the past year or so. These
projects are listed in a table attached. A substantial amount
of IBRD/IDA resources was freed up for other projects and
countries by this OPEC co-financing.
The pattern of lending by the development banks to
OPEC countries has changed as a result of the higher incomes
of these countries. Lending of soft funds from IDA, the
FSO and the Asian Development Fund to these countries has
been stopped with the exception of limited amounts of FSO
funding for Ecuador. These FSO loans to Ecuador have been
financed from sources other than the U.S. contribution,
including Ecuador's own contribution to the FSO. Lending
to the OPEC countries with the highest incomes such as
Venezuela and Iran has stopped. However, lending to the
poorer countries such as Indonesia and Nigeria has increased,
partly as a result of proceeding with loans on which work
had already started before the oil price increase. We have
urged the banks to concentrate their limited resources on
those countries with the greatest need.
My final point deals with our procedures to examine
the work of these banks. We are continuously working at
improving our oversight activities in regard to the banks'
lending programs and project implementation. Embassy, AID
and Treasury officials make visits to projects as frequently
as possible. At every opportunity we encourage and facilitate
project visits by members of Congress.
- 13 The primary mechanism through which the Administration
sets policy on the international development banks, both
on general policy questions and on each individual loan,
is the National Advisory Council on International Monetary
and Financial Policies ^NAC). Every loan and borrowing
operation and every substantial technical assistance operation
is reviewed in detail by the interested U.S. agencies in
the NAC before instructions are given to our Executive
Directors. Through this process we assist these institutions
to do an even better development job by bringing the very
considerable expertise found in the Federal Government to
bear in reviewing their projects. I would especially like
to mention the outstanding technical work of the Department
of Agriculture and the Department of Transportation in contributing highly useful inputs to these reviews. AID is one
of the most active agencies participating in the NAC and
contributes its immense development experience as well as
its knowledge of current conditions in developing countries.
The Department of Commerce and the Export-Import Bank help
us to be continually vigilant that American exporters have
the fullest opportunity for business. The Federal Reserve
provides extremely useful analysis of the monetary and
financial situation in the borrowing countries. The State
Department contributes its detailed knowledge of conditions
in the borrowing countries and provides the key foreign
policy element in NAC deliberations. In addition to chairing
the NAC, we in Treasury are particularly concerned with general
bank policies such as assurance of adequate self-help, avoiding
financing of cost-overruns, a consistent approach to maturities
and grace periods, and increased efforts to reach the agricultural sector and the poorer people in ways that will increase
output. The NAC also reviews such general U.S. concerns as
expropriation of U.S. investment and arrears on debts to the
United States in connection with each loan.
The annual report of the NAC should be an integral part
of the documents you consider in determining appropriations
for the development banks. In particular, I would call your
attention to chapter IV of the FY-75 report which reviews
developments in the banks and includes tables covering such
matters as the sectoral breakdown of lending and membership
in the regional banks and appendix C which includes the NAC
evaluation of all the loans approved during the year. If
this appendix were not so long -- a hundred fine-print pages —
I would suggest you might include it in your report because
it brings out the real life benefits for millions of people
- 14 around the world made possible through the work of the
development banks. The purpose and benefits of each loan
are given. Let me quote just one example of the sort of
information in the NAC report. For a $15 million loan to
Kenya, half from the IBRD and half from IDA, the following
is part of the analysis of benefits:
"The major quantifiable benefits stemming
from the project are substantial increases in
marketed production of wheat, maize, milk and
coffee estimated at $10.1 million per year after
full development. The project should also ensure
employment —either permanent or seasonal and
depending on the number of group owners involved—
for about 13,000 group farm owners, and will
benefit farm families comprising 80,000 persons.
These families are from the lower income levels of
Kenya's rural population, most of which would be
landless and unemployed if steps were not taken
to protect their investments. At full development,
the annual income of each family should have gained—
in addition to its subsistence income—$84 on the
mixed farms, and $420 on the coffee estates.
Currently, the average per capita income of the
rural family in Kenya, including subsistence produce,
is only about $70 per annum."
I know that some of you have felt the United States,
especially the Congress, cannot make a sufficient review of
the lending operations of the development banks in advance
of loan approval. Unlike the situation for the bilateral
aid program, we can not present you with a list of specific
projects that will be financed with the appropriations before
you today. This situation is inherent in the nature of these
multilateral institutions where the United States provides
only one dollar out of every three, four, or five they lend.
It would obviously be infeasible for them to present their
programs in advance to the governments and parliaments of
all their members, or even to the 20 to 25 donor members.
However, these institutions do not make sharp changes in
the pattern and nature of their lending from year to year.
Thus a review of last year's lending program will indicate
quite accurately the nature and direction of their lending
programs this year and next year.
In conclusion Mr. Chairman, I would like to apologize
for having dealt so much with figures, procedures and burdensharing. Underlying all these aspects we must keep in mind
that the fundamental purpose of these institutions and of
all the funds you appropriate for them is to help the people
in developing countries improve their miserable living
conditions. Support for the development banks is important
in building and maintaining the broad framework of international cooperation that is important to continued U.S.
prosperity. But this is an additional benefit. The basic
justification for the appropriations has to be that these
banks do a good job in using the money to help the developing
countries help themselves and that this development reaches
the people in these countries in a way that justifies U.S.
taxpayer support.
We have not asked for the amounts of money that these
institutions could use to accelerate development worldwide.
Given the need for budget stringency, which we in Treasury
know is so essential in the United States today, we have
asked for the minimum amounts necessary to keep these
institutions going in a manner consistent with the highest
priority needs of the poor countries and contributions being
made by others. The decisions you will make on these
appropriations may receive much attention in the capitals
of the world. But the practical effects of the appropriations will be spread to the poorest villages, slums, and
isolated areas where little is known of the United States,
burden-sharing or these institutions, but where improved
seed, a well, a visiting health team, availability of
credit, or a road to the market can make — at small cost —
an immense difference in the quality of life.
:/
ANNEX I
INTERNATIONAL DEVELOPMENT ASSOCIATION
The $375 million request for IDA in FY 1977 represents
the second installment of the U.S. share of the IDA Fourth
Replenishment, which was authorized by the Congress in July
1974. The IDA is the arm of the World Bank which provides
concessional lending to support projects in the world's
poorest countries which cannot afford to borrow at the near
commercial rates which apply to standard World Bank loans.
It is the largest multilateral source of assistance of
this type. It follows the same rigorous standards, and enjoys
the same high reputation throughout the world, as does the
World Bank itself.
Sixty-six countries of Asia, Africa, and Latin America
with annual per capita incomes below $375 have received IDA
credits. Currently, most credits go with per capita incomes
of less than $200. In FY 1975-1976, 92% of IDA credits were
to these poorest countries. The greatest concentration of
projects is in Asia and Africa, reflecting the fact that the
bulk of the world's poorest people are living in these regions.
About 60% of IDA credits go to South Asia — where 61% of
the population of all countries with per capita incomes below
$200 live.
The appropriation request before you is for the second
installment of IDA's ongoing Fourth Replenishment. This
replenishment was negotiated with 24 other donor countries
after consultation with Congressional committees. In that
negotiation, we sought, and achieved, broader sharing of the
burden by reducing the U.S. share. The U.S. share of the
$4.5 billion IDA IV is 33 percent, or $1.5 billion, down from
earlier U.S. participation levels which had averaged 41 percent
since the inception of the Association in 1960.
While the IDA I\/ resource replenishment will support new
lending commitments over the period fiscal year 1975-77, it
gives donors the option of deferring their initial contribution to fiscal year- 1976 and paying in four annual installments. The United States is planning to follow this course.
Most other donors are making their contribution to IDA IV in
three equal annual installments over the three-year replenishment period. As a result, most donors have already made twothirds of their contributions to IDA IV while the U.S. has
not yet paid its first installment.
- 2 -
By the end of October 1976, all of the first U.S.
installment of $375 million requested for FY 1976 will be
needed to cover the U.S. one-third share of disbursements
on approved credits. Subsequently, calls will be made
requiring the FY 77 appropriations under discussions today.
Full U.S. contributions to IDA IV are essential to insure
the continued participation of the other donor countries
and the continued operation of IDA at the lending levels
contemplated under the IDA IV agreement. Unfortunately
worldwide price inflation since the negotiation of IDA IV
has reduced the real value of IDA pledges substantially
below what was contemplated at the time international agreement was reached — this makes it all the more important
to provide the full amount of funding requested. Such
continued financial assistance from IDA is vitally necessary
if the momentum of development in the poorest countries of
the world is to be maintained at anything approaching
adequate levels.
The purpose of IDA lending is not relief or make work.
It is rather to expand productivity, for only in this way
can lasting improvement in the lives of the poor be achieved.
Toward this end all IDA projects are appraised against strict
rate of return standards, in exactly the same manner as
projects supported by World Bank loans on harder terms.
IDA credits are extended on highly concessional terms:
repayment is over 50 years at three-fourths of 1 percent.
This is consistent with the fundamental purpose of IDA,
which is to provide badly needed assistance to the borrower
rather than yield a commercial rate of return to the lender.
Most of the countries which borrow from IDA lack the capacity
to service external debt on conventional terms, and even if
they could, repayment on conventional terms would mean a lower
rate of return for the borrowing country itself, and thus a
smaller contribution to improved living standards and rising
domestic savings and investment capacities.
IDA's focus, particularly in the IDA IV period, is on
assistance to the poorest developing countries, and within
these countries emphasis is given to projects benefiting
the poorest groups of people. In FY 1974-75, about 40%
of IDA lending was for agriculture and a further 25-30% for
basic infrastructure — transportation, communications, power
and water supply. A complete list of IDA projects in FY 1975
and so far in FY 76 is attached to this annex.
0
- 3 The increased emphasis on agriculture reflects IDA'S
growing role in helping these countries meet their production
goals. Solving the world food problem has to be achieved
by increasing food output in the food deficit countries
themselves — India, Pakistan, Bangladesh, and a number of
countries in Africa.
An example of a recent agricultural project is a $27
million IDA credit to Ethiopia for the development of its
vast rangelands region which was hit by a severe drought
during the years 1970-73. Before this drought, Ethiopia's
livestock resources were the largest of any country in Africa
The true dimensions of the losses attributable to the drought
are not yet certain. However, it is estimated that about
15% of the national herd was lost, largely in the rangelands
areas.
The project will consist of three separate subprojects,
each with its own organizational structure. Each of the subprojects — the Southern Rangelands, Jijigga, and the Northea
Rangelands Development Projects — will provide an integrated
program of range management and veterinary services along
with improved roads and water facilities. They will help lay
the foundation for a sound future development of the livestoc
economy in the range areas.
At full development the project is expected to result in
an increased market production from the ranges of 100,000
head of cattle, 48,500 sheep and goats, and 3,000 camels
annually. The project would also result in an increase in
milk production of about 7.8 million liters annually. Incremental crop production from water development in the Northeas
Rangelands area would total about 1.1 million kg of cotton,
320,000 kg of sorghum or maize, and 120,000 kg of groundnuts
annually. The total annual value of incremental production
attributable to the project would be about $11 million.
Overall, the project is estimated to affect 100,000 families
in the rangeland areas, raising their average per capita
income significantly above its present bare subsistence level
A number of IDA projects are also directly aimed at
increasing the availability of the inputs vitally necessary
to expanded food production — seeds, extension services,
fertilizer, etc. A project recently approved for India
is a notable example.
- 4 In recent years, consumption of fertilizers has increased
in India. But it still remains very low relative to usage
in other countries. In 1974/75, consumption stood at 2.74
million nutrient tons. Although domestic production of
fertilizer has grown at an average annual rate of 16% since
1953/54, it supplies less than 60% of consumption. The
level of capacity utilization is low, reaching only some 60%
of the installed capacity of 2.6 million tons. The IDA
credit of $105 million will allow production in existing
facilities to be raised from the present industry-wide
average of about 60% of capacity to 85% by 1979. The credit
will assist 10 fertilizer plants in removing production bottlenecks, improving pollution control and increasing the production of industrial chemicals. The project will help to
increase fertilizer production by 253,000 tons per year of
nutr ients.
IDA infrastructure projects typically provide key elements
in the borrowing countries' national development efforts.
An example is a $14 million credit to Guinea for a highway
project which will help to link widely dispersed population
centers and productive areas to the port of Conakry. The
project, designed to enhance government efforts to revitalize
the agricultural sector, will include (a) rehabilitation of
approximately 2,500 kilometers of high priority roads and
initiation of proper maintenance operations on these roads;
(b) repair of existing equipment and plant and rehabilitation
of workshops; (c) purchase of needed equipment, spare parts,
and training materials; and (d) technical assistance to the
Ministry of Public Works, Mining and Geology in implementing
the projects and strengthening its managerial capabilities.
The project is expected to insure greater transport reliability,
expand the seasonal use of the most important unpaved roads
and reduce transport costs.
Another example of a basic infrastructure project recently
done by IDA is a $26 million credit to Nepal to help finance a
$68 million hydroelectric power project. Nepal has a very large
undeveloped hydroelectric power potential of"over 80 Megawatts
(MW). Total installed capacity is some 54 MW, of which only
33 MW is hydroelectric power. Electricity at present reaches
only about 3% of the population. But demand for electrical
energy has been growing at the rate of 22% a year, and existing
generating capacity is insufficient to meet the demand.
The project is located about 30 kilometers southwest of
Kathmandu, the nation's capital. It includes the construction
of a 107-meter high rock-fill dam, a powerhouse with two 30 MW
y
It
- 5 generating units and associated transmission and substation
facilities. When fully utilized, the project will replace
use of energy equivalent to about 65,000 tons of oil per
annum, saving approximately $8 million per year in foreign
exchange.
IDA lending operations have also focused increasingly on
equipping the populations of the poorest countries with the
skills essential to economic progress. For example, an $11.6
million credit to Malawi was made in support of a Government
investment program giving priority to the growth of primary
education, the improvement of secondary schools in the rural
areas, and the strengthening of various non-formal education
programs. The IDA project consists of the construction and
equipping of 22 new model primary schools which can be easily
duplicated in the rural areas, 22 rural education centers, one
teacher training college including a demonstration school,
and additional laboratories, workshops, dormitories and staff
quarters for seven existing secondary schools.
The project will provide facilities to expand and strengthen
ongoing education programs and help meet the rapidly increasing
demand for basic skills. It will also reduce socio-economic
disparities by increasing the enrollment of girls in secondary
schools and by teaching adults, through rural development
centers, the basic skills they require for productive employment.
Within these overall sector priorities, IDA's lending
activities have reflected increased emphasis on projects which
contribute to economic development by directly increasing the
employment, productivity, and incomes of the rural and, urban
poor. Strategies to accomplish these objectives cut across
virtually all lending sectors. In the interest of maximizing
employment opportunity and widening the impact of income increasing efforts, project costs are held to a minimum and technology
is adapted to local conditions and needs.
In this fiscal year IDA has approved several rural development projects embodying an integrated approach to the poverty
problems. An example is a $10.7 million project for rural
development in Niger. The project includes the provision of
extension services, applied reesearch, and credit aimed at the
improvement of groundnut, millet and cowpeas production in 15
selected areas; strengthening of cooperatives; expansion of
education and training programs, including a functional literacy
program, a training school for extension workers, and the provision of training scholarships for project personnel; a study
of means for developing the nation's irrigation potential;
- 6 construction of 80 kilometers of feeder roads; planting of
500 hectares of trees in fuel wood plantations; and improvement of livestock services and provision of credit for the
purchase of livestock by pastoralists who lost their herds
during the Sahelian drought.
It is estimated that increased production from the project
will result in higher incomes for some 37,500 farm families
and 14,000 pastoral families. After full development in 1982
it is expected that average yields in the project area will
be close to those previously obtained only in years of most
favorable rainfall. Yield increases are estimated to result
in increments in annual production amounting to 18,100 tons
of millet, 19,800 tons of groundnuts and 600 tons of cowpeas.
In addition, new production of 500 tons of seed cotton, 900
tons of sorghum and 7,000 tons of tomatoes and other vegetables
is expected to result from new irrigation facilities. An
increase of about 3,000 tons per year in annual livestock production is also anticipated.
Every week the Board of Directors of the World Bank, in
which voting power is weighted according to financial contribution to IDA, reviews and approves IDA credits proposed by
the institution's professional Management. All such projects
are first subjected to rigorous technical and economic appraisal.
Firm cost estimates are made; required technical and managerial
assistance is provided for; and institutional reforms essential
to project success are made a condition of credit disbursement.
IDA draws upon a pool of skilled personnel, established
policies, procedures and a wealth of experience in making
effective use of its resources. The managerial and technical
excellence of the World Bank is widely recognized throughout
the world. Of the joint IBRD/IDA professional staff, roughly
27 percent comes from the United States. The remainder comes
from 110 other nations.
acts
when
approval of the Board of Directors, a status report is presented
on all ongoing prjects in the country to enable"the Board to
assess the country's capabilities for taking on further work.
$1
- 7 Effective internal auditing and evaluation functions
are also well established. The evaluation department,
established a few years ago at U.S. urging, has continued
to grow in stature and effectiveness. It evaluates all
projects within one year after loan or credit funds have
been fully disbursed with a view to strengthening future
operations. It also undertakes broad country and sector
program evaluation. The evaluation unit reports directly
to the Board of Directors.
A number of countries which once received IDA credit
have now advanced economically to the point where it is no
longer necessary. Three developing countries are making contributions to IDA IV. They are Spain, Israel, and Yugoslavia.
Among the oil exporting countries, only Kuwait, which has
contributed to IDA since 1960, is contributing to IDA IV, the
negotiation of which preceded the dramatic increase in oil
prices. The World Bank, however, is in close contact with
the oil exporting countries to solicit their cooperation and
efforts to assist the developing countries. The Bank is
urging several of them to participate in the Fifth Replenishment
of IDA as contributing members, and expects that they will.
The United States strongly supports this goal and in the preliminary international meetings on this subject has stressed
the importance of such OPEC participation. In the meantime,
a number of Arab oil exporting countries have joined with the
Bank and IDA in co-financing projects. To date, these countries
have contributed financing of $1.0 billion to 35 IBRD/IDA projects. These additional resources enable the Bank and IDA to
significantly expand the scope of their activities.
The Administration firmly believes that IDA has been,
and continues to be, an effective and valuable instrument for
the advancement of vital interests which the United States
shares with other nations of the world. The President, as well
as the Secretaries of State and Treasury, have all underscored
IDA's continued priority importance to U.S. foreign interests,
both political and economic.
The appropriation requested today will enable the United
States to carry out its share of the IDA IV agreement negotiated
among twenty-five governments to attack the problem of world
poverty which is of direct concern and relevance to all nations.
Other nations are fulfilling their promised participation and
expect the U.S. to do the same. It is clear that IDA is making
the kind of contribution to the world economy which is very
much in the U.S. national interest to support. Consequently,
prompt and favorable action on the FY 1977 appropriation request
for IDA is vitally important.
-IDA credits approved, by area, country and purpose, July 1, 1974 to June SO, 1975
[Millions of dollars equivalents]
Area, country
Total
Tanzania
1376.15
Total. Africa ...
Cameroon
Amount
33
Purpose
Sites and services.
10.0
Rural development.
1&2
Highways.
51135
16.0
Rubber estate.
U.0»
j na
Highway.
4.0
Dahomey
'35.0
Egypt •••
Area, country
Purpose
Amount
Telecommunications.
93
Agriculture development.
32.0
6J0
Cocoa/cofee,
Upper Volta
9.0
Livestock.
73
Rural roads.
Education.
Agriculture program
lean.
Sugar.
Togo
Education.
20.0
Ethiooia
*9.0
Zaire
Total. Asia
Afghanistan
Roads.
26.0
Highways.
25.0
Railway and river.
1.016.10
13.0
9.0
Agriculture.
V/ater supply and
16.0
Telecommunications.
23.0
Education.
Ghana
13.5
Oil palm.
33.0
Fertilizer.
Guinea
7.0
Pineapple development.
15.0
Population.
27.0
Irrigation.
24.0
Forestry.
21.0
Telecommunications.
S3.0
Canal-Rajasthaa.
91.0
Fertiliser.
27.7
Dairy.
16.4
Dairy.
35.0
Drought.
\tmva
*73
*8.0
•10.0
Lesotho
,
Mala?asv Republic
Mslawi
MaU
Group farming.
Forestry.
Education. '
9.6
Rural development.
•6.75
Forestry.
10.0
Highways*
S.5
23s
Rural deveiooment.
*
Livestock.
Rice.
33 »
Highway.
3.0
Highway.
33
Education.
Mauritania
Mauritius
r
Monxco ..
14.0
Rwanda ..
3.0
Education.
Senegal ...
15.0
Education.
1.0
Irrigation.
>icrra Leone
^oniaiia
Sudan
-*iziiand
Bangladesh
Burma
Urban development
4.0
133
sewerage.
Agriculture.
•7.0
Agriculture development.
•5.0
Rural development.
3.0
Education.
10.0
Education
23.0
Power.
20.0
Irrigation-
5.0
Education.
India .
75.0
200.0
Industrial imports.
Industrial imports.
45.0
Irrigation.
75.0
Agriculture refining
corporation.
Jordan
'ilrt*
akhnn
34.0
Rural development.
24.0
O a meal command.
73
Irrigation.
6.0
Education.
1.0
Potash engineering.
5.0
35.0
power.
T e i ecoram u nicau'oas,
30.0
Development inane
ccmoant.
Sri Lanka
9.0
15.0
43
Dairy.
Program loan.
Development S a a ^
company.
Western Samoa
4.4
Highwavs.
ATTACHMENT
Page 2
ijd
IDA CREDITS APPROVED,
BY AREA, COUNTRY AND PURPOSE,
JULY 1, 1975 to JANUARY 31, 1976
(millions of dollars)
Country
Total, All Areas
Amount
Purpose
975.4
Total, Africa
196.1
Burundi
Cameroon
Chad
Ethiopia
Gambia
Ghana
Guinea
Liberia
Madagascar
Malawi
MaliMauritania
Niger
Rwanda
Senegal
Sierra Leone
Somalia
Sudan
Tanzania
5.2
3.0
5.0
27.0
4.0
10.0
14.0
6.0
5,6
11.6
10.0
8.0
10.7
Total, Asia
Bangladesh
Burma
India
II
II
II
Jt
(1
Q 5
2.0
7.3
5.2
7.0
10.0
6.0
11.0
677.1
18.0
4.6
100.0
22.0
7.5
57.0
40.0
110.0
705.0
4.0
150.0
18.0
Coffee Imorovement
SHEI
Polders
Rangelands
Tourism
Hi ghway
Highway
Rural Development
Highway
Education
Highway
Port
Rural Development
Highway
Terres Neuves
Education
Mogadiscio Port
Development Finance Company
Dairy Development
Technical Assistance
Education
Maize Development
Water Transport
Imports
Irrigation
Livestock
Rural Electrification
Water Supply £ Sewerage
Railway
Fertilizer
Forestry
Power
Cotton Development
ATTACHMENT j/j/
Page 3 '
Country
Amount
Nepal
Pakistan
Sri Lanka
26.0
8.0
25.0
Total, Europe, Middle
East, and
North Africa
Afghanistan
Egypt
Yemen, POR
Total, Latin America
Paraguay
Purpose
Power
Tarfaela Dam
Agricultural Development
38.2
10.0
25.0
3.2
Irrigation
Development Finance Company
Aden Port
4.0
4.0
Pre-investnsnt
ANNEX 2
\r
INTERNATIONAL FINANCE CORPORATION
The Administration is requesting $112 million asspart of
a $480 million capital increase in the International Finance
Corporation of which $45 million would be appropriated
for FY 77. International negotiations concerning this
capital increase have not yet been completed although this
proposal has received widespread support from both developed
and developing countries, and formal international agreement
is anticipated in the very near future. The proposal would
result in a substantial reduction — from 33% to 25% — in the
U.S. share of IFC capital.
As the Committee has not had occasion to deal with IFC
for many years, the following reviews briefly the role and
the activities of IFC.
Role
The IFC was established in 1956 to promote private
investment in the developing countries. While it is organizationally and financially separate from the World Bank, it is
affiliated to it by a common Board of Directors and President,
and its 104 country members must be shareholders of the World
Bank in order to join.
The Corporation's interest lies in stimulating and
supporting private sector activities in developing countries.
Its principal function is, to stimulate the flow of private
capital into productive investments by bringing together
investment opportunities, domestic and foreign private capital,
and experienced management. Among international development
institutions, it is unique in its ability to operate without
a government guarantee on its loans, or on its participation
in equity investments.
The Corporation's policy is to make an investment only
where sufficient private capital could not be obtained on
reasonable terms and where the project will contribute to
development and have the prospect of being profitable. Where
it invests in capital stock, it remains a minority partner
without management control. It basically supports only private
enterprises although under certain conditions, IFC will participate in enterprises in which there is some government
ownership provided they are managed on a business-like basis.
IFC loans are made at near commercial interest rates with
seven to twelve-year maturity. Where it buys stock, it
expects to receive reasonable dividends.
- 2 -
Activities
Considering its small initial capital base of $100 million,
the Corporation has had a significant impact upon development
because of its success in leveraging its own funds: it has
generated more than $4 of private investment for every $1 of
its own
invested in projects. Since its inception, the
Corporation has been associated with about $6.4 billion of
investments and has assisted in financing some 250 enterprises
in 57 developing countries. Most of these enterprises have
been medium-sized firms, controlled by local groups with local
management.
After a slow beginning, IFC's commitments have grown
rapidly in recent years from $51 million in 1968 to $212
million in 1975. IFC's cumulative gross commitments of
$1.3 billion, as of December 31, 1975, are more than four
times the 1968 level.
Some Examples of IFC Projects
IFC, through its projects, serves a number of purposes
and activities. In the area of large mineral projects, IFC's
key function is not the provision of capital, which large international companies can provide, but to act as the neutral
intermediary between the companies who fear nationalization,
and the governments of developing countries, which want to be
assured that such projects wiil be in their long-term economic
and social interests. A good example of IFC's involvement is
a $620 million copper venture in Peru; a country whose
relations with multinational corporations has been difficult.
IFC's investment was small — $15 million; but its presence,
which has been approved by the Government of Peru, serves as
an assurance of fair treatment on both sides. The project
will develop the copper deposits of Cuajone in Southern Peru
with reserves estimated at 468 million tons, in accordance with
an agreement between the Government of Peru and the Southern
Peru Copper Corporation which represents a consortium of four
U.S. firms. It will produce 2,500 jobs and earn for Peru about
$150 million annually in foreign exchange by 1982. In accordance
with national legislation, the employees and workers will
eventually own half of the project.
Another example in Kenya, a country of less than $200
annual per capital income, illustrates IFC's role in the transfer
of technology. The project, the first integrated pulp and
paper mill in East Africa, will introduce a technology new to
the area and provide training to local workers. IFC is
- 3 investing $17 million of a total cost of $50 million. Its role
in assessing project feasibility and arranging financing was
crucial. With the associated tree replanting, the project will
result in 2,300 jobs, and produce 45,000 tons of paper annually
saving Kenya $8 million per year in foreign exchange.
In the Philippines — approximately $2 million was
invested in the Maria Cristina Chemical Industries to
help finance a $4.7 million electric arc furnace that
will double productive capacity by producing some 21,000
metric tons of ferroalloys a year. The project, located in
a depressed area on the island of Mindanao, will be supplied
by more than 2,000 new backyard charcoal makers who are expected
to earn well over twice the average annual family income in
the region. It will also use other locally available raw
materials and hydroelectric power, thus permitting production
for world markets at competitive costs. Prospective annual
net foreign exchange benefits were estimated at $5 million,
partly through exports and partly through import substitution.
In addition, ownership of the company is being broadened by
including greater employee participation in the equity.
Capital Increase
The Corporation needs a capital increase now in order to
maintain its growth rate of the past five years. Without the
assurance of an increase, it would have to begin to restrict
planned commitments beginning in fiscal 1977 and new equity
investments would essentially cease by the following year.
The U.S. strongly supports such a capital increase for
several reasons. International support for the private sector
will make a notable contribution to accelerating the pace of
development and is very much in accord with U.S. interests
reflecting our own confidence in free enterprise and the private
sector. Second, while IFC has done an excellent job in 20
years in utilizing its initial small reservoir of funds
it seems reasonable that IFC has some catching up to do if
it is to remain a significant international institution.
It is worthy of note that the World Bank's capital has
tripled in that same 20 year period. Third, the present
capital base has become so small that it inhibits the
Corporation from undertaking somewhat riskier ventures for
smaller business and in poorer countries for fear of unacceptable losses. Fourth, the scale of significant investment
projects has increased enormously since the '50s and the IFC
should be in a position to support reasonably large projects
as well as small ones.
- 4 IFC also wants to play a more active role as a intermediary in the minerals field facilitating arrangements between
large private corporations and the governments of developing
countr ies.
The U.S. share of the $480 million increase in issued
capital stock is $112 million, or about 23% compared to our
33% share of current capital. This proportion reflects more
accurately the current U.S. position in the World Bank than
the present share which is based on the U.S. position in the
late '50s. Germany, Japan and the OPEC countries will have
larger shares.
The resolution governing the capital increase requires
that if a country is not in a position to make a binding
commitment to pay for all its subscribed shares, it must pay
for at least 40% of its quota. This means that if the authorization bill is approved by the Congress, then the U.S. will
need an appropriation for 40% of its subscribed shares in
order to make an initial commitment to IFC. As a result the
Administration is requesting a $45 million appropriation.
This figure differs from the budget figure of $41.7 million
because negotiations were not fully defined when the budget
submission was made. The Administration expects to ask for
appropriations for two additional installments in FY 1978
and 1979.
The following attachment will provide greater detail
about IFC's activity, its sources of financing and the capital
increase.
/ #
Geographical Distribution of Loans and Equity Investments
The table below indicates the geographical distribution of IFC
activity. Latin America is the regional leader followed by Asia. The
Southern Europe designation is mainly Turkey and Yugoslavia, as well as
loans to Greece and Spain.
TABLE 1
GEOGRAPHICAL DISTRIBUTION OF IFC ACTIVITIES
(as of December 31, 1975)
Amount
($ Millions)
No. of
Enterprises
I. Regional
Latin America
Asia
Southern Europe
Africa
Middle East
II.
100
63
37
37
14
$
545.1
317.0
288.6
122.3
58.2
(41%)
(24%)
(22%)
( 9%)
( 4%)
251
$1,331.2 (100%)
21
9
12
13
13
9
8
11
8
7
$262.9 1[20%)
128.5 1;io%)
118.1 1; 95)
76.1 (: 6%)
69.9 1: ss)
58.4 1! 42)
53.2 I: 4%)
51.8 1' A.")
\
44.1 1\ *3o'
3lal
42.5 1I 3%)
Leading Countries
Brazil
Yugoslavia
Turkey
Philippines
Mexico
Indonesia
Argentina
India
Korea
Iran
f
Source of IFC Financina
The two tables below illustrate a) IFC's dependence on borrowing from
the private sector via loan participation, and from the IBRD, and the diminish
ing importance of caniial as a source of financing and of equity as a form of
1 n W f i C + m<-iir» +•
For loan operations resources, IFC relies primarily on borrowings from
the World Bank. It is limited in the amounts of its borrowings by its
Articles which prohibit total debt from exceeding four times IFC's net worth
(unimpaired subscribed capital and surplus), so long as IFC is indebted to
the Bank. As of June 30, 1975, IFC's net worth was $178 million, placing
the limit upon IFC borrowings at $712 million. As of the same date, IFC had
already borrowed $448 million and would reach the ceiling in early FY!979 at
presently projected rate of operations.
Because World Bank loans cannot be used to purchase stock, IFC's equity
investments may not exceed its unrestricted mainly capital and accumulated
reserves resources. As of June 30, 1975, these resources totalled $183 mi 11 i
compared to existing investments of $127 million.
TABLE 2
SOURCES OF IFC FUNDS
($ Millions)
Actual - FY71-75
Income
42 I[ 7%)
Capital Subscriptions and Loan Repayments
78 I[13%)
IBRD and Netherlands Loans
Portfolio Sales
272 1[462)
25 I: 4%)
Calls on Participants
166 1[29%)
583 1;ioo%)
TABLE 3
IFC FINANCING TRENDS
6-30-70
6-30-75
a) Financed by 1) capital and reserves
2) borrowing
90%
10%
40%
60%
b) IFC debt outstanding as % of its disbursed
loans
18%
78%
c) Equity investment as % of portfolio
30%
22%
I ni
FACTUAL SUMMARY OF CAPITAL INCREASE
(in millions of dollars)
Proposed
Increase
' After
Increase
Authorized capital (12/31/75)
110 540 650
Issued capital stock (12/31/75)
107.6 480 587.6
Unallocated shares
2.4 60 62.4
Form of Commitment
a) subscribe to shares allocated, and b) make a binding commitment to
pay. Exceptional procedure where a commitment to pay must be qualified
because of legislative procedures: commitment for payment for a minimum
of 40% must be unqualified, and, appropriate legislative action allowing
an unqualified commitment to pay for the remaining 60% should be obtained
as quickly as practicable. Since our commitment to pay is subject both
to authorization and appropriation legislation, this is the procedure the
United States will follow.
Payment schedule
a) August 1, 1977
20% - U.S. share of 22.5
20% unqualified commitment for additional share of 22.5
b) August 1, 1973
Unqualified commitment above is due
c) August 1, 1979
20% - U.S. share of 22.5
d) August 1, 1980
20% - U.S. share of 22.5
e) August 1, 1981
20% - U.S. share of 22.5
6.
Schedule for U.S. legislation on IFC
Date of
Submission
Amount
($ Millions)
Authorization bill
March 1976
112
FY77 Appropriation
March 1976
45
FY78 Appropriation
January 1977
33
FY79 Appropriation
January 1978
33
General Data
1) Resolution approving increase will become effective on December 31, 1976,
or such later date as the Directors may determine.
2) Shares related to the increase will not be issued before August 1, 1977.
3) Shares'will be issued only when paid for in U.S. dollars.
4) Each share has a par value of $1,000 and is issued at par.
0
Annex 3
INTER-AMERICAN DEVELOPMENT BANK
The IDB is in immediate need of additional resources to
finance Latin American development. Its ordinary capital
commitment authority was virtually exhausted at the end of 1975.
Approval of most new loans must now be made in the form of contingent commitments pending replenishment of the Bank's capital
resources. The loan commitment authority of the concessionary
Fund for Special Operations (FSO) will be exhausted in 1976
even if the U.S. is able to contribute $225 million as
recommended by the Conference Committee on the FY 1976
appropriation bill. To allow the Inter-American Development
Bank to continue to play a key role in Latin American development
the Administration is seeking funding for the U.S. participation
in the replenishment of the IDB's resources for the 1976-79
period.
IDB OPERATIONS AND MANAGEMENT
Background. The Inter-American Development Bank (IDB) came
into existence on December 30, 1959; it made its first loan in
February 1961. Nineteen Latin American countries and the
United States were charter members. Trinidad and Tobago
joined the Bank in 1967f Barbados and Jamaica in 1969 and
Canada in 1972.
In its fifteen years of existence, the Bank has assumed an
important and growing role in Latin American social and economic
development, not only from the point of view of actual project
financing, but also through technical assistance, and development planning and programming. The IDB has proven to be a
well-managed organization and an innovative lender continually
finding new ways to improve its development impact by concentrating on the key development bottlenecks. Because it has the
experience and staff to give our contributions a major multiplier effect on development, the IDB is one of our most cost
effective development investments.
-2The Bank carries out its financing operations through two
lending windows, the ordinary capital and the Fund for Special
Operations (FSO). The IDB also serves as administrator for
special funds provided by several member and non-member
countries. The single largest of these funds is the U.S. Social
Progress Trust Fund (SPTF), which was established in 1961.
With the approval of a $15 million loan for El Salvador in
January 1976, virtually all of the total $525 million
available on soft terms for additional social development
projects in the poorest countries had been committed. In addition,
the IDB and the U.S. Government are coordinating closely
on programming the local currency reflows from SPTF loans so as
to maximize their usefulness in financing technical assistance
and appropriate activities related to FSO-funded projects.
The IDB also administers a $500 million Trust Fund established
by Venezuela in February 1975, from which loans totalling
$83 million were extended in 1975 on terms similar to ordinary
capital loans.
The ordinary capital window currently provides development
loans at an 8 percent interest rate with maturities ranging from
15-30 years. It obtains its funds largely from the financial
markets of the world, borrowing against callable capital, much
the same as the World Bank.
The Fund for Special Operations was designed to offer
financing for economic and social development when lending on
conventional terms is not appropriate. FSO loans are made at
1-4 percent interest for 20-40 years. FSO loans have been
extended entirely from resources provided by the Government of
the United States, Canada, and the Latin American members of
the Bank. Until 1973, repayment of FSO loans was in local
currencies. Since then, such loans are repayable in the
currencies lent.
Subscribed Share Capital. At the end of 1975, IDB subscribed capital totalled $5,965 million, of which the paid-in
portion was $983 million, and callable capital $4,982 million.
The U.S.
Callable
share Capital.
was 40 percent.
The callable portion of ordinary capita!
is a contingent liability of the subscribing countries which
can be called solely and only to the extent necessary, to meet
obligations of the Bank to its bondholders. Callable capital
constitutes a guarantee which makes it possible for the Bank to
issue its own securities in private financial markets.
0
-3As long as the Bank is able to meet the obligations on its
bonds from the proceeds of principal and interest repayments by
borrowers on their loans, or from the other resources of the
Bank, the callable capital will not impose any burden on member
governments. Should calls be necessary they must be a uniform
percentage of all member governments capital shares, although
each member is liable to the full amount of its callable capital
subscr iption.
The net income of the IDB during 1975 was $59 million,
raising its total reserves to $297 million. These reserves
provide assurance to the holders of the Bank's obligations
regarding their financial soundness and a substantial margin
against potential calls on callable capital. Because they have
built up reserves against losses and continue to add to these
reserves from net earnings, the IDB has never found it necessary
to take recourse to callable capital. In fact recourse to
callable capital is highly unlikely since it would imply massive
and sustained defaults by borrowers. To date, there have been
only two defaults in the IDB of which $1.8 million remains
unrecovered. These were loans to private enterprises made before
government guarantees were required for all loans.
Ordinary Capital Borrowing. The Bank has expanded the
market for its bonds in capital markets worldwide. Less than
one-half of its borrowings have been in the U.S. market. As of
December 31, 1975, $633.3 million of the Bank's outstanding debt
of $1,580.4 million was represented by long-term bond issues
placed in the U.S. market. Borrowing in 14 non-member
countries, mainly in Europe accounted for $821 million and
$125.8 million has been borrowed in Latin America.
Fund for Special Operations. The Fund for Special Operations was initially established with authorized resources of
$150 million. The United States provided $100 million and the
Latin American countries $46.3 million, half in dollars and half
in their national currencies. The resources of the FSO were
increased by $3,173 million during replenishments in 1964, 1965,
1967 and 1970. To date, the United States has made available
$2,765 million to the FSO, not including the $225 million
recommended by the Conference Committee on April 1.
-4The FSO makes loans on concessional terms primarily to
finance projects with an emphasis on social development such as
in health, education, and rural water supply. The small proportion of FSO loans that are extended to the more developed
countries consist almost exclusively of local currencies and are
reserved for projects that, while very worthwhile and socially
important, are not likely to generate a stream of income sufficient to amortize an ordinary capital loan. The bulk of FSO
lending is directed to the less developed borrowing countries
and in those cases may be used also for income generating
projects. The rationale is that the poorest countries need
concessional convertible currency assistance regardless of the
nature of the project.
In accordance with Bank policy, and at U.S. urging, the most
developed Latin American countries (Argentina, Brazil, and
Mexico), are reducing their borrowing from the FSO. FSO convertible currency commitments to these countries and Venezuela
dropped from $90 million in 1973 to $67 million in 1974 and to
$45 million in 1975. In 1974 Venezuela stopped all borrowing
from the FSO. During the period of the replenishment these four
countries plus Trinidad and Tobago have agreed not to seek convertible currency loans from the FSO. The Bank will concentrate
its soft-term lending on the neediest member countries and on
those sectors that have the greatest direct impact on low-income
groups, such as agriculture, education, health, and water supply
and sewerage.
The Latin American member countries also contribute their
own currencies to the FSO. The Bank uses these local currencies
primarily for loans in the contributing country. The Bank has
also used the currencies of its more developed member countries
-- Argentina, Brazil, Mexico and Venezuela — to finance projects
in other member countries when these countries are suppliers of
Bank-financed imports. Under the terms of the proposed replenishment this arrangement for expanded use of local currencies
will be extended to all currencies contributed to the FSO.
Bank Lending Activities. In its fifteen year operating
history, the IDB has loaned $8.8 billion in support of Latin
American economic and social development. Of this total, about
$4 billion in loans were made from the Bank's ordinary capital
resources and $4.1 billion from the FSO . The
total amount loaned by the IDB from 1961 to the end of 1975
represents about 40 percent of the total development financing
received by Latin America from the IBRD, IDA, AID and IDB.
In 1975 alone the IDB accounted for 47 percent of official
external capital for Latin America. IDB loans have financed
projects involving a total investment of over $20 billion.
/, 0 V
Roughly a quarter of its loans, or $2 billion, financed
high-priority agricultural development projects. An additional
$1.9 billion was lent for electric power projects and $1.6 billion
for transportation and communications. It also provided substantial
sums in the water supply, housing and education sectors
Innovation in Lending. Among all of the international
development banks, the IDB has perhaps been the most innovative
lender. The following represents several types of activities
in which the IDB has been in the forefront with a proven record
of accomplishment:
— The IDB has been the leader in lending for integrated
rural development where organizational and logistical problems are
especially difficult, such loans combining rural health services,
education, small farmer credits, and feeder roads. Rural water
supply is also a good example of a sector in which the IDB has
played a pioneering role by providing potable water to the
Latin American rural population through loans in nearly all
of its member countries. Over the past five years, IDB-financed
projects provided potable water for the first time to an
estimated additional 10 million people. Even with this effort,
only 25 percent of Latin America's rural population has access
to this service.
— IDB has taken the lead in lending through cooperatives.
Availability of loans for use by cooperatives has increased to
80% of the Bank's agricultural credit loans and all of the
loans for rural community development and rural electrification.
In several countries loans to increase the domestic supply of
fisheries have also been made through cooperatives. And in
October 1975 the Bank approved a $9 million loan to the Latin
American Confederation of Cooperatives to support its efforts to
strengthen programs being carried out in 10 countries.
-- The IDB is in the forefront in encouraging Latin American
integration projects. With a view to increasing economic
efficiency, the IDB has taken a leading role in promoting
individual projects that benefit more than one member country.
Examples include IDB loans for the Acaray hydroelectric
project in Paraguay, which delivers part of its output to
Argentina and Brazil; an integrated road project that serves
several countries in Central America, and the Trans-Andean
highway between Argentina and Chile.
Utilization of Resources . Heavy use of callable capital
and reliance on borrowing operations to raise private capital
have provided needed leverage and reduced U.S. budgetary outlays,
clearly very desirable results. Last year, the Inter-American
Development Bank began promising major new efforts to raise
additional private funds for economic development projects.
-6A new "Complementary Financing" program permits commercial
banks and other organizations to take up without recourse the
earlier maturities of specific loans. In turn, the IDB agrees
to perform the necessary technical analysis and act as collection
agent for a fee. The interest rates charged by the commerrcial
banks vary at a given spread above a reference rate. (Either the
prime rate in the United States or the Libor in London.) This
new procedure makes possible direct participation by private
banks in the development process at appropriate maturities and
interest rates and at reduced risk. Thus far the IDB has utilized
$30 million of complementary financing. During 1976 the Bank
hopes to mobilize an additional $100 million. The procedure
also helps to introduce some IDB borrowers to the private capital
markets. As their creditworthiness reputation develops, they
will be able to borrow more in this area and eventually require
less lending by the IDB.
In yet another exercise to expand usable resources, the
Bank and its member countries are looking for ways to improve
the "four currency agreement" in which local currency of one
developing member country may be used to finance projects in
another. The U.S. Executive Director recently asked Bank management for a further study of how the IDB can derive maximum benefit
from the local currency contributions of its member countries.
Trends in Lending. Turning to the most recent developments
in IDB lending policies, the Bank continues to channel assistance
to the poorest and least developed member countries. In calendar
year 1975, for example, $306 million of FSO resources went
to category D borrowers which are the least-developed members
of the Bank, including such countries as Haiti, Paraguay,
Bolivia and Central America, exclusive of Costa Rica. Emphasis
is also being placed on helping the poorest elements of the
population within these countries. For some time, the IDB
has led the way in financing of potable water, rural electricity,
and health and education projects, and also tried to reach
poor farmers with agricultural credit programs. During claendar
year 1975, the Bank approved loans totalling $138.7 million
to cooperatives and similar organizations. Of this total,
$53.67 million came from FSO resources and $9.0 million was
supplied from the Social Progress Trust Fund. Bank management
estimated that more than 1.6 million individuals will benefit
from the work to be undeertaken by the cooperative enterprises.
In January of this year, the IDB approved additional loans
involving $12.1 million for cooperatives in programs which
should benefit 110,000 more oeople. In the same month, the IDB
also approved expenditures of $48.0 million over three years to
assist the Inter-America Foundation in its programs. The
-7Administration of the Bank is now preparing a proposal to provide
between $10 and $20 million to the Inter-American Savings and
Loan Bank. In this program, concessional funds from the Social
Progress Trust Fund would be used for the benefit of lesser
income participants of S and L's in Latin America.
Efforts to Increase Effectiveness of Lending Programs
The Bank also is concerned with efficiency. Last year,
the IDB took the lead in establishing a new Hemispheric Committee
to help promote greater agricultural production. Its membership
consists of representatives from A.I.D., the World Bank and
other international organizations interested in agriculture.
The objective of this group is innovative and constructive change,
not only in the projects, the Bank and others finance, but also
in the government policies which ultimately determine how
successful these individual projects will be. Greater participation by private business and application of modern methods is
certainly one avenue to be followed.
Another extremely important prospect is the application of
intermediate technology. The use of idle labor with new methods
and simple or less sophisticated tools needs much greater
emphasis as a factor for more effective utilization of scarce
foreign capital. Within the Bank, particular efforts have been
made in this respect in agriculture in Brazil, Colombia, the
Dominican Republic and Mexico.
A recent loan to Mexico for integrated rural development,
approved by the Bank's Board of Directors in October of 1975,
offers especially interesting possibilities for application of
intermediate technology. It is designed to provide permanent
employment and raise income levels of 1.3 million people in 15
regions of Mexico. Directly productive investments under the
loan include establishment of small orchards and development
of quarries and industries including brick-making, garden produce
processing plants, and sewing shops. Naturally, the leading
objective of employment generation calls for use of the most
appropriate technologies and this aspect of the program will
be closely supervised. As a necessary correlative to these direct
investment projects in Mexico there are such infrastructural
investments such as water supply systems, home schools and health
centers. Completion of the entire program is expected to double
or triple annual family income in the 15 regions and to increase
the total value of production by $35 million per year.
Another recently approved loan involving rural health
services in Haiti presents an excellent example of how the Bank's
work in a critically important field in affecting poor people
-8in rural areas. The loan amounts to $6.3 million from FSO
resources and is designed to build and equip 36 dispensaries,
23 health centers and one new health and training center. Bank
management has estimated that it will benefit 1.9 million
people in both the northern and southern regions of the country.
The Bank is giving steadily increasing attention to projects
which directly benefit the poor. One of the best indicators of
the attention given by the IDB to the needs of the poor is the
percentage of concessionary loans made to the poorest Latin
American countries. The percentage rose steadily from 17% in
1970 to almost 55% in 1975. This trend is continuing.
IDB REPLENISHMENT AND NONREGIONAL MEMBERSHIP
The proposed replenishment of the IDB's resources for
the 1976-79 period provides for an increase of $5,303 million
in the authorized capital stock of the Bank, and $1,045 million
in the FSO, for a total of $6,348 million. Of this total, the
U.S. would provide $2,250 million, the Latin Americans would
furnish $3,588 million and Canada would provide $307 million.
The proposed membership of twelve nonregional countries will
also increase the Bank's capital. The nonregional countries,
ten from Europe plus Japan and Israel, will contribute to the
Bank about $745 million over a three-year period (1976-1978).
This total would be divided equally between the Bank's hard
loan and soft loan windows, providing about $373 million to
subscribed capital and another $373 million to the FSO.
Proposed U.S. Subscriptions and Contributions. The U.S.
share of the capital increase would be $1,650 million, of
which $1,200 million is to be subscribed in three equal installments
of $40 million paid-in and $360 million in the form of callable
capital in FY 1976, FY 1977, and FY 1978. An additional $450
million of callable capital is to be subscribed in FY 1979.
U.S. contributions to the FSO would total $600 million, to
be provided in three annual installments of $200 million over
the period FY 1977-79.
The U.S. share of total new resources for the IDB during this
replenishment period would be 30 percent compared with the 48
percent U.S. share during the last replenishment initiated in
1970. The composition of U.S. participation would be 73 percent
capital and 27 percent FSO, compared to 45 percent and 55 percent,
respectively, in the 1970 replenishment exercise. The impact on
budget outlays would be only $720 million, compared with $1,150
million under the 1970 replenishment.
-9Creation of Inter-Regional Capital Stock. The most important
change in the Bank required by the entry of the nonregionals
is the creation of a new series of capital stock to be designated
as inter-regional capital stock. This new stock will be created
to avoid certain limitations attached to ordinary capital
borrowings which would reduce the utility of the new members'
subscriptions. In the past, the Bank has included covenants
in its bond issues which restrict the amount of total borrowings
backed by its callable ordinary capital resources to the callable
capital of the United States available on demand. The existence
of this covenant means that contributions to the callable
capital of the Bank from countries other than the United States
cannot serve the purpose of supporting additional IDB borrowing.
Beginning in 1975 such covenants were no longer included in
the Bank's bond issues. Since such covenants were included
in previous bond issues — some of which will not mature until
1995 — the holders of these bonds could enjoin the Bank from
borrowing for its ordinary capital resources in excess of
the U.S. callable capital subscription until all these bonds
have been retired or redeemed. Thus, the Bank has decided
to create a new category of capital under which it will be
able to borrow against the callable capital of countries other
than the United States.
Any member country would have the option of subscribing in
whole or in part to either ordinary capital or inter-regional
capital. For the 1976-78 period, one-half of the U.S. subscription would be made to inter-regional capital. In the same
period, Canada and Venezuela would make 100 percent of their
subscriptions to inter-regional capital, as would the nonregional
countr ies.
For the purpose of computing voting power and preemptive
rights, no distinction is to be made between ordinary and interregional capital. An eventual merger between ordinary and interregional capital is anticipated when bonds with the restrictive
covenants are no longer outstanding.
Effect on U.S. Voting Power. The effect of the new memberships
and the proposed replenishment would be to reduce U.S.
voting power from the present 40 percent to slightly less
than 35 percent. In the FSO, this voting power
would preserve the veto of the United States since decisions
on soft loan operations must be approved by a two-thirds majority.
Moreover, one of the proposed amendments to the IDB Charter
provides that the United States will have not less than a
34.5 percent voting share in the Bank as long as it wants
such a share.
-10-
ft
Budget Impact. The impact of these requests on the U.S.
budget over the next several years is substantially less then
the total authorization. Of the $2,250 million authorization
request, actual cash outlays would amount to $720 million
($120 million paid-in capital and $600 million FSO). This
cash outlay represents 32 percent of our total participation,
a reduction from the $1,150 million, which represented 64
percent of the last replenishment. Our $1,530 million subscription
to callable capital is not expected to require any expenditures
now or in the future because such capital would be called
only in the highly unlikely event of a massive and widespread
default by Bank borrowers.
Appropriation of the first $40 million of the three equal
installments of paid-in capital and the first $200 million of
three equal installments of callable ordinary capital would be
sought in FY 1976. Since the covenants limiting borrowing to the
amount of U.S. callable capital available on demand would not
apply to inter-regional callable capital, we would propose not to
seek appropriation of the $930 million proposed for subscriptions
to inter-regional callable capital. On the basis of authorization
legislation, our inter-regional callable capital would be backed
by the full faith and credit of the United States. Payment of
the paid-in portion would be in the form of a letter of credit,
and only a part of this would result in cash outlays in FY 1976.
An appropriation would be requested in FY 1977 for the first
$200 million of the U.S. contribution to the FSO but only a small
fraction of this amount would result in budgetary expenditures
in FY 1977. Appropriations for the balance of the U.S. contribution
to the FSO would be sought in FY 1978 and FY 1979.
ANNEX 4
ASIAN DEVELOPMENT BANK
The Asian Development Bank was created in 1966 to
foster economic growth and cooperation in the poorer
countries of Asia and the Far East. The Bank has 27 regional
members providing 72% of its capital and 14 nonregional members,
including the United States, Canada, and 12 West European
countries providing 28% of its capital. The aggregate voting
power of the developed member countries, which include all
the non-regional members plus Australia, Japan, and New Zealand,
represents approximately 54% of the total. The United States
participated actively in the establishment of the Bank and
its subscription to the Bank's capital stock currently amounts
to $361.9 million or 11% of the total.
Bank Resources
The Bank's ordinary capital lending, at interest rates of
8.75 and terms of 15-25 years, is financed from its subscribed
capital and the proceeds of- its borrowings. As of December
31, 1975 the ADB's subscribed capital stock amounted to
$3,201.5 million of which 33% was paid in and 67% was callable.
Callable capital is used exclusively to guarantee borrowings
from the international capital markets and represents a
potential budgetary outlay only in the unlikely event that
the Bank could not meet its obligations to bondholders.
Through a bond covenant the ADB is restricted to borrowing
an amount not more than approximately 97% of its convertible
callable capital, currently $1,264.4 million. If the Bank
were to limit its new commitments to amounts which could
be financed without additional capital, the Bank had resources
sufficient to commit only $184 million in new loans as of
December 31, 1975. Given the virtual exhaustion of commitment authority, the Bank has already initiated discussions
on a capital replenishment. The U.S. has not yet taken any
position on the size and timing of such a replenishment,
although it is clear that additional funds are needed
relatively soon.
The U.S. subscribed its first of three installments
to the first ADB capital replenishment in FY 1975. Most
other countries completed their subscriptions to the replenishment during 1973-1975. The request for"$120.6 million in
FY 1977 completes the US contribution to the replenishment
and is vital to the lending program of the ADB as the figures
mentioned above indicate.
The funds are urgently needed
- 2 to permit continued ADB lending to countries such as the
Philippines, South Korea, Indonesia, and Thailand — the
major 1975 ADB borrowers. These Asian rim countries have
shown strong self-help efforts to achieve economic growth
and are of particular importance to the United States.
Of the $120.6 million sought for FY 1977 only $24.1
million are paid-in funds which will entail budgetary
outlays. The remaining $96.5 million is callable capital
which is not likely to require any US outlays. In FY 1975
only the $24.1 million of paid-in was appropriated, but
on the basis of authorizing legislation the US subscribed
the full $120.6 million first installment. However, we
subscribed to the callable capital only reluctantly because
we believe callable capital for this relatively new bank
should be appropriated. We are happy that the Senate/House
Conference Committee on April 1 recommended appropriation
of the full $120.6 million for FY 1976. The callable capital
proportion of the third installment is also being requested
in FY 1977 for appropriation. Appropriation of this
amount does not increase Treasury outlays but it gives
financial analysts and the bond market greater confidence
in the ADB's bond issues and, thus, with no real cost
to the United States, the ADB will be able to borrow at
better rates and longer terms than otherwise. Completion
of the US subscription to the first replenishment will also
allow us to increase our voting power in the Bank, which
is now 9.5 percent, to close to the original 16 percent.
In 1975 the ADB borrowed $322.8 million in world capital
markets of which $75 million (23%) was raised in the United
States. This was the first ADB issue in the U.S. since
early 1971 as the Bank has been relying more heavily on
the Japanese and West European markets. The U.S. notes,
with an 8.5 percent coupon rate, were priced at 99 percent
with full maturity in five years.
Bank Lending Activities
From its establishment through December 31, 1975 the
Bank has approved 150 loans from ordinary capital resources,
for projects in 15 member countries, in an aggregate amount
of $1,925 billion, of which $684 million has been disbursed.
In CY 1975 the Bank committed $494 million for new loans.
Tne Bank has become an important institution in Asian
development, and being a regional organization, olays a major
role in mobilizing self-help resources and bringing local
knowledge to Asian development problems
%•
;
In response to suggestions by the Administration and
Congress and by its own borrowers, the ADB has been paying
increasing attention to the social impact of its operations.
Of particular concern to the Bank are efforts to create
employment opportunities and increase rural incomes. Lending
for agriculture and agro-industry was over 37% of total
ADB/ADF lending in 1975 compared with 24.5% in 1974.
The extent of this change in sector emphasis during the past
couple of years is shown by the fact that despite the 1975
lending program, cumulative Bank loans to public utilities
at the end of 1975 totalled $907 million (35.1%), compared
with agriculture's $589.4 million (22.8%).
Recent irrigation and land development projects have been
used by the Bank to provide not only infrastructure, but also
farmers' credit, seeds, fertilizer, and other inputs as well
as improved marketing facilities. Additionally, more attention
is being given to the development of extension services and
other farmers' institutions. The objective of such integrated
projects is to ensure that all the various factors needed
to increase productivity are provided in the appropriate "balance
An example is the Pulangui River Irrigation Project in the
Philippines approved in 1975 which includes all of the following
elements:
construction of irrigation canals, drainage system
and roads;
establishment of two pilot farms for demonstration
of extension services and the introduction of intensive rat
control measures;
the improvement of the land tenure system;
other farm services such as timely supply of farm
credit, fertilizer, and other farm inputs.
The benefits of the project include employment totaling 2.6
million man-days during the construction period and about
477,000 man-days after the construction of the Irrigation
project and improved income distribution in the area as crop
production incomes of nearly 3000 small farmers increase
from $191 at present to $1,572 after 1982 for self-owners
and $1,365 for leaseholders.
Many of the same concerns are also being addressed
for the first time in other sectors. For example, in 1975
the Bank provided financial and technical assistance for
sewerage and slum redevelopment projects. These projects,
0
- 4 -
together with water supply, are a part of the ADB's efforts
to increase the direct impact of its operations on lower income
groups in urban areas. Under the Bandung Urban Development
and Sanitation Project a comprehensive study will be conducted
for the improvement of housing, roads, footpaths, water supply,
sewerage, solid waste disposal, health clinics, and other
facilities. The first stage of the subsequent project will
improve living conditions of about 34,000 households with
average incomes of less than $50 per month.
Asian Development Fund
When the Bank was established it was recognized
that it would have to provide financing on concessional
terms to meet the needs of its poorer developing member
countries. Prior to 1973 the ADB's soft-loan special
funds were contributed on an unscheduled basis through
bilateral arrangements made by the Bank with donor
countr ies.
In 1973, the ADB's Board of Governors, with United States
support, adopted a resolution creating a new multilateral
special fund, the Asian Development Fund, to which all contributions would be made and used on the same terms and conditions.
Subsequently, agreement was reached among the Bank's developed
country members on an initial resource mobilization for the
new ADF of $525 million for the three-year period ending December 31, 1975. In FY 1972 and FY 1975 the Congress authorized
U.S. special funds contributions totaling $150 million, of
which $100 million has been appropriated and contributed to
the ADF. The final U.S. contribution of $50 million to the
initial mobilization is included in the FY 1976 appropriation
request.
As of December 31, 1975 the ADF/SF had committed $658.8
million for concessionary loans. This left only $40.9 million
remaining for new commitments in 1976, not including the
>ov million U.S. contribution requested for FY 1976.
no^Re^°gnizing the dePletion of ADF resources, multilateral
W e r e h e l d in 1 9 7 5 w i t h a
thl A^t°nS
view to replenishing
eS
Ur
S
Uring these
r
nJ
°
r *
°
negotiations the U.S. "
e
tated th3t he could give no
J S
.?
indication of
9
f a U S
the ini ^ ef t^'u °
' " contribution, in part because
S had n0t Yet
to t X in?*- f
d i e t e d its contribution
tial
i H
resource mobilization of the ADF and conC nCer ni
had o Spf h
i ?5 U ' S - Participation in a replenishment
did indicate IZL tl* W l t h C o n ^ e s s The U.S. representative
G U S
c o n t
of the ^DB La
i5 ' '
^ s to be a strong supporter
?riS?iS; B tr2 h nSS f " ^
^
^
«Pect to continue con-
if
- 5 -
%
Recognizing that the U.S. was unable to commit itself
concerning the specific timing or amount of any U.S. contribution, the ADB Board of Governors on December 3, 1975,
adopted a resolution providing for the replenishment of ADF
resources. The resolution provides for an ADF replenishment
in an amount not to exceed $830 million for the 1976-78
period. Most donor countries agreed to contributions equal
to approximately 150 percent of their initial contributions.
As no decision has yet been made on the total U.S. contribution to be requested for the ADF replenishment, the
United States reserved its position on the $231 million
proposed in the resolution for the U.S. share while commenting
that such an amount seemed large. We formally abstained
on the resolution.
Pending final determination of the total three year U.S.
contribution level, draft legislation authorizing an initial
U.S. contribution of $50 million for FY 1977 has been transmitted
to Congress. Since contributions by other countries beyond
the first year of the replenishment are contingent on U.S.
participation, a U.S. commitment of the $50 million in FY
1977 is essential for the successful implementation of the
total ADF replenishment package. This amount represents
the same level appropriated in FY 1974 and FY 1975 and requested
in FY 1976. The Administration has not yet determined the
level of ADF appropriations to be requested for FY 1978 and
FY 1979; in any case the level will be below the suggested
$231 million.
Special Fund Operations
In 1975 the ADF approved concessionary loans totaling
$166 million, which was considerably less than the Bank's
expected program of $200 million in part because no loans
were approved for South Vietnam, Cambodia, or Laos. The loans
went to the poorest South Asian and Pacific states with
Bangladesh, Pakistan, Burma, and Sri Lanka as principal
borrowers. Agricultural and agro-industry projects accounted
for 65% of the total lending and public utilities for 29%.
Only Asian countries with 1972 per capita incomes of less
than $300 are eligible for the loans which carry a service
charge of 1% with maturities of 40 years including 10 years
grace period on repayments.
Indochina
The Asian Development Bank, with strong U.S. support,
made loans to South Vietnam, Cambodia, and Laos in previous
years when conditions in these countries were quite different
from the present situation. In April, 1975, the Bank suspended
- 6 -
0
all loan operations in Vietnam and Cambodia. Operations have
not resumed and no new loans have been considered or approved.
There has been no contact by the ADB with Cambodia since last
April. Although the Vietnamese have indicated some interest
in the IMF, IBRD, and ADB, our attitude, and that of the ADB,
is that benefits are limited to those countries willing to
accept and implement the obligations and responsibilities
of membership including Bank staff access to national economic
data, freedom of staff entry and movement, adherence to conditions
stipulated in loan agreements, and international competitive
bidding for project procurement. Until the present governments
of South Vietnam and Cambodia agree to follow these procedures
we expect no ADB financial assistance to these countries.
At this time there is no evidence that these countries are
prepared to comply with ADB requirements.
In Laos the ADB is closely monitoring its operations
to ensure that loan conditions are being met and the projects
properly implemented. As indicated below, the actual amount
of funds disbursed to suppliers for projects in Vietnam,
Cambodia, and Laos as of December, 1975, was only $12 million.
ADB/ADF Indochina Loans
(U.S. millions $)
South Vietnam
Cambodia
Laos
1/
Loans Approved
Amounts
Disbursed
$44.6
1.7
11.7
$5.7
.6
5.7
A
Paid-in 1/
Convertible
Currencies
$ 4.5
1.2
0.2
Contributed to ADB by these countries
Conclusion
AS Secretar
Y Simon pointed out in his speech at the
ADB annual meeting in Manila last year, Asia has a special
significance for the United States.
He echoed President
Ford s promise that the United States would continue to
" " k cooperatively with others in maintaining the security
and building the prosperity of the region. In an increasingly
interdependent world, the United States, as a nation of the
W 6
rnltltL
A V S t h e A t l a n t i c , must remain involved. The
competence of the Asian Development Bank is a strong asset
in assisting our efforts to achieve these goals.
2
><>
ANNEX
AFRICAN DEVELOPMENT FUND
Authorization for US membership in the African Development Fund (AFDF) is presently pending before Congress. The
House of Representatives voted in favor of the authorizing
legislation (HR 9721) on December 9, 1975 and the Senate on
March 30, 1976. A conference is expected to be scheduled shortly
to resolve differences in the Senate and House versions
of the bill. The Administration is requesting an amendment
to the FY 1976 budget or a supplemental budget to provide
$15 million to be made available to the AFDF in three annual
installments over the FY 1976-1978 period.
African Development Bank. The AFDF is the concessional
loan affiliate of the African Development Bank (AFDB). The
AFDB was established in the early 1960's to assist in the
economic and social development of the newly independent
African nations and to promote economic cooperation among
them. The Bank's membership is exclusively African, with 41
member countries presently subscribing convertible currencies
to the ordinary paid-in capital of the Bank amounting to
$235 million. Through December 31, 1975, the Bank had
authorized $317 million for ordinary capital loans for 107
projects in thirty-seven member countries, mainly in the
public utilities and transport sectors.
The Bank faces an extremely challenging task because
Africa is the world's least developed continent. Over half
of the twenty-five poorest, least developed countries in
the world are in Africa; thirteen of the world's eighteen
land-locked developing countries are African; twenty-two of
thirty-three of the United Nations' "most seriously affected"
(MSA) countries are African. About 75 percent of the
African population is engaged in subsistence agriculture and
in half of the countries per capita income is less than
$100 per year. Because of these dramatic problems many of
Africa's developing states simply cannot afford to borrow at
the 6% rate of interest for 8 to 20 years offered by the
Bank for many of their high priority development projects.
To meet the need for softer terms for these projects, the
Bank decided to establish a source of concessional funds.
-2Establishment of the African Development Fund. In
1966, in recognition of these problems and in an effort to
increase the involvement of the industrial nations in
African development efforts, the Bank undertook discussions
with developed countries on establishing a concessional
facility associated with the Bank. After six years of
negotiations, and with U.S. assistance in drafting the
charter, the African Development Fund was inaugurated in
July 1973. The present members of the Fund are Canada,
Brazil, Japan, Saudi Arabia, twelve European donors and the
Bank itself representing all of its member countries.
The Fund is legally spearate from the Bank and managed
by its own board of directors, six of whom are chosen by
the Bank and six by the door countries. A 75 percent
weighted vote is required for all operational decisions.
The Fund uses the Bank's staff and draws upon its
expertise, as do the concessional funds of the other international development lending institutions. All loans bear
a 3/4 of one percent service charge, with a forty-year
maturity plus a ten-year grace period. The Fund
directs its loan resources toward social development
projects. Although all members of the AFDB are theoretically
eligible for concessional loans, only the poorest recevie
them in practice.
Fund Resources. Since the Fund's establishment, donor
nations have pledged about $145 million in concessional loan
resources and the Bank has contributed another $7 million.
The proposed U.S. appropriation of $15 million for the
African Development Fund—which represents about 9 percent
of the contributions so far pledged by members would bring
the level of total subscriptions to about $167 million. The
United States would be the fourth largest contributor, after
Canada which has pledged $25 million and Japan and Germany,
each of which has pledged $16.7 million.
The AFDB recognizes the importance of concessional
lending in a region as poor as Africa and is continuing to
seek additional resources for the Fund, through the enlistment of new members, the increase in donor subscriptions, and
bilateral loans and grants. The replenishment of the Fund's
capital resources for the 1976-1978 period was discussed in
Paris in November 1975, the fourth in a series of such
meetings. The AFDF hooes that the current donor members
will contribute twice as much in the next three years as in
tne last three years. The proposed U.S. contribution would be
0
paid in over the new replenishment period. Thus, it is
likely that the United States share would drop substantially
in donor ranking.
Fund Operations. During the first two years of
operation (1974 and 1975) the Fund made 40 loans totalling
$140 million to finance projects, predominantly in the
area of agriculture. Sixteen of these loans, for $60
million, have been for long-term development projects such
as village wells, roads, earthen dams, and irrigation in
the six drought-affected countries comprising the Sahel.
The Fund staff has laid out an ambitious lending program
over the next three years. Management has estimated that
during the 1976-78 period, the Fund will lend between $350
and $385 million. As of October 1975 the Fund's pipeline
contained 93 projects, mainly in the agricultural and
transport sectors, totaling $304 million.
During late November 1975, a delegation of Treasury
officials, Congressmen and Congressional staff visited four
West African countries in order to view at first hand the
activities of the World Bank and the African Development
Bank and the economic problems of the borrowing countries.
In Mali, of one of the world's poorest countries which has
suffered from severe drought in recent years, the group
visited two projects which had benefited from AFDB/AFDF loans.
One, a state-owned textile mill, manufactured printed cloth
to be marketed locally from raw cotton produced in Mali.
The plant not only provided much needed employment for some
850 Malians, but helped conserve scarce foreign exchange
by reducing the need for importing the goods. The group was
also shown a demonstration well shaft that had been dug by
hand and reinforced with concrete to teach people from
outlying bush areas modern well-drilling techniques. The
AFDF project uses non-capital intensive or intermediate
technology, which can be used in villages and on farms.
This "operation wells" program designed by the Government of
Mali to meet the water requirements of the rural population
and livestock, is a significant example of a development
project (to which the AFDF contributed $4.4 million) directly
improving the daily lives of the poor.
In Liberia the delegation visited the Liberian Bank for
Development and Investment (LBDI) which had received $3
million from the AFDB. The AFDB has made similar loans to
-4national development finance corporations like the LBDI
throughout Africa. In visiting a Liberian-owned chicken
farm near Monrovia, the group saw an example of how the
AFDB line of credit was being used effectively to extend
small loans to individual Liberians, for productive purposes.
US Membership in Fund. Because the US participated in
the drafting of the agreement establishing the Fund, we
would have been eligible to be an "original participant"
had we contributed to the Fund by December 31, 1974. This
would have made our membership in the Fund automatic and
entitled us to participate in the election of directors in
May 1975. Because we did not meet the December 31 deadline,
the terms of our membership are not at this moment defined
and our entry into the Fund is subject to unanimous approval
by the Board of Governors. We believe that, if the
proposed appropriation is approved, we will be able to
negotiate membership in the Fund under terms similar to the
original charter conditions.
One aspect on which we have already held informal
discussions with the Fund Management concerns Article 13
of the Fund's charter which provides for maintenance of
value on currency holdings during the period after a
member's contribution has been paid and before the funds
are lent out or exchanged for another currency. In order to
avoid being subject to this limited maintenance of value
obligation, we have secured agreement from the Fund management that our contribution would be converted to another
currency on receipt. According to Article 13, this
procedure will free the US from any maintenance of value
obiigation.
Importance of Africa to U.S. Africa has a growing
economic significance for the U.S. Total U.S. exportsto
all Africa rose from $3.7 billion in 1974 to around $5.2
billion in 1975. As a result, Africa's share of U.S. world
exports grew from 3.7% in 1974 to 4.2% in 1975. Under the
articles of the Fund, procurement of goods and services for
projects financed by the Fund is limited to members only.
Until the United States joins the Fund U.S. exporters
and contractors will be unable to compete for this potentially
substantial source of export earnings reoresented by Fund
projects. Moreover, our export sector and service firms will
be at a major disadvantage in terms of follow-uo business
and will not have incentives to establish markets in some
Atr ican countr ies.
-5*
During the ten-year period from 1964 to 1974, U.S.
investment in Africa quadrupled. Investment and trade
in minerals and petroleum account for the largest share of
U.S. economic activity in Africa. Three-quarters of U.S.
direct investment in Africa are in these areas. In 1974,
African petroleum alone accounted for 26 percent of total
U.S. imports of crude oil. For the first nine months of
1975 Africa's share rose to 34 percent. During the same
period we obtained the following percentages of our
mineral imports from Africa: cobalt—36%; manganese—44%;
antimony—40%; platinumum—39%. In addition to minerals,
we obtain 21% of our coffee and 48% of our cocoa from Africa
exporters.
Despite several problems, U.S. participation in the
AFDF is consistent with our national interest. Looking
at the African continent from the perspective of the long'
term, the extent to which we can assist, through the AFDF,
in raising the living standards of Africa's poor, is clearly
in the U.S. interest.
Following enactment of the authorization the
Administration hopes that prompt action will be taken on
the request for $15 million of appropriations in FY 1976 for
the AFDF. Early action is necessary to permit the U.S.
to join the Fund before the annual meeting in early May.
At that meeting elections will be held for executive
directors, providing what may be the only opportunity during
the next three years for election of a U.S. executive
director. If these appropriations are provided in FY 1976,
the Administration does not plan to request additional
appropriations for the AFDF in FY 1977.
TRENDS IN SHARE OF INTERNATIONAL DEVELOPMENT BANK
RESOURCES PROVIDED BY THE UNITED STATES
(7o of Contributed Resources)
ADB
IDB
OC
IBRD
IDA
Initial Contribution
41.4
42.6
43.1
First Replenishment
32.9
41.9
Second Replenishment
28.0
FSO
OC
SF
68.5
20.0
28.6
43.1
68. 5 ^
18.2
40.0
43.1
83.3
Third Replenishment
39.9
41.2
75.0
Fourth Replenishment
33.3
32.4
66.7
57.4
Fifth Replenishment
Cumulative U.S. Share
25.3
37.7
40.4
69.2
18.8
28.6
>
x
1/
ON
If the SPTF is included, the U.S. provides a total of 90.7% of IDB concessional
resources through the first replenishment.
OIDB
March 12, 1976
fc
International Development Bank Loans
To OPEC Countries
FY 1974 Through FY 1976
(millions of dollars)
Country
iAbu Dhabi
Algeria
Ecuador
Indonesia
Iran
Iraq
Kuwait
Libya
:igeria
Qatar
Saudi Arabia
Venezuela
Total
FY 1974
ADB/IDB
World Bank
SF
Bank IDA OC
FSO
FY 1975
World Bank
ADB/IDB
SF
Total Bank
IDA OC FSO
157.5 157.5 48.0
23.2 5.5 55.7
4.0
84.4
165.32
332.0
48.0 84.0 11.78 21.54
265.0 -
265.01
35.0 23.5
77.1 14.2
52.5
Total
48.0
62.5
423.3
FY 19761/
World Bank
ADB/IDB
SF
Grand
Bank
IDA 0C FSO Total Total
46.0
68.0
40.7*
66.05
46.0 251.5
40.7 187.6
134.05 722.67
52.5
317.5
173.0
248.0
• ,m
75.0 22.0 -
75.0; 173.0 -
-
22.0!-
590.7 89.5 11.78 77.24 769.22 609.5
22.0
112.1 37.7
759.3 114.0 -
106.75 -
220.751749.27
•'•' Includes $29.6 million from Venezuelan Trust Fund.
1/ Through March 1, 1976.
E3
M
X
OIDB
March 11, 1976
V
ANNEX 8
CO-FINANCING OPERATIONS BETWEEN
BANK/IDA AND ARAB DEVELOPMENT BANKS
(in US$ millions equivalent)
IBRD
LOAN
IDA
CREDIT
CO-FINANCING
INSTITUTION
0
AMOUNT
LENT
TOTAL
PROJECT
COST
COUNTRY AND PROJECT
FY
Burundi- Coffee
Improvement
76
5.2
Kuwait Fund
1.2
Rwanda- Highways
70
76
9.3
9.5
Saudi Fund
5.0
25.7
Sudan- Irrigation
Supplemental
73
75
42.0
20.0
Kuwait Fund
Kuwait Fund
Arab Fund
Saudi Fund
11.0
39.0
14.5
28.0
96.0
Tanzania- Textiles
Maize
75
76
15.0
Kuwait Fund
BADEA 1/
15.0
5.0
44.3
38.0
Zaire- Mining
75
100.0
100.7
435.0
Water Supply
76
21.5
Libyan-Arab
Foreign Bank
BADEAi/
10.0
70.4
Ghana- Cocoa
76
14.0
BADEA!/
5.0
30.0
Mauritania- Ports
Highways
76
75
8.0
3.0
Kuwait Fund
Kuwait Fund
8.3
3.8
27.5
13.7
Nepal- Hydroelectric 76
26.0
Kuwait Fund
17.5
63.0
Algeria- Ports 74
18.0
70.0
Arab Fund
20.0
Kuwait Invest- 60.0
ment Company
Cement 76
46.0
Local Algerian 89.8
Egypt- Fertilizer 74
Banks
22.1
20.0
Arab Fund
23.8
Kuwait Fund
10.2
Abu Dhabi Fund 10.1
Libyan-Arab
Foreign Bank 3.4
Cocton Ginning
74
25.6
Qatar
Suez Canal
. 75
50.0
34.5
IS 5
Saudi Fund
50.0
Kuwait. Fund
34.5
Saudi Fund
Cement
75
10.0
40.0
Abu Dhabi
Railways
75
23.0
37.0
Qatar
Telecommunications 75
65.0
Arab Fund
23.0
Saudi Fund
1/ Arab Bank for Economic Development in Afri„a
30.0
Saudi Fund
7.5
148.0
293.2
214.4
132.4
2SS.0
8^.0
•>Q6.3
•73.4
pfANNEX 8
cont'd
- 2-
COUNTRY AND PROJECT
FY
IBRD
LOAN
IDA
CREDIT
CO-FINANCING
INSTITUTION
AMOUNT
LENT
v
Jordan - Thermal Power 73
Power
76
10.2
5.0
Syria - Thermal Power 74 25.0
75
8.6
Kuwait Fund 33.0 62.6
Abu Dhabi Fund
15.0
lunisia
Gas Pipeline
Phosphate
Sewerage
emen, A. R.
Agriculture
Water Supply
Agriculture
Highways
Water & Sewerage
emen,
P. D. R.
Highways
Ports
qgoslavia
Oil Pipeline
Totals
71
73
75
7.5
23.3
28.0
Kuwait Fund
Arab Fund
10.2
13.4
TOTAL
PROJECT
COST
25.0
22.0
Kuwait Fund
Kuwait Fund
Saudi Fund
2.5
6.9
30.0
14.3
64.2
86.1
73
74
75
75
75
10.9
6.25
10.0
9.0
8.1
Kuwait Fund
Abu Dhabi Fund
Abu Dhabi Fund
Kuwait Fund
Arab Fund
5.9
1.0
10.0
5.0
21.0
17.5
6.8
23.2
15.7
31.2
75
76
15.5
3.2
Kuwait Fund
Arab Fund
15.3
13.6
31.8
17.6
76
49.0
Kuwait Fund
Libya
125.0
70.0
377.0
485.9
366.65
1,141.8 3,321.2
$240 million for the first installment of the fourth
replenishment of IDB ordinary capital ($40 million of
paid-in capital and $200 million of callable capital);
$15 million for the initial U.S. contribution to the
African Development Fund.
FOR RELEASE ON DELIVERY
STATEMENT OF THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE THE COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
ON S.3133
APRIL 8, 1976, 10:00 A.M.
Mr. Chairman and Members of the Committee;
Thank you for giving me the opportunity to discuss with
you the subject of questionable foreign payments abroad by
U. S. corporations. In my testimony today, I will touch on
some broad policy issues involved in bribery and other questionable payments by (1) reviewing the current status of the
Administration's initiatives in this area and (2) outlining
my views on S.3133, which you are considering.
Mr. Chairman, I welcome your contribution to the efforts
to deal with this very difficult problem as I share you concerns about the problem of bribery and other illicit payments
outside the United States. Both government and business should
unite in unequivocally condemning illegal or unethical activities by American business, whether at home or abroad. Corruption, whether it involves bribes to secure overseas government
contracts, illegal contributions to political candidates here
at home, or any other form of graft, is abhorrent on ethical
grounds and undermines the functioning of a competitive free
enterprise system. It results in higher prices and lower quality of goods and services to the consumer. Bribes and kickbacks are based on the power of an individual to allocate
business in an arbitrary manner and, thereby, to interfere with
the normal competitive reasons for making trade and investment
decisions. Not only does this distort trade and investment
flows but it also erodes the general reputation of the American
business community, may adversely affect our relations with
foreign governments and can contribute to a general deterioration in the climate for fair and open international trade and
investment. Bribery is, therefore, not only morally wrong but
is destructive of the basic economic principles on which our
country was built. Accordingly, the Administration has attached
the highest priority to finding solutions to the problem of
WS-774
corrupt practices in international economic affairs and has
initiated a number of efforts toward this end-
Domestic Actions Taken
J?o2£
I think that it would be useful for me to review briefly
with you the initiatives currently under way within the Executive Branch.
Internal Revenue Service. Let me outline for you first some of
the steps which the Internal Revenue Service can, and is, taking
in this area as part of its continuing program to combat corporate tax evasion and avoidance. At my direction, the Internal
Revenue Service has intensified its investigations of tax evasion and avoidance by U. S. corporations through improper deductions of bribes, kickbacks, and similar illicit payments made
abroad and in the United States.
As part of the Service's efforts to uncover corporate tax
evasion and avoidance wherever it exists, it has issued instructions to its Revenue Agents to:
— make it mandatory to interview selected corporate officers
and key employees regarding the use of slush funds,
and to secure written affidavits in appropriate situations:
— refer to the Intelligence Division any false statements
made in connection with these affidavits for appropriate
criminal action;
— examine corporate officers1 individual tax returns at
the same time as the corporation return is being audited;
— use summons to gain access to financial information;
— make use of the IRS Office of International Operations
to examine books and records of U. S. companies abroad;
— use coordinated and simultaneous industry-wide audits
of the principal concerns in a given industry furnishing
similar services or products;
— examine international transactions of multinational
corporations;
— strengthen our cooperative efforts with other nations
with whom we have tax treaties.
The Internal Revenue Service is currently receiving taxrelated information from the Securities and Exchange Commission.
This information is being disseminated to IRS field offices
where the particular corporations are being, or will be, examined
by audit teams including some of its best revenue agents including international and computer specialists.
3
- -
2*7
We do not keep statistics on the additional tax collected
specifically from investigations of illegal payments by major
corporations or for any other specific issue. Audits of such
corporations usually involve a number of issues making it a
difficult task to isolate the additional tax resulting from
this one item. However, as a result of these intensified
efforts by the IRS and other agencies to uncover tax evasion
and avoidance schemes, several major corporations have disclosed
that they have been making illegal payments.
In addition, the Intelligence Division is an active participant in the IRS effort in dealing with this erosion in corporate and personal integrity. Criminal prosecutions will be
vigorously pursued when prosecution standards are met. The
Intelligence Division is currently investigating 34 major corporations to determine whether illegal payments were fraudulently claimed as tax deductions or credits.
The Internal Revenue Service's efforts in this area cannot
be viewed as a panacea in the area of improper or illegal payments, however. The Service's responsibility is to determine
whether taxpayers' treatment of such payments was proper or
resulted in a violation of Federal tax statutes.
Securities and Exchange Commission. As you know, the Federal
securities laws which the SEC administers are primarily designed
to protect investors by assuring full and fair disclosure of
material facts regarding the nature of business operations of
companies which have issued registered securities. The SEC is
to be commended for its activities in obtaining disclosure of
material facts regarding the conduct of publicly-held corporations on the foreign payments question.
To date, the Commission has brought court actions against
some of this nation's largest publicly-held corporations. In
each, the SEC has alleged that the defendants violated the
reporting provisions of the Securities Exchange Act of 1934
by filing periodic reports with the Commission which omitted
or misstated material information.
In those cases where settlements have been reached, the
judgments enjoin the defendants from further violations of the
Federal securities laws, and are enforceable by criminal contempt proceedings in the event of further violations. In
addition, certain ancillary relief has been obtained where
typically the subject company has been required to establish a
special committee generally comprised of independent members
of its board of directors, in order to conduct a full investigation of the irregularities alleged in the Commission's complaint. Upon the conclusion of an investigation, such special
committees submit a complete report of the investigation to the
board of directors, which, of course, has the ultimate responsi-
- 4 bility for reviewing and implementing any recommendations
contained in the report.
Lastly, the SEC has also instituted a voluntary disclosure
program where approximately 25 publicly-held corporations have
voluntarily come to the Commission's staff to discuss the existence and disclosure of improper and illegal practices in the
past five years. A prerequisite for entering this voluntary
program is that the board of directors declare that the company
shall end all such practices and authorize a complete investigation of all related matters covering this five year period.
Departments of Defense and State. Action has also been taken
by the State and Defense Departments in connection with the
administration of the Foreign Military Sales Program. They
are, for example, making an effort to ensure that foreign
governments are fully informed of all agents' fees that are
included in the price of defense goods and services sold to
them under the program. In addition, if the foreign government
advises that a fee is unacceptable or if the Defense Department
determines that a fee is unreasonable or not bona fide, the
DOD will not allow the fee under the FMS contract.
International Initiatives
Complementing these domestic actions, we have also taken
a variety of initiatives in international forums aimed at
cooperative action among governments to deal with this problem.
OECD. In September of last year at the annual meeting of the
International Monetary Fund, the United States proposed to
other industrial countries the idea of cooperative international
action to curb illicit payments. They all responded positively.
Two months later, a provision on ethical conduct was included
in the draft Guidelines for Multinational Enterprises under
negotiation in the Organization for Economic Cooperation and
Development.
United Nations. Another initiative was taken by the United
States early last month in the United Nations Commission on
Transnational Corporations where we proposed a comprehensive
international agreement to curb corrupt practices. In presenting this proposal, the United States outlined a number of
principles on which we feel the agreement should be based.
These include the following:
it would apply to international trade and investment
transactions with Governments;
it would apply equally to those who offer or make
improper payments and to those who request or accept
them;
70
—
importing Governments would agree to (i) establish
clear guidelines concerning the use of agents in connection with government procurement and other covered
transactions and (ii) establish appropriate criminal
penalties for defined corrupt practices by enterprises
and officials in their territory;
— all Governments would cooperate and exchange information to help eradicate corrupt practices;
— uniform provisions would be agreed for disclosure by
ae
enterprises, agents, and officials of political contributions, gifts, and payments made in connection with
covered transactions.
Although the members of the Commission were not in a
position to give a definitive reaction to our proposal, we were
encouraged by their initial responses. We were also pleased
by the action of the Commission, which referred our proposal
to its parent body, the Economic and Social Council (ECOSOC),
with a recommendation that the Council take the issue up as a
matter of highest priority. We anticipate that the ECOSOC
will form a group of experts from member governments to draft
the agreement and hope to see the results of their work within
a short time.
GATT. In November of last year the Senate passed Senate Resolution 265 which called for the U.S. Government to seek an
international code of conduct covering bribery, kickbacks,
and other similar activities as part of the multilateral trade
negotiations currently being conducted under the General Agreement on Tariffs and Trade and in other appropriate international
forums. Subsequently, the United States urged our trading
partners that an international code of conduct on business
practices be made a major goal of the negotiations.
Information Exchange. Lastly, the State Department, the Justice
Department and the SEC have developed procedures to facilitate
the exchange of information on questionable payments with
interested foreign governments through cooperative arrangements
with their law enforcement officers.
President's Task Force
I believe that these activities represent a significant
response to the problem of corrupt practices in international
economic affairs. I anticipate that they will be strengthened
and intensified under the coordination of the new Cabinet-level
Task Force on Questionable Corporate Payments Abroad, which the
President established last week. The Task Force was charged
- 6 by the President, in part, with ensuring that existing government actions to deal with corrupt practices abroad will be
fully coordinated. It also has a mandate to conduct an indepth review of this matter and to recommend any new Federal
Government actions as it may feel are necessary.
The Task Force is chaired by Secretary Richardson, and
I am privileged to be a member. In my judgment there is no
person more eminently qualified to assume this responsibility
than Elliot Richardson. I intend to give him my full support
in our search for effective and practical solutions to this
problem, and the Committee will look forward to working closely
with the Congress in this effort. As our work progresses, we
will certainly do our best to promote an interchange of ideas
with individuals and groups in the private business sector and
other sources as well.
Private Sector Initiatives
I think it is important to emphasize, however, that the
search for solutions to this problem cannot be solely the concern of governments. It is critical for the private sector
to come to grips with the problem. This obligation extends
not only to those firms that have engaged in corrupt practices,
but also to the business community, as a whole. The sad fact
is that the unethical practices of a small percentage of our
business community are coloring our views of almost the entire
private sector. The vast majority of
businessmen are honest. What is required today, however,
is more leadership from those businessmen who have deep
convictions, will stand up for them and will go to the
public to state the case for ethics in business, instead of
keeping quiet while the free enterprise system comes under
increasingly heavier attack.
As I indicated at the outset of my statement, these
practices, aside from being morally wrong, cause serious
distortions in the operation of the free market and have
negative effects on the reputation of business in general.
All firms, even those who have not indulged in illegal
practices, are adversely affected as a result. All of us
who want to preserve our free enterprise system find such
conduct abhorent and we must join in an international effort
to find ways to deal with the problem.
23/
In this connection, I was gratified to learn last
month that the International Chamber of Commerce had formed
a Commission on Unethical Practices — a blue-ribbon panel
of business leaders from many nations — to develop guidelines for promoting ethical and proper conduct in international commercial affairs. In addition, I understand
that a number of individual firms have created special task
forces to establish procedures to prevent unethical practices
by their employees.
These actions indicate that the private sector does
see the need to deal squarely and effectively with this
problem. I know that such efforts will be a constructive
adjunct to initiatives being taken by the United States
and other countries and look forward to seeing their results.
Comments on S.3133
C, In the same vein, I welcome your initiative in
introducing S.3133 and appreciate the opportunity to discuss
it with you.
While I am strongly attracted by the general principle
of greater disclosure, I do have some reservations as to the
approach taken in the bill to achieve it. More specifically,
I think we must also look at this bill in relation to the
initiatives the United States now has underway in international organizations. Our chief concern here is that a
unilateral effort like that involved in S.3133 might undercut
the vital principle that cooperative action by the whole
international community of nations is needed in order to deal
effectively with this problem. It is a truism that it takes
two to make a bribe. We must discourage those who offer
bribes, to be sure, but any effective approach must also
strive to deter those who solicit and accept illicit payments
as well.
- 8 The bill would require that a broad range of payments
made abroad be disclosed to the public, even though the vast
majority of these payments would likely be legitimate payments for agents and representatives engaged to assist in
the sale of goods and services to governments and government
corporations. In this respect, the disclosure requirements
in the bill may go too far in that (1) a great amount of
paperwork associated with reporting would be required by both
the private sector and the SEC and (2) a number of what are
ordinary, legitimate and confidential matters relative to
commercial relationships would be opened up for examination
by competitors, customers and governments.
The bill would place a heavy responsibility on the
Securities and Exchange Commission for enforcing both its
disclosure requirements and its criminal sanctions, both of
which would take the SEC into areas beyond its basic mandate
of protection of investors. Whether this should be done
requires further study and, of course, the views of the SEC
and the Department of Justice should be taken into account.
In this regard I might note that the disclosure and criminal
sanctions would be applicable only to corporations which have
issued registered securities and thus come within the ambit
of the Securities Exchange Act. I question whether any new
disclosure requirements and criminal sanctions should be
limited only to corporations with registered securities, as
a bribe offered by a privately-held corporation or a partnership
is no different from a bribe offered by a publicly-held
corporation.
The upshot of my remarks is that while I support the
intent of the bill before you today, I have serious reservations as to whether it represents the optimal approach to
dealing with the problem of bribery and corrupt practices in
international commerce. Although domestic legislation may be
needed, the problems in this area are complex and should be
carefully considered before we take action. The Task Force
on Questionable Corporate Payments Abroad was established
specifically to give these problems and possible solutions a
hard and searching analysis and evaluation before we commit
ourselves to one course or another. I suggest that you give
us a chance to look into these matters further before taking
action on this legislation. In this process we will exclude
no reasonable possibility, but we will of necessity take
into account the considerations I have just outlined.
Mr. Chairman, I also have a few technical points to
make with respect to specific aspects of this bill. Our
staffs can get together later to explore them, so I will
you
orietly
not an
spell
idea
tothem
mention
of where
out some
inour
detail
of
principal
these
now.questions
concerns
Rather, I
in
lie.
would
order
For
like
toexample,
give
J3J
one section of the bill has the effect of automatically
adopting as a part of U.S. criminal law the relevant
criminal laws of all foreign nations. Do we want this?
One consequence of retaining this provision might be to
create a situation where a single act was punishable under
the laws of two countries. Finally, enforcement of the
provisions of the bill could well result in the extraterritorial application of U.S. law and might require the
U.S. Government to investigate the conduct of foreign
government officials, resulting in potentially serious
political problems with other countries.
The Lockheed Situation
Before concluding my statement, Mr. Chairman, I would
like to take a moment to bring this Committee up to date on
the Lockheed situation. When I appeared before you in my
capacity as Chairman of the Emergency Loan Guarantee Board
(ELGB) last August and again on February 19, I indicated
that the ELGB strongly condemned the payment of any type of
bribe or kickback for the same basic reasons I have described
today.
Since last summer, when it became aware that Lockheed
had been involved in these practices, the ELGB has acted
on a number of fronts to stop these activities. Initially,
the ELGB insisted, as a condition to the continuance of the
guarantee program, that Lockheed cease making any further
questionable payments, and the ELGB worked with Lockheed to
develop a definitive corporate policy to control the Company's
relationship with foreign consultants. That policy expressly
prohibits any foreign commissions or other payments that are
not legitimate business expenses which would be deductible
on the Company's U.S. tax returns. It also prohibits the
maintenance of any slush fund or other fund outside normal
accounting channels. The details of the plan were adopted
by Lockheed's Board of Directors in a resolution that provides
that any Lockheed employee who violates the policy will be
dismissed immediately. During the fall of last year, Lockheed,
under ELGB supervision, took steps to assure full implementation of its new policy. I might add that, at your request,
copies of Lockheed's policy and the Company's plans to
implement it were furnished to you last month.
The ELGB has been closely monitoring Lockheed's activity
under its new policy and will continue to do so. To complement that monitoring effort, the ELGB intends, in connection
with Lockheed's refinancing plan, to insist on an amendment
to its Agreement with Lockheed and the lending banks that will
expressly define the making of future improper payments as an
event of default. These amendments also would establish a
formal system of reporting to the ELGB to assure that no
wrongful payments are made in the future. In addition, the
- 10 -
3tf
ELGB will require a special accounting of past payments
from a committee of outside Lockheed directors that has
been established.
On February 19, I stated that we were in the process
of negotiating with Lockheed for the names of the countries
in which payments to government officials were known or
suspected to have been made. We are close to completing
these negotiations and in addition have obtained a substantial amount of detailed information relating to existing
and potential foreign sales. Lockheed's revised 12/75
Financial Forecast will be completed within the next two
weeks, at which time the ELGB staff will be in a position
to finish its assessment of the impact that disclosure of
foreign bribes may have on Lockheed's operations and hence
the repayment of guaranteed borrowings. I would like to
add that based on the ELGB's assessment of the company fs
latest forecast thus far, I still believe there is a
reasonable prospect that Lockheed will be able to return to
the private capital markets by the time the Government
guarantee program ends.
Lastly, I would note that, following the February 19
hearings, the GAO made a request of Lockheed and of the ELGB
for further access to Lockheed records. Lockheed has recently
agreed to provide the GAO access to its records concerning
foreign agents and consultants in exchange for the GAO's
promise that the information obtained would be kept confidential
I am informed that the GAO sent a team out to Lockheed fs
headquarters last week to begin their review of those records.
The Treasury Economic Analysis group has begun an update of
its assessment of the impact of a Lockheed failure. Although
this analysis has been delayed pending the availability of
Lockheed's 1975 yearend audited financial statements, Lockheed
has indicated this information will be available in the next
few days, and our analysis can then be completed shortly.
Conclusion.
In sum, Mr. Chairman, I share your concern about the
problem of bribery and corruption, at home or abroad.
Although, I do have significant reservations as to the
general approach embodied in S.3133 as well as some of its
specific provisions, I agree with the objectives you are
seeking. There is no room in our society for such practices.
What is needed is a united effort by business and government.
The fact of the matter is that no free society or free
economy can long survive without an ethical base.
Since the President's Task Force on Questionable
Corporate Payments Abroad has just been established, I believe we should be given some time to analyze this important
area more deeply. I assure you that we are committed to finding the proper solutions. LetoOo
us work together to formulate
recommendations for action.
Department theTREASURY
NGTON, D.C. 20220
T E L E P H O N E 964-2041
J33April
FOR IMMEDIATE RELEASE
7, 1976
RESULTS OF AUCTION OF $2.5 BILLION
OF 14-DAY TREASURY BILLS
The Treasury has accepted $2.5 billion of the $7.6
billion of tenders received for the 14-day Treasury bills
to be issued April 8, 1976, and to mature April 22, 1976,
auctioned today. The range of accepted bids was as follows:
Price
High
Low
Av e r a g e
99.815
99.811
99.812
Discount Rate
4.757%
4.860%
4.834%
Tenders at the low price were allotted 56%
WS-775
Investment Rate
4.83%
4.94%
4.91%
FOR RELEASE ON DELIVERY
STATEMENT OF DALE S. COLLINSON
T A X LEGISLATIVE C O U N S E L
D E P A R T M E N T OF THE TREASURY
BEFORE THE WAYS AND MEANS COMMITTEE
APRIL 12, 1976, 10:00 A.M.
Mr. Chairman and Members of the Committee:
Thank you for inviting me here today to discuss the status of the
Airport and Airway Trust Fund.
In your press release announcing these hearings you indicate
your interest in determining "whether the taxes currently dedicated
to that trust fund should be continued at existing levels, reduced, or
otherwise modified. n In m y statement I will discuss the general tax
policy principles bearing on such a determination and supply current
information regarding the financial condition of the trust fund. Representatives of the Department of Transportation will cover the
transportation policy issues.
History of Air Transportation Taxes
Preliminary to any assessment of the propriety of the excise
taxes presently levied on air transportation, it is essential, I believe,
to recall the process by which we arrived at the present situation.
This history is familiar to most of you, and I will, accordingly, keep
m y summary brief.
Since the adoption of the Air Commerce Act in 1926, the Federal
Government has exercised a vital role in the development of the
country1 s air transportation system. The Federal Government has
directly subsidized air carriers, financed aircraft development and
airport construction, and has maintained and operated important
elements of the airway system.
Initially, the posture of the Federal Government was clearly one
of subsidizing the development of airports and the airway system
through general revenue appropriations. The cost of the federal
programs was, thus, assessed against the populace as a whole,
through general taxes, rather than the specific users of airport
facilities and the airway system. Air transportation was a new
industry and could not be expected to sustain, in its infancy, the
full financial burden of the extensive capital expenditures that were
then needed.
WS-776
J£7
- 2As the air transport industry grew and achieved maturity, it was
recognized that it was no longer appropriate to defray from general
revenues the Federal Government's costs for the development, operation and maintenance of airports and the airway system. Over a
period of years, the Congress has, accordingly, ^adopted a series of
air transportation excise taxes as "user charges" designed to collect
those federal costs from the users of airports and the airway system.
Thus, the Tax Rate Extension Act of 1962 dropped the general excise
tax of 10 percent on passenger transportation, which was originally
enacted during World War II as a revenue measure. But it retained
a 5 percent tax on air passenger transport as a user charge. The
5 percent user tax was made permanent by the Excise Tax Reduction
Act of 1965. More generally, the latter Act reflected an attempt to
eliminate use of excise taxes as general revenue measures and
instead, in the words of your Committee's report on the Act, to
"restrict continuing Federal excises to taxes in the nature of benefit
charges (primarily those devoted to the highway trust fund), sumptuary excises on alcoholic beverages and tobacco products, and items
taxed for regulatory purposes. "
The fullest implementation of the user charge concept as regards
air transportation taxes was achieved in the Airport and Airways
Development Act of 1970. This aspect of the Act was summarized
in the report of the Committee on Interstate and Foreign Commerce
as follows:
"To provide additional revenue for the financing of
the increased Government outlays for the expansion and
development of the airport and airway system, the administration proposed new and increased air user taxes
to pay for an increasing portion of the total Government
expenditures for the air transportation system. Without
the new and increased user taxes, the general taxpayer
would be required to finance most of the cost of the
system through general fund appropriations, if the need
is to be met. . . . The Ways and Means Committee
agreed that the users of the Federal aviation system could
properly pay for a greater share of the cost than at
present, and that the goal should be for the civil part
of this system to eventually become self-sustaining from
the air user taxes. As indicated in table 2, the civil
share deficit is expected to decline from about $3 75
million in Fiscal 1971 to about $36 million in Fiscal
1979. "
Section 208 of the Airport and Airways Development Act of 1970
created the Airport and Airway Trust Fund. Section 208(f) provided
that amounts in the trust fund were to be available, as provided by
- 3appropriation acts, to defray (1) expenses incurred under Title I of the
Act, (2) expenses incurred under the Federal Aviation Act of 1958 and
attributable to planning, research and development, construction or
operations and maintenance of air traffic control, air navigation,
communications, or supporting services for the airway system, and
(3) those portions of the administrative expenses of the Department
of Transportation which are attributable to activities described in (1)
and (2). In short, section 208(f) contemplated that the receipts of the
trust fund would be broadly available to meet the civil part of the government's expenditures for the air transportation system. This was,
of course, consistent with the statement of Congressional intent previously
quoted from the report of the Interstate and Foreign Commerce Committee.
In fact, however, the Airport and Airway Trust Fund operated under
the principles adopted in 1970 only during the 1971 and 1972 Fiscal
Years. The Airport and Airways Development Act was amended in
1971 to severely restrict the expenditures that could be made out of the
trust fund, and it is that change in the original provisions that is
responsible for the greatest part of the present substantial surplus
in the trust fund.
To see what happened, it is sufficient to examine the treatment
of operation and maintenance expenses. Prior to the 1971 amendment,
trust funds could be used to pay the operation and maintenance expenses
of the air traffic and navigation system. Appropriations totaling
$1,023 million were authorized from the trust fund for such expenses
through Fiscal Year 1972. A s a result of the 1971 amendment, these
activities have been funded, beginning with Fiscal Year 1973, from
general fund revenues.
The significance of the change for the financial condition of the
trust fund is readily apparent from a comparison of the experience
of the trust fund during its first two years (Fiscal Years 1971 and
1972) with that of the following three years (Fiscal Years 1973-1975).
Fiscal Years
1971-1972
($ millions)
Fiscal Years
1973-1975
($ millions)
Net user tax receipts
Federal payment to fund
Transfers of general
fund balances
Interest
$1,211
647
$2,561
73
876
- 4
124
Total receipts
$2,735
$2,759
Receipts
J3f
- 4Fiscal Years
1971-1972
($ millions)
Fiscal Years
1973-1975
($ millions)
Expenditures
Operations
Grants in aid for airports
Facilities and equipment
Research and development
Other
$1,078
167
345
85
Total expenditures
$1,677
I
$
80
767
752
198
1
$1,800
But for the transfer to the trust fund in Fiscal Year 1971 of previously appropriated but unexpended general revenue account balances
and the transfer to the fund in Fiscal Year 1972 of a federal payment
from general revenues, the trust fund would have been in deficit at
the end of Fiscal Year 1972. A s previously indicated, it was not
anticipated under the 1970 legislation that the fund would become selfsufficient until 1979, and the legislation therefore provided for just
such transfers in order to bridge the gap between revenues and
expenses. If operation and maintenance expenses had not been shifted
from the trust fund to general revenue financing, payments into the
trust fund from the general revenues would have been required during
the last three fiscal years in accordance with the original plan; and
there would be no significant trust fund surplus. The effect of the
1971 amendments was instead to peg expenditures below net tax
receipts, with the predictable result that the trust fund is experiencing a mounting surplus.
Tax Policy
It is the existence of the trust fund surplus, which stood at over
$2.3 billion at the end of February on a cash basis and which had uncommitted balances at the end of Fiscal 1975 of $890 million, that presents
the question "whether the taxes currently dedicated to [the] trust fund
should be continued at existing levels, reduced, or otherwise modified.'
But the answer to that question lies not in the financial condition of the
trust fund but in the basic principles of economic and tax policy that
have led over the years to the adoption of the present user taxes on
air transportation.
The user charge concept, which has been reaffirmed by every
President since Harry Truman, is grounded in basic principles of
iair competition, fair taxation, and efficient allocation of resources.
<#<7a
- 5-- Fair Competition. Air carriers compete with water,
rail and road carriers for passengers and freight.
Requiring each mode of transportation to bear its
share of the cost of federally provided transport
facilities is necessary to ensure fair competition.
-- Fair Taxation. The cost of special services and
facilities should be borne by those who use them and
thereby reap the benefits rather than the general
taxpayer, where the persons benefitted are fully
able to pay. That is, the users should pay unless
there is some overriding justification for redistributing income from the general taxpayer to the
users.
-- Efficient Allocation of Resources. If users of
special services or facilities are not required
to pay their share of the costs, the market system
for matching demand and supply at a price reflecting value to the purchaser and cost to the
supplier will be inoperative. The users will
demand more of the services or facilities than
they would if the price fully reflected the cost,
and resources will be shifted from more productive activities to the special services or
facilities.
These reasons for assessing air transportation user charges are
independent of the existence of a surplus in the trust fund. The trust
fund is a useful accounting mechanism to emphasize the direct relationship between the costs of the system and the receipts from the
user charges. It also assures that the user charges are expended
for the purposes for which they were collected. But the principles
of fair competition, fair taxation, and efficient allocation of resources
would require the levying of user charges at least at the present
levels even if no trust fund had been created.
While we conclude that the existence of the trust fund surplus
is not grounds for reducing the present air transportation user charges,
we recognize that the existence of a very substantial and mounting
surplus creates practical political problems. For one thing it makes
more difficult resistence to pressures to expend larger sums for the
purposes authorized under the trust fund provisions, over and above
the sums actually needed or that would be justified in terms of the
Nation's overall priorities.
-6The preferable solution would, of course, be to return to the
precepts underlying the 1970 legislation and to authorize the use of
trust fund monies for the operation and maintenance of the airway
system. The Administration, however, is seeking only the expenditure of trust fund monies for the maintenance of the facilities of
the airway system.
One final tax policy issue should be noted. This concerns the
allocation of air transportation user charges among different
classes of users, for example as between general aviation and
commercial aviation. In principle, each user should pay his
individual allocable portion of the total costs. Such exactness is,
of course, impossible; it is necessary here, as elsewhere, to
accommodate the competing claims of equity, simplicity and administrative convenience. The air transportation user taxes are, thus,
a combination of ticket taxes, fuel taxes, annual license taxes, and
international departure taxes designed to allocate the charges
equitably among different classes of users. This allocation takes
into account the fact that the costs of the system are partly dependent on usage and partly attributable to the necessity to have
facilities available on a standby basis to meet peak demands on the
system. For example, the justification for an annual license fee
is that the cost of maintaining peak demand capacity should be
allocated among all users, independently of the actual use of the
airways by each licensed aircraft. More generally, the determination of the appropriate user tax burdens for different classes of
users requires an allocation of costs among users, which presents
difficult engineering and economic issues that fall mainly in the
province of the Department of Transportation rather than the
Department of the Treasury.
Financial Condition of Trust Fund
Attached to this statement is an analysis of the accumulated
receipts and expenditures of the Airport and Airway Trust Fund through
February 29, 1976. As previously noted, the cash balance in the trust
fund at the end of February was in excess of $2.3 billion and the uncommitted balance at the end of Fiscal 1975 was $890 million.
Conclusion
As a result of a sustained effort over many years, your Committee
in cooperation with several different Administrations has put in place
a combination of air transportation user taxes that have tried to implement sound principles of fair competition, tax equity, and economic
etiiciency. W e urge the Committee not to abandon the ground thus
gamed and to maintain essentially the present level of user tax revenues,
The solution to the trust fund surplus lies, we believe, in returning
f i o l ^ f + P a r w W a ? t 0 t h e P r e c e P t s o f the 1970 legislation by authorizing
use of trust fund monies for the maintenance of the facilities in the
airway system.
o O o
AIRPORT AND AIRWAY TRUST FUND
RECEIPTS AND EXPENDITURES
CUMULATIVE THROUGH FEBRUARY 29, 1976
Cumulative
through
June 30. 1975
July 1, 1975
through
February 29. 1976
/ Cumulative
through
February ?Q, 1Q7f>
I.MCHFTS:
IlCt..
T.i" (Transferred fro. General Fund) .
,. m y lUuld f««l o t h e r t b a n 6»sollne . . .
•• • •
f" T l r t s used on aircraft
s.' TuD.a used on aircraft
4. oesollne:
.
Commercial 4. cents tax
t\ . ^on-commercial A cents tax
Non-co»rercial 3 cents tax
c'
Transportation by Air. seats, berths, etc
6
e! ua« of international travel facilities .
7'. Transportation of propertj. cargo. . . .
8. use of elTll aircraft
Total Tax Receipts
Lees reimbursement to Oeneral Fund-Refund of Taxes
«nd Estimated Tax Credits:
1. Commercial Aviation Gasoline
£. Kon-Comaerclal GasoHne
3. Civil Aircraft
4. Any LlQuld Fuel other than Gasoline
Total Reimbursement for Tax Refunds . . .
Ret Tax Receipt
C. Federal Payments
Transfers from the General Fund_L(
Interest income.
Net Receipts
II.EXPENDITURES
A
Federal Aviation Administration
1. Operations
2. Orants-ln-ald for airports
S. Facilities and Equipment
4. Research and Development
B. Aviation Advisory Commission - Salaries and Expenses
C. Interest on refund o f t a x e s
Total Expenditures
II. BALANCE END OF PERIOD • • •
118,128,597.78
8,220,000.00
1,380,000.00
16,618,377.00
540,000.00
70,000.00
134,746,974.78
8,760,000.00
1,450,000.00
6,200,000.00
68,221,531.76
49,878,717.73
3,009,581,797.48
232,818,321.87
187,330,762.01
98,682,468.20
800,000.00
7,578,576.00
5,681,432.00
520,198,798.26
33,043,159.00
29,195,009.00
15,472,124.17
7,000,000.00
75,800,107.76
55,560,149.73
3,529,780,595.74
265,861,480.87
216,525,771.01
114,154,592.37
3,780,442,196.83
629,197,475.43
4,409,639,672.26
5,600,000.00
917,211.21
1,719,244.28
102,933.96
8,339,389.45
900,000.00
40,475.42
211,520.99
299,483.39
1,451,479.80
3,772,102,807.38
720,279,000.00
873,032,809.39
124,064,291.36
627,745,995.63
4,399,848,803.01
-068,984,674.63
5,489,478,908.13
696,730,670.26
720,279,000.00
873,032,809.39
193,048,965.99
6,186,209,578.39
1,158,667,454.04
934,182,023.59
1,098,057,298.91
283,121,415.28
1,940,670.19
71,417.55
3,476,040,279.5f
2,013,438,628.57
530,861.97
215,818,107.96
128,192,666.04
47,488,806.96
-013,725.97
392,044,168.90
304,686,501.36
1,159,198,316.01
1,150,000,131.55
1,226,249,964.95
330,610,222.24
1,940,670.19
85,143.52
3,868,084,448.46
2,318,125,129.93
6,500,000.00
957,686.63
1,930,765.27
*02,417.35
9,790,869.25
ASSETS HELD BY THE DEPARTMENT OF THE TREASURY
ASSETS:
Investments in public debt securities:
Government account series, Treasury certificates
of indebtedness, Airport and Airway Trust Fund
series maturing June 30: .
^
„..,,„ «,«« «o
6 5/8% of 1976
, , - • , -• .- $1,936,148,000.00
6 3/4% of 1976
—
, fc , 1,936,148,000.00
Total Investments, par value
Undisbursed" balance
Total Assets • • 2.013.438,628.57
Wa1
,-» oon ton «;7
77,290,628.57
$
49,129,000.00
404,917,000.00
$1,887,019,000.00
404,917,000.00
355,788,000.00
-51,101,498.64
2,291,936,000.00
26,189,129.93
304.686,501.36
2.318.125,129.93
/ Unexpended balances of certain General Fund accounts transferred to the trust fund
Pursuant.to the Airport and Airway Revenue Act of 1970, section 280(c).
T
«• S. Treasury Department
Bureau or\Government Financial Operations
«- f. RPAjnlvine Funds
Trusts
g.
Branch
FOR IMMEDIATE RELEASE
Contact; S. Cox
Extension 2861
April 8, 1976
TREASURY AMENDS ELIGIBILITY REQUIREMENTS FOR PARTICIPATION
IN TREASURY'S MINORITY BANK DEPOSIT PROGRAM
Secretary of the Treasury William E. Simon announced today that the
Treasury has amended eligibility requirements for banks seeking to participate in the minority bank deposit program administered by the Treasury
to include banks that meet the following criteria:
1. More than 50 percent of the bank's stock is owned by
women;
2. The majority of the Board of Directors are women; and
3, A significant percentage of women hold senior management
positions.
Heretofore, banks whose stock is more than 50 percent owned by members of minority groups or which are independently controlled by minority
group members were eligible to participate in the program. Thus, today's
action enlarges the universe of banks eligible to participate.
The minority bank deposit program was established in 1970 to help
carry out the objectives of the Federal Minority Business Enterprise Program, that is, to provide opportunity for full participation in our free
enterprise system by socially and economically disadvantaged persons.
Secretary Simon said that it is clear beyond doubt women have not had
the opportunity to participate fully in the ownership and management of
banks and that the purpose of the new criteria for Treasury's minority
bank deposit program is to build on the intent of Executive Order 11625
while also serving two other objectives. First, a bank meeting the new
criteria will inherently be more likely to assure equal credit opportunities for women and thereby assist in carrying out the intent of the Equal
Credit Opportunity Act (15 U.S.C. 1691). Second, while improvement in
the number of women in senior banking positions has been achieved by
Treasury as part of its contract compliance efforts pursuant to Executive
Order 11246, the present action also serves as affirmative action in this
direction.
The Secretary announced that upon adoption of the new requirements,
The First Women's Bank of New York had been added to the list of banks
participating in the minority bank deposit program.
oOo
WS-777
J?w
April 12, 1976
Attached is a preliminary analysis on "U. S. Taxation
of the Undistributed Income of Controlled Foreign Corporations," prepared by the Office of International Tax
Affairs of the Treasury Department, for consideration by
the House Ways and Means Committee Task Force on the Taxation of Foreign Income.
The analysis does not represent an Administration
position and does not contain recommendations.
WS-778
S. Taxation of the Undistributed Income
of Controlled Foreign Corporations
Department of the Treasury
April 1976
PREFACE
This preliminary analysis was prepared by Gary Hufbaucr
and David Foster of the Office of International Tax Affairs
for consideration by the House Ways and Means Committee Tar.k
Force on the Taxation of Foreign Income. The analysis does
not represent an Administration position and does not
contain recommendations. In the event that the Task Force
recommends legislation, it is anticipated that the Treasury
Department will comment on those recommendations.
2
TABLE OF CONTENTS
Issue
1
Present Law 4
1. Classical system of taxation 4
2. Exceptions to recognize economic reality and
avoid double taxation
5
(a) Consolidated return
5
(b) Dividends received deduction
5
(c) Subchapter S
6
3. Exceptions to.discourage tax abuse by individuals . 6
(a) Accumulated earnings tax
6
(b) Personal holding company tax
6
(c) Foreign personal holding company
7
4. Exceptions to discourage tax abuse by corporations
8
(a) Section 367
\ \ \ \ \ \ \ \ \ \8
(b) Subpart F and its exclusions
.10
(i) Minimum distribution
.13
(ii) Less developed country corporations . 13
(iii) 30-70 rule
14
(iv) Shipping income
14
(v) Agricultural sales
14
Analysis 16
1. International tax neutrality 16
2. Constitutional problems
28
3. Foreign reaction
31
(a) Tax treaties
32
(b) Foreign statutory change
35
(c) Average foreign tax rates
38
4. Administrative aspects
43
5. Investment impact
45
6. Financial impact
52
7. Revenue impact
57
(a) Policy options
59
(b) Behavioral change
62
(i) Change in distribution rates
64
(ii) Foreign vs. domestic investment . . .66
(iii) Minority participation and "decontol". 71
(iv) Higher foreign taxes
76
8. Summary of the analysis
77
(a) Tax neutrality
77
(b) Tax avoidance
78
(c) Tax simplification
79
(d)
Investment
and financial impact
79
(e) U.S.
tax revenue
80
tions
Retain present system
78
Broaden subpart F
82
(a) The substantial reduction test
82
(b) 50 percent subsidiaries
83
(c) Shipping income
83
(d) "Runaway plants" and tax holiday
manufacturing
84
(e) Simplification
85
Partial or complete termination of deferral
85
(a) Required minimum percentage distribution . . . 87
(b) Allocation of the deemed distribution
between CFCs
87
(c) The extent of consolidation
87
(i) Individual foreign corporation
approach
88
(aa) Hop-scotch method
89
(bb) Link-by-link method
90
(ii) Consolidation of foreign operations. . . 91
(iii) Consolidation of worldwide operations. . 93
(d) The problem of decontrol
94
Terminate deferral in the context of repealing
domestic tax preferences
95
SW1
LIST OF TABLES
Table
1
Estimated Tax Revenue Consequences in 1976 of
Achieving Alternative Standards of International
Tax Neutrality with Respect to U.S. Corporations
in Non-Extractive Industries
Table 2 Comparison Between Foreign Tax Relief and
Foreign Input Subsidies
Table 3 Statutory and Realized Corporate Income Tax
Rates on Manufacturing Firms, 1974
25
37
39
Table 4 Estimated Impact of Terminating Deferral on
Selected Economic Variables for Multinational
Manufacturing Firms .
49
Table 5 The Effect of Deferral on the Use of Local
Debt by a Hypothetical Foreign Subsidiary . . . . 53
Table 6 Financing of Foreign Affiliates, 1972 56
Table 7 Actual Revenue From Subpart F and Potential
Revenue from Termination of Deferral, with
Overall Limitation on Foreign Tax Credit
Table 8 Revenue Changes from Alternative Proposals
to End Deferral
58
Table 9 Termination of Deferral with Alternative Consolidation Requirements and with Current Dividend Distribution Rate
Table 10 Revenue Effect of 100 Percent Dividend Distribution Rate
61
60
55
Table 11 Termination of Deferral with Assumed Changes
in Investment Location and Means of Finance . . . 67
Table 12 Termination of Deferral with Assumed Adverse
Impact on Competitive Position of U. S. CFCs . . . 68
Table 13 Net Earnings by Extent of U. S. Ownership in
Foreign Affiliates
73
Table 14 Revenue Changes from Subpart F and Termination
of Deferral with Increase of Non-CFC Earnings . . 75
3&
I.
ISSUE
Since the introduction of the Federal income tax in
1913, the United States has employed a "classical" system of
taxing corporations and their shareholders.
Under a classical
system, corporations and their shareholders are separately
taxed.
A
corporation's tax liability is not affected by
the amount of dividends it distributes to its shareholders,
and conversely (with limited exceptions)
a
shareholder's
tax liability depends on dividends received, and is not
affected by either the amount of tax paid by the corporation
or by the corporation's retained earnings and profits.
These principles extend to a U.S. shareholder in a
foreign corporation.
No U.S. tax is imposed on the U.S.
shareholder until (and unless) the shareholder receives
dividends from the foreign corporation.
This consequence
of a classical system of taxation is called deferral,
because the U. S. tax on the income of a foreign corporation
is deferred until dividends are paid.
The bulk of U.S. investment in foreign corporations
is undertaken, not by individual shareholders, but by U.S.
based multinational enterprises.
So long as earnings are
retained abroad by foreign corporate subsidiaries, the U.S.
parent corporation pays no U.S. tax on the foreign
- 2 income.-^ If taxable corporate earnings are defined the same
way abroad as in the United States, and if the host government applies a tax rate lower than the U. S. corporate tax
rate of 48 percent, the difference in rates represents a
temporary tax saving to the parent corporation.
Multinational firms based in the United States argue
that deferral is necessary to allow them to compete on
even terms with foreign firms. In their view, tax neutrality requires the same rate of taxation on all firms
operating in the same country. The U. S. multinational firms
suggest that the termination of deferral would bring about
changes in foreign tax practices and dividend distribution
rates that would erode or eliminate U.S. tax revenue gains,
and that, without deferral, the foreign expansion of U.S.
firms would be curbed, profits and U. S. tax revenues might
decline, and U. S. exports to foreign markets might fall.
Others object that deferral enables foreign investment
to enjoy tax advantages not available for domestic investment. In this view, tax neutrality requires the same taxation of investment at home and investment abroad. Expressing concern for the impact of foreign investment on American
jobs, and the loss of potential tax revenue, labor groups
1/ The foreign subsidiary may pay interest, royalties, and
management fees to the U.S. parent corporation, and
these types of income would, of course, be taxed currently
by the United States.
in particular have questioned the continuance of deferral.
This concern was expressed most strongly in the late 1960s
and early 1970s.
Since 1972, a system of flexible exchange
rates and the DISC legislation have, to some extent,
answered the concern over foreign tax advantages.
-4II.
1.
2*3
PRESENT LAW
-r.lag-slcal system of taxation.
Under present law,
a corporation and its shareholders are taxed separately.
The corporation is taxed on its earnings; the shareholders
are taxed on distributed dividends.
This known as a
"classical" or separate entity system of taxation.
By
contrast, under an "integrated" system of taxation, either
the taxes imposed on the corporation are claimed (in whole
or part) as a tax credit by the shareholder, or the corporation is allowed a reduced tax rate on dividends paid.
Britain, France, Germany, Canada, Japan, and other industrial
countries have adopted various types of integrated tax systems.
The Administration has proposed an integrated system for
the United States, and the proposal is now under Congressional consideration.
Over the years, the United States has made limited
exceptions to its separate entity system of taxation.
Cer-
tain exceptions are intended to recognize the economic
unity of an affiliated group of corporations within the
United States, to avoid double taxation when dividends are
distributed from one corporation to another, or to encourage
small business.
Other exceptions are intended to discourage
- 5 tax abuse by individuals investing in domestic or foreign
corporations. Subpart F is principally designed to discourage tax abuse by U.S. corporations which control
foreign corporations.
2. Exceptions to recognize economic reality and avoid
double taxation.
(a) Consolidated return. Under specified circumstances
(Section 1501), related domestic corporations are permitted
to file a consolidated return. The consolidated return
recognizes the economic unity of a corporate group. Through
the mechanism of a consolidated return, the profits of one
domestic corporation may be used to offset the losses of
another. In this way, related corporations can share their
investment risks.- A foreign corporation cannot, however,
2/
join a consolidated return.—
(b) Dividends received deduction. Dividends distributed from one domestic corporation to another are entitled
to an 85 percent or 100 percent dividends received deduction,
depending on the extent of affiliation between the two corporations (Section 243). The purpose of the dividends
received deduction is to avoid double taxation at the corporate level. Dividends received by a domestic corporation from
1/ Only one surtax exemption can be claimed on the consolidated return.
2/ Certain contiguous country corporations, defined under
Section 1504(d), are allowed to join a consolidated return.
a foreign corporation are not eligible for the deduction.(c) Subchapter S. Under Subchapter S (Sections 13711379) certain small corporations can elect to be treated
for tax purposes much like a partnership. If an election is
made, there is no corporate tax, all earnings (whether or
not distributed) are taxed to the shareholders, and losses
can be claimed as a deduction by the shareholders. The
purpose of Subchapter S is to encourage small business.
3. Exceptions to discourage tax abuse by individuals.
(a) Accumulated earnings tax. The Revenue Act of
1913 contained the antecedents of today's accumulated earnings tax (Section 531) . This is a penalty tax imposed on
a corporation when it unreasonably accumulates earnings
for the purpose of shielding shareholders from personal
income taxation.
(b) Personal holding company tax. In 1934, Congress
enacted the personal holding company tax (Sections 541-547).
This is a penalty tax on the undistributed personal holding company income of a corporation that receives at least
60 percent of its adjusted ordinary gross income from passive
investment sources and certain types of personal services,
1/ The dividends received deduction is available for dividends paid by a foreign corporation which earns at least
^U percent of its gross income from a U.S. trade or busi
ness (Section 245).
7
" -
2<r£
and is owned to the extent of more than 50 percent in value by
five or fewer individuals.
The tax applies to the corpora-
tion and not to the shareholders.
The tax can be mitigated
if the corporation declares a "deficiency dividend. "
(c)
Foreign personal holding company.
In 1937, Con-
gressional investigation brought to light the formation
of "incorporated pocketbooks" abroad by United States citizens.
These corporations, designed to collect and retain
passive investment income, were domiciled in countries,
such as the Bahamas and Panama with little or no corporate
income tax.
As foreign corporations, they could not be
effectively taxed either on their accumulated earnings or
as personal holding companies.
The Congressional remedy was to enact the foreign
personal holding company legislation (Sections 551-558)
which taxes each U. S. shareholder on his pro rata share of
the foreign corporation's undistributed income.
Certain
tests must be met before the foreign corporation is characterized as a foreign personal holding company.
At least 60
percent of its gross income must be derived from passive
sources (dividends, interest, rents, royalties, capital
gains, income from an estate or trust, personal service
income and certain other items) , and more than 50 percent in
value of the stock must be owned by not more than five U.S.
individuals.
When these tests are met, each shareholder is
- 8 deemed to receive a distribution from the foreign personal
holding company, and deferral of U. S. tax liability on the
foreign income is effectively precluded.
The foreign personal holding company legislation did
not reach foreign investment companies that sold shares
widely among U.S. individuals. Such companies, domiciled
in low-tax jurisdictions, could thus retain their dividend
and interest income free from U. S. tax. The shareholders
could later realize the income in the form of capital gains,
if and when the shares were sold.
The Revenue Act of 1972 abolished this device in one
of two ways. Either the gains realized by the shareholder
on disposition of the stock would be taxed as ordinary
income to the extent of accumulated earnings (Section 1246),
or the foreign investment company could enter a binding
election to distribute at least 90 percent of its income
annually (Section 1247).
4. Exceptions to discourage tax abuse by corporations.
(a) Section 367. The Internal Revenue Code permits
numerous types of tax-free corporate reorganizations. One
corporation may acquire another, a subsidiary may merge
into a parent, or a corporation may divide into several
1/ The individual shareholders are not permitted to claim
a credit for any foreign corporate income tax paid. The
deemed paid credit (Section 902) is only available to
U. S. corporations.
parts, all without creating a taxable event.
The underly-
ing philosophy is that, so long as assets remain in
"corporate solution", and are not distributed to individual
shareholders, reorganization is a matter of economic convenience for the firm and need not provide an occasion for
taxation.
Reorganizations that involve foreign corporations
create an exception to this basic philosophy. The concern
arose very early that domestic or foreign corporate income
that had not previously been taxed by the United States
could forever leave its tax jurisdiction through corporate
reorganization. In 1932, the predecessor of Section 367
was enacted. It prevents tax-free exchanges involving
foreign corporations unless "it has been established to the
satisfication of the Secretary or his delegate that such
exchange is not in pursuance of a plan having as one of
its principal purposes the avoidance of Federal income taxes."
In any reorganization involving a foreign corporation,
the U.S. taxpayer must first obtain a Section 367 ruling
from the Internal Revenue Service that the exchange is not
in pursuance of such a plan, or the transaction will be
treated as a taxable event. Often the taxpayer must pay a
"toll charge", involving partial recognition of the gain,
in order to receive a favorable Section 367 ruling. The
ruling might also be accompanied by a closing agreement
an
- 10 which preserves the U. S. tax base (Revenue Procedures
68-23 and 75-29).
(b)
Subpart F and its exclusions.
The early anti-
abuse provisions were addressed to situations where an
individual U. S. shareholder took advantage of lower U. S. or
foreign corporate tax rates, or where a U.S. corporation took
advantage of the tax-free reorganization provisions.
The
Revenue Act of 1962 partially terminated deferral in answer
to the tax abuse which may arise when a U. S. parent corporation takes advantage of lower foreign corporate tax rates
on ordinary income in tax haven countries.
The Kennedy Administration originally sought the complete termination of deferral, but Congress adopted a more
focused approach.
The history and drafting of subpart F
(Sections 951-964) indicate that it represents a compromise
between the complete termination of deferral and the classical system of taxing foreign corporate income.
The purpose
of subpart F is to terminate deferral in tax abuse situations, yet otherwise retain the separate taxation of a
foreign corporation and its U. S. shareholders.
Subpart F, as enacted in 1962, taxes U.S. shareholders
currently on the income of a controlled foreign corporation
J&e
- 11 -
when the nature of the corporation and its sources of income
combine to exhibit tax haven characteristics.
The foreign
corporation is potentially subject to subpart F if it is
a controlled foreign corporation (CFC), that is to say, if
the voting stock is more than 50 percent owned by U. S.
"shareholders", defined as individuals or corporations each
1/
controlling at least 10 percent of the voting stock.
If the foreign corporation can establish that it did not
have as one of its purposes a substantial reduction in taxes
(Section 954(b)(4), it will not fall within Subpart F.
The
substantial reduction test is not defined with reference to U.S.
taxes.
Rather the test is whether taxes have been reduced by com-
parison with the taxes that would have been imposed by the
buying or selling country, or the paying or receiving
country, if a third country corporation had not been interposed in the transaction (Regulations 1.954-1(b)(4),
example (1)). A company which was not organized with tax
reduction as one of its significant purposes can, however,
still have subpart F income on individual transactions undertaken for the purpose of tax avoidance.
A controlled foreign corporation's income is subject
to subpart F if it is derived from the insurance of U. S.
risks, or if it is characterized as foreign base company
income.
Foreign base company income includes:
(i) foreign
1/ In the case of a controlled foreign corporation that
insures U.S. risks, the test is whether more than 25
percent of the voting stock is owned by U.S. shareholders.
(Section 957(b)) .
- 12 personal holding company income (interest, dividendsrents, and similar categories of passive income); (ii)
foreign base company sales income (income derived by the
CFC from selling or buying personal property to or from a
related person, if the property is both produced and sold
for use outside the country in which the CFC is incorporated) ; and (iii) foreign base company services income
(income derived from the performance of technical, managerial, or similar services or on behalf of a related person
outside the country of CFC incorporation) .
When the foreign corporation and the composition of
income meet these statutory tests, the U.S. shareholders
are generally deemed to receive a distribution of retained
earnings and are taxed accordingly, with provisions for a
foreign tax credit (Sections 960 and 962) . As a backstop to
subpart F, the Revenue Act of 1962 required that when a
U.S. shareholder disposes of shares in a controlled foreign
corporation, the gains must be reported as ordinary income
to the extent of earnings and profits accumulated after
1962 (Section 1248).- This provision forestalls the
1/ An exception was made for the disposition of shares in
a less developed country corporation (Section 1248(d)(3)).
accumulation of earnings in a CFC not subject to subpart F,
and the taxation of that income at more favorable capital
gains rates.
A
The Revenue Act of 1962 provided several exclusions
to the general rule of current U. S. taxation of subpart F
income.
The Tax Reduction Act of 1975 repealed or modi-
fied four of the exclusions and added one new exclusion.
(i) Minimun} distribution.
The parent corporation
could elect a so-called "minimum distribution1'.
The mini-
mum distribution was a constructive distribution of earnings from CFCs with and without subpart F income.
If
the minimum distribution showed that average foreign taxes
were equal to a certain percentage or within certain percentage points of the U. S. tax rate, the deemed distributions under subpart F were reduced or eliminated.
The
minimum distribution election was repealed by the Tax
Reduction Act of 1975.
(ii) Less developed country corporations.
The subpart
F income of a CFC derived from and reinvested in "qualified
investments" in less developed countries was excluded from
the definition of foreign base company income.
Less developed
countries were broadly defined to include all nations outside
of industrial Europe, Canada, Japan, Eastern Europe, and the
Sino-Soviet bloc. „ This exclusion was repealed by the Tax
Reduction Act of 1975.
l
- 14 (iii) 30-70 rule.
If less than 30 percent of CFC
income was characterized as foreign base company income,
then a special rule provided that none of the income
would retain that character and no deemed distribution
was required.
If between 30 and 70 percent of the income
was characterized
as foreign base company income, then
the actual percentage would have that character and that
percentage would be subject to a deemed distribution.
Above 70 percent, the entire CFC income would be characterized as foreign base company income and would be deemed
distributed.
The Tax Reduction Act of 1975 changed the
30 percent rule to a 10 percent rule.
(iv) Shipping income.
As originally enacted, subpart
F provided an exclusion from foreign base company income
for income derived from, or in connection with, the use
of any aircraft or vessel in foreign commerce.
The Tax
Reduction Act of 1975 required that shipping income be
reinvested in shipping operations to qualify for this
exclusion.
(v) Agricultural sales.
The Tax Reduction Act of 1975
modified the definition of foreign base company sales income
to exclude income from sales of agricultural commodities
which are not grown in the United States in commercially
marketable quantities.
The Tax Reform Act of 1975, H. R
10612, passed by the House and now under consideration by
-15 -
z&y
the Senate, would broaden this exclusion to cover agricultural products which are significantly different in grade
or type from agricultural products grown in the United States.
2<f
- 16 III. ANALYSIS
1.
International tax neutrality.
*
Tax neutrality is
a broad concept which is often defined in conflicting ways.
Whether foreign corporate income is taxed by the United
States currently or only when dividends are distributed is
one element in a definition of international tax neutrality,
but it is not the only element. The relationship between
deferral and international tax neutrality must be viewed in
the overall context of U.S. and foreign tax rules.
Tax neutrality at the corporate level— for foreign
investment can be defined either with reference to the taxation of domestic profits, or with reference to the taxation of the profits of competing foreign firms. These
alternative standards are usually designated as "capitalexport neutrality" and "capital-import neutrality". In
their pure forms, the concepts of capital-export neutrality and capital-import neutrality say nothing about the
division of tax revenue between home and host country
tax authorities. In principle, either type of neutrality
could be reached consistent with various revenue sharing
arrangements between the taxing authorities. In practice,
under present international rules, each type of neutrality
tends to be associated with a certain division of revenue.
1/ This paper does not analyze tax neutrality at the individual level.
- 17 -
^
Capital-export neutrality is achieved when the total
rate of corporate tax on foreign profits is the same as on
comparable domestic profits. For example, if the French
subsidiary of an American firm pays 40 percent of its profits in tax to France, and if the United States corporate
tax rate was a uniform 48 percent, capital-export neutrality would be served by a current U. S. corporate tax of 8
percent on the French subsidiary's profits.
In order to achieve capital-export neutrality under
existing domestic tax law, several underlying conditions
must be met.
First, host country taxes paid should be
credited against the home country tax liability,
with the refund of excess foreign taxes; alternatively, home country taxes should be credited
against the host country tax liability;
Second, foreign income, including undistributed subsidiary earnings, should be taxed
currently to the parent corporation by the home
country;
Third, the home country should employ the
same accounting practices in calculating domestic
and foreign profits (in particular, the same
depreciation conventions should be used);
Fourth, any capital subsidies provided for
investment in the home country (for example, an
investment tax credit) should be available for
investment abroad. Similarly, preferential taxation of export earnings, such as the DISC, should
be extended to foreign production;
Fifth, the same treatment should apply to
sub-Federal income taxes levied at home and
abroad. If state and local taxes are deductible
at home, then to the same extent they should be
- 18 deductible in computing taxable foreign source
income;
Sixth, losses of foreign subsidiaries should
be deductible to the same extent as the losses of
the parent companies.
Capital-export neutrality could alternatively be
achieved under a domestic tax law which was free of all
corporate tax preferences, and instead taxed corporate
income at a uniformly lower rate. In order to achieve
capital-export neutrality under such a neutral domestic
tax law, several conditions must be met, many the same as
before.
First, (and this is the main difference),
tax preferences for domestic corporate income
must be repealed, and nominal corporate tax rates
must then be lowered so that there is no net
revenue change from the taxation of domestic
income;
Second, host country taxes paid should be
credited against the home country tax liability,
with the refund of excess foreign taxes; alternatively, home country taxes should be credited
against the host country tax liability;
Third, foreign income should be taxed currently by the home country;
Fourth, the home country should employ the
same accounting practices in calculating domestic
and foreign profits;
Fifth, the same treatment should apply to
sub-Federal income taxes levied at home and abroad;
Sixth, losses of foreign subsidiaries
should be deductible to the same extent as the
losses of the parent companies.
- 19 -
Jl<3f
A regime of capital-export neutrality, whether achieved
under existing domestic tax law or under a neutral domestic tax law, would, unlike present law, encourage U. S. firms
to locate their productive facilities wherever pre-tax
returns promised to be greater. A firm would be indifferent
between a 20 percent pre-tax rate of return on investment
in Canada, in Brazil, or in the United States, for it would
receive the same after-tax return in all cases. Tax considerations would play no role in investment decisions,
pre-tax returns on U. S. investments of equivalent risk
would ultimately be equalized around the world, and the
United States capital stock would be allocated in a manner
designed to maximize world production.—
Capital-import neutrality for corporate investment is
achieved when firms of all nationalities operating in one
industry -- for example, the Italian office equipment
industry -- pay the same total tax rate on profits earned
in the country where the industry is located --in this
2/
case Italy.—
Pure capital-import neutrality in this
1/ This statement ignores the misallocation caused by
tariffs, quotas, and other impediments to free international trade.
2/ When a host country has an integrated system of taxing
corporations and their shareholders, the analysis of
capital-import neutrality can become more complicated.
This discussion envisages a host country with a classical separate entity system of taxation.
- 20 -
2^
situation would emerge if Italian tax law made no differentiation among enterprises of diverse national origin.
For example, Italy could not withhold tax on dividends,
interest, and royalties paid to foreign corporations unless
it also withheld tax on such payments to Italian corporations.
Furthermore, foreign nations should make no attempt to impose
an additional tax on corporate earnings arising in Italy.
Indeed, one way of achieving capital-import neutrality is
through the unilateral exemption of corporate foreign source
income from domestic taxation, as is virtually done by
France and the Netherlands.— Under territorial taxation,
as this approach is called, the home government relinquishes
all tax claims, and the host government collects all-the tax
revenues arising from the enterprise. However, a revenue
sharing arrangement between the host and home countries would
equally be consistent with capital-import neutrality.
Capital-import neutrality is sometimes called 'competitive" neutrality, because firms of diverse national origin
compete on an equal tax basis in any particular country and
industry. Because tax considerations do not distort competition, capital-import neutrality promotes the most efficient
use of resources between firms in that country and industry.
1/ France and the Netherlands do tax a small portion of
corporate foreign source income.
- 21 -
jfy,
Both in legislation and in bilateral tax treaties, the
United States has attempted to ensure the type of tax neutrality appropriate to different situations, while at the
same time protecting U.S. sources of tax revenue.
Thus,
United States taxation of the foreign income of U. S.
owned firms embodies a mixture of capital-export neutrality,
capital-import neutrality, and revenue protection clauses.
The keystone of U. S. taxation of American enterprise
abroad is the foreign tax credit.
Subject to certain
limits, U.S. firms may take a credit against their tentative
U. S. tax for the foreign income tax levied on the repatriated
earnings of foreign corporate subsidiaries— , on the total
earnings of foreign branches, and on interest, rents,
royalties and fees paid from foreign sources.
The foreign
tax credit essentially cedes to the host country the first
slice of tax jurisdiction, and hence most of the revenue.
To the extent that a U.S. firm repatriates dividends, interest,
rents, royalties or fees from its foreign corporate subsidiary, or operates abroad through foreign branches, the
foreign tax credit may come close to ensuring capital-export
neutrality.
1/ There is both a direct credit (Section 901) for foreign
withholding taxes on dividends, and an indirect credit
(Section 902) for foreign taxes paid on the underlying
corporate earnings.
- 22 There are several reasons why the foreign tax credit
does not achieve capital-export neutrality under existing
law.
The U. S. foreign tax credit limitation rules operate
so that when foreign taxes exceed the tentative U. S. tax on
foreign source income, the excess foreign tax credit cannot
be claimed currently (but it can be carried forward or
carried back to other taxable years).
If the excess credit
could be claimed without limit, foreign governments could
erode U. S. tax revenues on domestic source income.
But
because the excess foreign tax credit cannot be claimed,
capital-export neutrality disappears whenever the foreign
tax rate exceeds the U.S. rate.
Foreign investment offer-
ing a given pre-tax return then becomes less attractive than
domestic investment offering the same return.
In addition
to the foreign tax credit limit, other
features of the law reduce the extent of capital-export
neutrality.
U. S. parent corporations cannot offset the
losses of foreign subsidiaries against domestic income,
although the losses of foreign branches of U. S. corporations
may be offset against domestic income.
The investment tax
•
y
credit is not available for capital expenditures abroad,
and the asset depreciation range (ADR) cannot be used for
A-
1/ Section 48(a)(2).
- 23 -
J?£
computing earnings and profits of a foreign subsidiary.
DISC is not available for exports by foreign subsidiaries.
Like the limit on applying the foreign tax credit, these
measures shield the U. S. Treasury and promote domestic
investment, at the expense of capital-export neutrality.
Two asymmetries, however, favor foreign over domestic
investment: U.S. taxation of foreign subsidiary earnings
is deferred until dividends are declared, and foreign subFederal taxes may be credited against the tentative U. S.
tax, whereas U. S. state and local taxes can only be deducted
from earnings.
To the extent that the earnings of a foreign corporate
subsidiary are not remitted as dividends, United States
tax practice comes close to achieving capital-import
neutrality. No current U.S. tax is levied on those earnings; instead U.S. taxation is deferred until repatriation.
(Under the foreign personal holding company legislation
and subpart F, certain kinds of tax haven income may be
taxed currently, whether or not repatriated.) When earnings
are retained abroad, deferral places the American-owned
1/ The tax rules provide that guideline periods, but not
the asset depreciation range, may be applied to property
predominately used outside the United States (Revenue
Procedure 72-10; Regulation 1.964-1(c)(i)(iii)).
- 24 foreign subsidiary on much the same tax footing as its local
competitors. Pure capital-import neutrality cannot be
achieved, however, unless the United States (and other countries) abandon their claim to tax foreign source income
(although home countries could seek revenue sharing arrangements with host countries) and host countries pursue a
strict policy of non-discrimination.
In essence, an American multinational enterprise can
elect to have its foreign ventures taxed either under a
modified form of capital-export neutrality (by operating
through a foreign branch or by distributing the earnings
of a foreign subsidiary) , or under a modified form of
capital-import neutrality (by operating through a foreign
subsidiary and retaining the earnings abroad). In neither
case is the neutrality pure, and the level of purity partly
depends on the host country.
The 197 6 revenue consequences of present law, and of
possible changes, are summarized in Table 1 for the nonextractive industries.- Corporate pre-tax foreign earnings were about $24.9 billion, foreign taxes claimed about
1/ The taxation of petroleum and hard minerals involves
special considerations which do not easily fit into the
concepts of capital-export neutrality and capital-import
neutrality. For this reason, Table 1 is confined to the
non-extractive industries.
Tabic 1
Estimated Tax Revenue Consequences in 197h of Achieving Alternative Standards of
International Tax Neutrality with Respect to U.S. Corporations in Non-Hxtractive Industries
(Millions of Dollars)
Capital-export neutrality
With extension of
With removal of
U.S. domestic tax
U.S. tax preferences
preferences to
foreign investment :< for domestic investment
Capi tal-import
neutrality
Foreign source income of U.S. corporations, before taxes
24,900
24,900
24,900
Present total taxes on the foreign source income of
U.S. corporations under current law
Net U.S. taxes
Foreign taxes
12,270
1 ,970
10,300
12,270
1,970
10,300
12,270
1,970
10,300
Change in total taxes on the foreign source income of
U.S. corporations in non-cxtractive industries
-1 ,590
-2,990
1,970
890
890
Remove U.S. tax preferences for foreign investment
Western Hemisphere Trade Corporation deduction
Non gross-up of dividends from l.DC corporations
Deferral of tax on retained profits of foreign
subs 1d1ar1es
Allowance of credit for foreign taxes comparable to
state income taxes
Allow credit (or refund) for foreign taxes in excess
of overall limitation
36 5
36 5
450
450
- 180
-180
Remove U.S. tax preferences for domestic investment
and reduce U.S. corporate tax rate on domestic
and foreign source income to 33 percent 1/
Extend U.S. domestic investment tax preference to
foreign investment
Investment tax credit
Asset depreciation range
Domestic International Sales Corporation (DISC)
2U
55
2TJ
55
- 3,700
2,300
1,000
-300
1,000
-1,970
Adopt territorial income tax
Hypothetical total taxes on the foreign source income
of U.S. corporations in non-extractive industries
Office ol the Secretary ot the Treasury
Office of Tax Analysis
10,680
9,280
10,300
April 5, 1976
- 26 $10.3 billion (41 percent of earnings) and U.S. tax collections were about $2.0 billion (8 percent of earnings).
A standard of pure capital-import neutrality at the
corporate level would require zero U. S. tax collections
on corporate foreign source income. The adoption of a
territorial system would thus involve a 1976 revenue loss
of nearly $2.0 billion by comparison with present collections. This revenue loss could be unilaterally absorbed by
the United States, or it could be shared between the United
States and various host countries. Capital-import neutrality, in whatever manner achieved, would not of course
answer those critics of deferral who wish to increase U. S.
tax revenues and promote domestic investment.
A standard of capital-export neutrality under existing domestic tax law would also reduce the revenue collections of U. S. and foreign tax authorities (assuming the
revenue loss is shared). In 1976, the net revenue loss
from a system of pure capital-export neutrality would have
been almost $1.6 billion. The net loss represents a combination of revenue effects. If the law were changed to
end deferral, to provide a deduction rather than a credit
for that portion of foreign taxes which correspond to U. S.
state and local taxes, and to eliminate certain minor nonneutralities, there would be revenue gains. But these
gains would be more than offset if the law were also change
J7£
- 27 to compensate for foreign taxes in excess of the tentative
U. S. tax, and to extend the investment tax credit, the asset
depreciation range and DISC to investment abroad.
A standard of capital-export neutrality under a neutral
domestic tax law would likewise reduce the revenue collections of U. S. and foreign tax authorities on U. S. investments abroad.
After the repeal of domestic tax preferences,
and a compensating reduction in rates so that the corporate
tax on domestic income remained unchanged, the nominal
U. S. corporate tax rate could be reduced from 48 percent
to 33.2 percent.
As a result, however, current U.S. revenues
from foreign source income would decline by $3.7 billion.
This would be partly offset by higher revenues from the termination of deferral, from the repeal of the WHTC, from
gross-up of dividends from less-developed country corporations, and from other changes.
But a net revenue loss of
$3.0 billion on foreign source income would remain after
all adjustments.
Few would argue that the United States should unilaterally implement a standard of capital-export neutrality
and incur all the associated revenue costs.
Such a stan-
dard would require tax cooperation between the United States
and foreign governments.
On the other hand, legislation by
the United States to end deferral would not, by itself,
move the international tax system closer to a standard of
- 28 capital-export neutrality. Rather, it would reinforce the
existing preferential taxation of corporate profits earned
within the United States.
2.
Constitutional problems. The taxation of a share-
holder on the constructive receipt of a corporation's
undistributed earnings raises constitutional issues. Can
such earnings properly be viewed as "income" under the terms
of the Sixteenth Amendment? This issue has recently been
litigated in connection with subpart F. The court decision:;
upholding subpart F provide some indication of the potential
reach of U S. law if a wider termination of deferral is
2/
sought.
The Sixteenth Amendment gives Congress the power to
impose income taxes. If a tax is not levied on "income",
it would be considered a "direct tax" under the ruling in
Pollock v. Farmer's Loan and Trust (157 U.S. 429, 158 U.S.
601, 1895), and would require apportionment among the
states according to population. The opponents of subpart F
have relied on the Pollock opinion to argue that the current
taxation of each CFC shareholder's portion of undistributed
1/ It should be emphasized that the investment tax credit or
DISC can exert a very different impact on investment per
dollar of revenue cost than, for example, deferral or the
foreign tax credit. Therefore, an examination of total
revenue gains and losses under alternative tax systems
provides only a rough guide to their impact on the
location of investment.
2/ Subpart F has withstood legal attacks based on the due
process clause of the Fifth Amendment, the principles of
international law, and the Sixteenth Amendment. The
Sixteenth Amendment issues are most important, and they
are the only ones discussed here. The discussion draws
on a paper by Howard Liebman.
- 29 -
J/7/
earnings and profits cannot possibly constitute a tax on
"income" and must, therefore, be apportioned among the
states as a "direct tax." The basis for this reasoning
lies in the decision of Eisner v. Macomber (252 U. S. 189,
1920) holding that a stock dividend on accumulated profits
is not "income" under the Sixteenth Amendment. But Macomber
was a close decision and has since been undercut by numerous
judicial exceptions. Thus, in 1961, the Treasury Department's General Counsel concluded that, "enactment of [subpart
F] is appropriately within the constitutional powers of the
Congress both to lay and collect taxes and to regulate commerce with foreign nations."This view has been upheld by the Tax Court:
The Supreme Courtf s pronouncements
have been to the effect that taxation
of undistributed current corporate
income at the stockholder level is
within the Congressional power.2/
Although the Supreme Court has not ruled on subpart F,
other courts have endorsed the Tax Court's position. There
appears to be no constitutional barrier to the termination
1/ Memorandum from Robert H. Knight to Treasury Secretary
Dillion, June 12, 1961, in President's 1961 Tax Recommendations, Hearings before the House Committee on Ways
and Means, 87th Congress, 1st Session (1961), Volume 1,
p. 322.
V Estate of Leonard E Whitlock, 59 T. C. 490, 507 (1972);
artirmed 494 F.2d 1297 (10th Circuit, 1974).
- 30 -
of deferral for a wider class of income than that presently
defined in subpart F.
A more general termination of deferral would, however,
provide an incentive for U. S. shareholders to "decontrol"
their existing controlled foreign corporations and to take
minority positions in new ventures rather than establish
new controlled foreign corporations. The incentive to
escape current taxation might be mitigated if the ownership
threshold used to define a controlled foreign corporation
were reduced to 50 percent or less. However, a lower threshold might conflict with the "constructive receipt" doctrine underlying both subpart F and the foreign personal
holding company legislation. If the U. S. shareholders are
not a closeknit, controlling group that can force the
declaration of a dividend, the constitutionality of a lower
threshold under the Sixteenth Amendment and the due process
clause of the Fifth Amendment must once again be assessed.
How can the United States tax a shareholder on an undistributed gain when the shareholder lacks the degree of control
required to realize the imputed gain? It may seem "patently
unfair and unjust to tax anyone on income which he has not
received and which is not within his control."-7
1/ Statement of Randolph W. Thrower, Hearings before the
benate Committee on Finance, 87th Congress, 2d Session
(1962) part 6, p. 2251.
- 31 -
P
The most recent cases dealing with subpart F have
indicated that actual control rather than numerical control
is the key issue. In Garlock (58 T.C. 423, 1972) "actual
control" by U.S. shareholders in a reorganized Panamian subsidiary was found where the U.S. shareholders only owned
50 percent, and foreign investors, chosen for their sympathy towards the management, owned callable cumulative
preferred stock. Hans P. Kraus (59 T.C. 681, 1973; affirmed,
490 F.2d 898, 2d Circuit 1974) presented similar facts.
The court looked to substance rather than form and concluded that divestment in order to avoid the impact of
subpart F must result in actual decontrol. These and other
cases suggest that subpart F could be extended to situations
where U.S. shareholders own less than 50 percent of the
foreign corporation, provided that U.S. shareholders exercise actual control. 1/
3. Foreign reaction. Any significant change in the
U.S. approach to deferral would raise tax treaty questions
and might prompt offsetting foreign tax legislation.
1/ Income from the insurance of U.S. risks earned by a
foreign corporation which is owned more than 25 percent
by U.S. shareholders in presently taxed under Subpart F
(Section 953 and 957(b)). The 25 percent test has not
been litigated, and it is not clear whether it furnishes
a precedent for a less than 50 percent ownership test in
the absence of actual control.
- 32 -
2V
(a) Tax treaties. The United States has in force
tax treaties with 37 countries, (including extensions to
former colonies). Four treaties have been signed and await
ratification by the U.S. Senate and foreign parliamentary bodies
Eleven tax treaties are in various states of active negotiation.
The deferral of U. S. tax on the income of controlled
foreign corporations is not specifically addressed in these
treaties. The U.S. has made no treaty commitments which
would preclude partial or total elimination of deferral.
However, the classical U. S. system of taxation and the
consequent deferral of U. S. taxation of retained foreign
corporate earnings are well understood by foreign tax officials, and these elements of U.S. law play an important
role in treaty negotiations.
Less developed countries frequently raise the issue of
a tax sparing credit. The tax sparing credit is a home
country foreign tax credit for taxes waived by the host
country, usually through a tax holiday or preferential tax
rates designed to encourage a particular industry. The
United Kingdom, France, Germany, Japan, Canada and most other
industrialized countries grant a tax sparing credit in their
bilateral tax treaties with less developed countries.
During the 1950's and 1960's, the United States negotiated
seven treaties with either a tax sparing credit (Pakistan,
India, Israel, and the UAR) or, as a substitute, an investment
tax credit (Brazil, Thailand, Israel).
In none of the
seven cases, did the credit provisions receive Senate
approval. The United States Treasury no longer negotiates
treaties with either a tax sparing credit or an investment
tax credit.
However, in negotiations with less developed countries,
the United States has emphasized that deferral does not
frustrate local tax incentives. If the host country chooses
to reduce its corporate tax rates as an investment incentive
measure, the United States will not absorb the incentive
through offsetting taxation so long as the foreign subsidiary
reinvests its earnings abroad. Moreover, the U.S. ordering
rule for associating dividends with earnings and profits
ensures that U.S. taxes need never erode the foreign tax
relief, even if earnings are distributed during the post-tax
relief period. The United States follows a last-in-first-out
rule in tracing dividends to the underlying earnings and profi
Thus, suppose Country X grants a five year tax holiday, and
in the sixth year imposes a 45 percent tax on current earnings
During the tax holiday period, the controlled foreign corporation accumulates earnings and profits of $12 million, but distributes no dividends. In the six year, the corporation earns
$3.63 million (before tax), pays foreign taxes of $1.63
million, and therefore has after-foreign-tax earnings of $2.0
million. A dividend of $2.0 million is distributed to the
- 34 U. S. parent. The entire dividend is deemed to be paid out
of current earnings, and none of the dividend is deemed to
be paid out of accumulated earnings. The grossed-up divid1/
end for U S. tax purposes will be $3.63 million.
The
net U. S. tax on the dividend, after allowance for the foreign
2/
tax credit of $1.63 million, would be $0.11 million.-'
The combination of deferral and the dividend inventory
rule has proven satisfactory to many of our tax treaty partners. Developed countries have not had to negotiate the U.S.
tax treatment of their own tax relief provisions for particular regions or industries. Less developed countries have
often dropped their initial demands for a tax sparing credit
or similar provisions. If the United States were to terminate
deferral, some treaty countries would no longer be satisfied
1/ Under present law, dividends for a less developed country
corporation are not grossed-up, and a different formula
is used to calculate the foreign tax credit. H.R. 10612
would require the gross-up of such dividends.
2/ In this case, the deemed paid foreign tax credit is calculated as :
Dividend ^ . <-OY
Fa-rn-i^rro o-F+-^ t„
=
z—
earnings alter foreign tax
$2 0
= fj^ x $1.63 = $1.63
x Foreign corporation income tax
&
K
The tentative U. S. tax before the credit would be 48 percent
of $3.63 million, or $1.74 million. After the foreign tax
credit of $1.63 million, the net U. S. tax would be $0.11
million.
- 35 -
^^^
with existing arrangements. They might seek new negotiations
with a view toward provision of deferral by treaty. Alternatively, they might take unilateral statutory steps along
the lines discussed below.
(b) Foreign statutory change.
If the United States
limits the extent of deferral, countries which provide tax
relief as an incentive measure might narrow the scope of
that relief to exclude companies which would be subject to
current U. S. taxation.
The result could be heavier foreign
taxation of U S . controlled foreign corporations, by comparison with competing firms either owned locally or by third
country parent firms.
In selected instances, heavier foreign
taxation might serve to equalize the taxation of U. S. investment at home and abroad, but it would erode the potential
gains in U. S. tax revenue from the termination of deferral,
and it might put U. S. firms at a severe competitive disadvantage .
There are several ways foreign taxes on U. S. controlled
foreign corporations could be selectively increased.
Subsidiaries of U. S. corporations might no longer be eligibile for special tax holidays and investment tax credits.
Egypt» f° r example, under present law provides tax relief
for foreign investors only if the home country does not tax
the income either when earned or distributed.
Alternatively,
withholding taxes could become payable on deemed dividend
- 36 distributions, as well as on actual dividend distributions,
and withholding tax rates could be increased.
In cases where the foreign country wished to encourage U.S. firms, methods could be found which would circumvent the U. S. termination of deferral. The foreign country
could provide tax relief for joint ventures in which the
U S. corporation held a minority interest, and therefore
was not subject to current U. S. taxation. Alternatively,
the foreign country could provide U. S. controlled corporations with input incentives, -- for example wage or energy
subsidies -- while taxing the CFCs at rates close to the
U. S. corporate rate. This possibility is illustrated in
Table 2.
In both situations, the firm has sales of 1,000, raw
material costs of 400, and wage costs of 500. In Case A,
with U. S. deferral, a tax holiday in the foreign country
ensures that the firm realizes after-tax income of 100.
In Case B, without U. S. deferral, a wage subsidy of 100
coupled with a foreign corporate tax of 50 percent ensures
that the firm still realizes after-tax income of 100.-^
1/ The wage subsidy cannot be conditioned on the payment of
tax, or it would be regarded as a tax refund for purposes
of calculating the U. S. foreign tax credit. On average
wage subsidies might equal corporate tax payments for a
group of firms, but (unlike the example) they would not
be identical for each firm.
- 37 -
Table 2
Comparison Between Foreign Tax Relief and Foreign Input Subsidies
Case A
U.S. taxation with
deferral
Foreign tax holiday
Sales
Raw materials
Wages
Less: wage subsidy
Income before tax
Foreign tax
Income after foreign tax
Deemed or actual
dividend dis tribution
U.S. tax after foreign
tax credit
Income after all taxes
1,000
400
500
100
100
100
Office of the Secretary of the Treasury
Office of Tax Analysis
Case B
U.S. taxation without
deferral
Foreign corporate tax
of 50% plus wage subsidy
1,000
400
500
(100)
200
100
100
100
100
February 3, 19 76
- 38 In the eyes of the firm, little has changed.- In both
cases, the foreign government collects no tax, in the second
case, the wage subsidy just offsets the tax, and in both
cases the United States collects no tax. It is not clear
what the United States would gain by encouraging foreign
2/
countries to undertake this sort of fiscal subterfuge.-'
(c) Average foreign tax rates. With the termination
of deferral, many foreign countries would be concerned about
the U. S. tax status of subsidiaries engaged in particular
industries and regions. Although national average tax rates
often conceal the situation for individual industries and
regions, they do perhaps indicate the most seriously affected
nations.
Table 3 shows 1974 statutory and realized corporate
tax rates, the withholding rate applied to dividends payments to the U. S. , and the total (corporate and withholding)
realized tax rate on grossed-up dividends for more than 60
countries. Realized corporate tax rates are computed as
the ratio of taxes paid to the U. S. definition of pre-tax
1/ In the long run, however, the firm may respond differently to a wage subsidy than a tax holiday. For example,
a wage subsidy might induce the firm to use more labor
and less capital to produce a given level of output.
2/ It should be noted that the foreign tax credit mechanism generally encourages foreign governments to tax
dividends, interest, rents, royalties, and other foreign income paid to U. S. corporations at a rate near
48 percent.
Table 3
Statutory and Realized Corporate Income Tax Rates on Manufacturing Firms, 1974
Count ry
Canada
Statutory Tax Rates
Corporate
Distributed
Tax Rate 1/
profits tax
2/
rate, if different
48.0
Local
Income
taxes
Realized
Corporate
tax rate 3/
13.0
41.1
15.0
53.4
37.5
32.5
48.0
43.0
11.9
12. 7
41.9
17.1
36.0
40. 5
30. 3
43.1
27.1
44.6
Withholding tax rates
on dividends distributed
to
U.S.
Total realized
Statutory
: Realized
tax rate on
or Treaty
:
Rate on
Rate
: grossed-up
grossed-up
: dividends
dividends
15.0
8.8
49.9
5.0
2.3
9.4
3.4
2.6
8.5
15.0
2.8
3.6
8.3
55
46
35
50
51
38
17
44.8
21.2
42.^
49.4
40.8
45.9
30.7
52.9
Europe:
Aust r ia
Belgium
Denma rk
France
Germany
Greece
Ire land
Italy
Luxembourg
Nether lands
Norway
Spain
Sweden
Swi tzerland
United Kingdom
55.0
42.0
36.0
50.0
51.0
38. 2
50.0
43.8
40.0
48.0
26. 5
32.8
40.0
8.8
52.0
27. 5
0
25.0
15.0
0
27. 0
4/
13.0
4/
5/
14.0
0
4/
21.3
25.0
28.0
26.2
15.0
5.0
5 0
15.0
30.0
5.0
5.0
5.0
10.0
15.0
15.0
5.0
5.0
26.4
4.4
2.9
4.1
6.4
8.9
10.5
Oceania
Aus t ra 1 ia
New Zealand
47.5
45.0
42.9
51.7
15.0
5.0
8.6
2.4
51.5
54.1
42.0
42.9
42.2
28.2
20.0
12.0
11.6
8.6
53.8
36.8
La t in Amer ica
Mexic o
Argent i na
VO
cont inued
Statutory tax rates
Count ry
Corporate
tax rate 1/
Brazil
Chile
Columbia
Ecuado r
Peru
Uruguay
Venezuela
Cos ta Rica
El Salvador
Guatemala
Honduras
Nicaragua
Panama
96. 7
41. 7
36.0
20.0
55.0
37.5
50.0
40.0
15.0
52.8
40.0
30.0
50.0
Distributed
: Local
profits tax
_.: income
rate, if different— : taxes
33.5
Withholding tax rates
on dividends distributed
to U.S.
Realized
Realized
S tatutory
rate on
corporate
or treaty
grossed-up
3/
tax rate
rate
dividends
30
39
47
18
47
25
30
33
7
21
25
1
15
40.0
25.0
40.0
20.0
40.0
30.0
25.0
15.0
15.0
38.0
10.0
5.0
0.0
10.0
17.4
24.2
10.5
32.5
15. 7
18. 7
10.5
9.9
35.1
7.9
3.7
0.0
8.5
Total realized
tax rate on
grossed-up
divid e n d s
47. 7
63.6
57.8
51
63
43
40
43
42
28
28
1
23
Africa:
Algeria
Morocco
Liberia
Ethiopia
Kenya
Nigeria
Rhodesia
South Africa
Zambia
o
50.0
48.0
45.0
40.0
40.0
45.0
40.0
43.0
45.0
0.0
54.5
5. 7 6/
38.6
19.0
18.0
25.0
15.0
18.0
11.4
14.1
18.0
65.9
19. 8
38.6
29.1
19.0
41.3
50.6
38.8
0.0
0.0
30.9
41.9
28.0
12.5
15.0
15.0
15.0
15.0
10.1
14.3
10.4
8. 7
10.8
10.5
44. 7
15.1
60.0
30.0
10.0
53. 7
16.6
8.5
64.2
61.3
23.6
21.2
57.0
39. 3
25. 7
31.0
11.1
52. 2
68.1
4.7
Middle East:
Iran
Israel
Lebanon
10.0
56.5
42.0
55.0
42.0
60.0
60.0
33. 3
3.4
15.0
Asia:
Sri Lanka
India
V
N&
Table 3 -
continued
Withholding
C o u n t ry
Statutory
Corporate
Tax Rate 1/
Malaysia
Pakistan
Phill ipplnes
Singapore
Ta iwan
T h a i land
Hong Kong
Japan
Indonesla
Tax
Rates
Distributed
2/
profits
tax
r a t e , if d i f f e r e n t
40
60
35
40
25
30
15
40
45
28.0
on d i v i d e n d s
tn
Loca 1
Income
taxes
12.0
Rea11 zed
Corporate
tax rate 3/
27
52
29
26
6
14
15
47
36
Statutory
or Treaty
Rate
tax
:
:
TT . S
Realized
: Total realized
tax r a t e on
Rate on :
grossed-up
grossed-up
d iv i d e n d s
dividends
40.0
15.0
35.0
40.0
10.0
25.0
0.0
6/
rates
distributee)
10. 0
20.0
56. 7
59. 7
54.2
56.1
15.4
36.2
15.5
53.0
49. 1
28.8
7. 1
24.6
29.2
9.4
21 .3
0.0
5.6
12.7
Other Western Hemisphere:
Bahamas
Bermuda
Netherlands
A n 1 1 1 les
34.0
Dominican Republic
Jama i c a
41.1
45.0
40.0
45.0
P u e r t o Rico
Trinidad & Tobago
O f f i c e of
Office
NOTES:
the S e c r e t a r y of
of Tax A n a l y s i s
0.0
0.0
the
5.1
0.3
5. 1
0.3
15.0
0.0
0.0
21
22
18.0
37.5
12.2
36.7
15.0
10.0
14 .1
29.0
13.2
4.5 6/
Treasury
4. 5
35
51
25
43
6.3
April
_1/ For some countries, 1974 rates were unavailable and 1973 rates were used.
2/ The distributed profits tax rate reflects both split rates and imputation systems.
3/ Estimated by increasing (or decreasing) the 1968 realized corporate rate for manufacturing by the percentage
change in the statutory corporate rate.
4/ Dividends are fully deductible from earnings in Greece and Norway; in Belgium, they are deductible within limits,
5_/ Included in the corporate rate.
6/ This is the realized rate for all industries
SOURCES:
M.E. Kyrouz, "Foreign Tax Rates and Tax Bases," National Tax Journal, March 1975; unpublished data.
6,
1976
- 42 earnings and profits, which is the base from which the
3/
deemed paid foreign tax credit is computed.The realized
rates are estimated from 1968 data, adjusted for changes in
statutory rates between 1968 and 1974.
The figures in Table 3 are confined to the manufacturing sector. Termination of deferral would have its
greatest impact on manufacturing. Realized foreign tax
rates on mineral income frequently exceed the U. S. tax
rate, so deferred U. S. taxation makes no difference. Undistributed corporate earnings arising in the trade, finance,
and insurance sectors are to some extent taxed currently
under subpart F (as amended by the Tax Reduction Act of
1975). Thus, low foreign tax rates applied to those sectors
are already partly offset by current U. S. taxation.
Table 3 reveals that realized corporate tax rates on
manufacturing are generally well below the statutory rate.
The median ratio of realized to statutory tax rates in 1974
was approximately 80 percent; in only 11 of the 63 countries
did the realized rate exceed the statutory rate.
1/ The term "realized tax rate1' indicates the ratio between
taxes paid and earnings and profits, as reported for U.S.
tax purposes. By contrast, the term "effective tax rate"
often refers to the ratio between taxes paid and book
income, as reported for financial purposes. Foreign effective rates for selected countries are reported in Survey
of Current Business, May 19 74 (Part I)
- 43 -
Jt?&
For purposes of evaluating the consequences of terminating
deferral on a country-by-country basis, the correct procedure
is to compare foreign total realized tax rates on grossed-up
dividends with the U.S. statutory corporate rate of 48 percent. 1/
The U.S. foreign tax credit is so designed that the termination
of deferral would usually result in higher U.S. taxation of
retained corporate income in those countries with realized tax
rates below the U.S. statutory rate. 2/ Table 3 reveals that in
1974, 26 countries imposed a total realized tax rate on grossedup dividends above the U.S. statutory rate of 48 percent, while
37 countries imposed total realized rates below the U.S. statutory
rate. The partial or complete termination of deferral would
principally affect U.S. investment in the 37 countries in the
latter category. 3/ Of these 37 countries, 27 were less developed countries which presumably rely on tax relief to promote
development.
4. Administrative aspects. U.S. "shareholders" in a
controlled foreign corporation are required to report the CFC's
earnings and profits under U.S. accounting standards. This
information is needed to calculate the deemed paid
T7 The realized U.S. corporate tax rate on domestic source income
was about 41 percent in 1974, but the U.S. statutory rate and
not the realized rate applies to foreign source income.
2/ This generalization does not apply to U.S. firms which use
the overall limitation in reporting the foreign tax credit,
and also have excess foreign tax credits.
3/ This statement assumes that the termination of deferral would
lead to the imposition of withholding taxes on the deemed
distribution, or that companies would distribute 100 percent
of their earnings. To the extent earnings are retained
abroad, and no foreign withholding taxes are imposed, the
better comparison is between the realized foreign corporate
tax rat^T and the (J S. statutory rate of 48 percent.
- 44 1/
foreign tax credit.
In most cases, therefore, the eli-
mination of deferral would require little information not
2/
already reported for U.S. tax purposes.
However, in practical terms, the Internal Revenue
Service would need to expand its auditing efforts and its
staff of international specialists very substantially if
deferral were terminated. The present IRS staff includes
some 150 international specialists. These specialists are
responsible for questions concerning international pricing
and allocation of expenses, subpart F, DISC and similar
special status corporations, and other international tax
issues. In 1974, about 700 international audits were
completed.
1/ The deemed paid credit (Section 902) is calculated as:
Dividends ^ ^ _ , . ,
Earnings and profits
X Forei
Sn
lncome tax
=
Deemed
Pald
cre
The denominator of the first term on the left must be calculated according to U.S. accounting standards. Note that
earnings and profits is an after-tax concept.
2/ Additional information would be required to the extent that
the definition of earnings and profits for purposes of the
deemed paid foreign tax credit (Sections 902 and 964)
differs from the general definition of earnings and profits
Moreover, CFCs that presently distribute no income would
now be required to report earnings and profits.
Under existing law, the direct and deemed paid foreign
tax credits are generally more than sufficient to offset
U. S. tax liability on dividends from foreign subsidiaries.
From a practical standpoint, therefore, it is not rewarding
for the Internal Revenue Service to examine the majority
of CFC returns (in 1974, about 40,000 CFC returns were
filed).
But with the partial or complete termination of
deferral, the exact calculation of the earnings and profits
of a foreign subsidiary would become more important.
The
IRS would have to increase its international staff very
substantially to meet the new demands.
5.
Inve s tmen t imp act.
With the termination of deferral
foreign subsidiary corporations, facing a higher tax rate
than competing local firms, might diminish their activities.
Out of a given volume of pre-tax earnings, CFCs would have
fewer funds available for reinvestment.
In order to
maintain the same after-tax earnings as a percentage of
investment, they might sacrifice less profitable product
lines and, where possible, they might raise prices.
result, CFC sales abroad might contract.
As a
But there is a
wide range of opinion on the ensuing consequences for
investment in the United States.
Some observers believe that investment would be partly
shifted back to the United States, thereby increasing U.S.
corporate earnings.
These observers contend that foreign
and domestic investment are at least partial substitutes,
and that, when markets and investment opportunities are
- 46 -
lost in one area, multinational firms will reallocate
their resources to another part of the globe.
Other observers contend that little or no investment
would be shifted back to the United States. They argue
that profitable investment and production opportunities
are highly specific both in time and place, and that the
loss of foreign markets abroad does little to create new
investment opportunities in the United States. Indeed,
the loss of foreign markets might impair the access of
American producers to new foreign technology, and might
impede the realization of economies inherent in large
scale production and international specialization, with
a consequent attenuation of domestic investment opportunities.
Professor Horst has constructed a mathematical model
to simulate the impact of terminating deferral on manu1/
facturing investment in the United States and abroad.
In this model, foreign and domestic investment are assumed
to be partial substitutes for one another. Investment
in each location is determined both by relative after-tax
rates of return, and by the firm's overall supply of
1/
las Horst, "American Multinationals and the U.S.
^ ini?tcher Sch°o1 of Law and Diplomacy,
mber 1975.
- 47 -
<?/£
financial resources. The model assumes that a multinational
manufacturing firm maximizes its global after-tax earnings.
The firm invests both in the United States and in a single
foreign country.
Its investment can be financed out of
its own retained earnings, with new equity capital, or with
borrowed funds, raised either in the American or in the
foreign capital market.
U.S. funds can be transferred to
the foreign affiliate either as equity capital or as
interest-bearing debt.
The division of taxable income
between countries depends on investment and sales in each
country, and on the level of deductibile intrafirm expenses,
such as interest payments, royalties, and head-office
charges.
A change in tax policy, either in the United States or
abroad, will have two conceptually distinct effects: a
substitution effect, resulting from any change in the aftertax rate of return on foreign or domestic investment; and a
liquidity effect, resulting from any change in after-tax
earnings available for reinvestment.
The size of the sub-
stitution and liquidity effects depends not only on the
opportunities for investing and borrowing in the two
countries, but also on the firm's own internal use of
debt and equity capital.
- 48 Although the model is basically simple, it requires
more than thirty equations to capture the details of
foreign and domestic investment opportunities and tax
systems.
Many parameters must be estimated before usuable
results can be obtained.
As in any exercise of this
nature, the results are subject to a considerable margin
of error.
The results are summarized in Table 4.
The estimates
portray the investment impact after complete adjustment to
the termination of deferral.
Complete adjustment could,
of course, require several years.
Both the substitution
effect and the liquidity effect are reflected in the
estimates.
The estimates in Table 4 suggest that the stock of
plant and equipment investment in the United States manufacturing sector might ultimately increase by $2.2 billion (a change
of 0.7 percent) with an end to deferral, while the stock
of U.S. owned manufacturing assets abroad might ultimately decrease
by $3.5 billion (a change of 2.3 percent).
Consolidated
after-tax earnings would decrease by about $980 million.
U.S. corporate taxes would increase by about $1,000 million.
Foreign corporate income and withholding taxes would decline
Table 4
Estimated Impact of Terminating Deferral on Selected
Economic Variables for U.S. Multinational Manufacturing Firms 1/
(Millions of Dollars)
; Initial Values: Estimated Changes
Total domestic assets 2/
314,000
2,200
Total foreign assets 2/ 151,000 -3,500
Consolidated after-tax earnings V 28,500 -980
U.S. corporate income tax on domestic and foreign
income after investment tax credit and foreign
tax credit 3/
13,400
1,000 47
Foreign corporate income and dividend withholding taxes 7,700 -210 5/
Office of the Secretary of the Treasury April 6, 1976
Office of Tax Analysis
Sources: The estimated changes are adapted from estimates made by Thomas Horst, "American
Multinationals and the U.S. Economy," Fletcher School of Law and Diplomacy,
November 1975, and unpublished work. The initial values are derived from: U.S. Senate,
Committee on Finance, Implications of Multinational Firms for World Trade and Investment
and Labor, February 1973; Survey of Current Business, October 1975; Statistical Abstract
of the United States, 1975; U.S. Treasury Department, Statistics of Income 1972:
Corporation Income Tax Returns.
1_/ The initial value figures refer to the year 1974. The estimated change figures represent
the impact after complete adjustment to the termination of deferral. The figures in the
estimated change column include the impact resulting from the extension of subpart F in the
Tax Reduction Act of 1975.
2/ The initial value figures are based on the 1970 estimates for giant multinational manufacturing
firms contained in Implications of Multinational Firms, p. 432, increased to reflect smaller
manufacturing firms with overseas investment (15 percent of total overseas investment), and
increased again to reflect growth between 1970 and 1974 (Statistical Abstract of the United
States, 1975, p. 500; Survey of Current Business, October 1975). The foreign asset figures
include investment by foreigners in U.S. affiliates. The estimated changes are based on
Professor Horst's model.
3/ The initial values refer to the consolidated after-tax earnings and U.S. and foreign income
—
taxes for all manufacturing firms claiming a foreign tax credit. The estimated changes are
based on Professor Horst's model.
4/ This estimate reflects additional U.S. taxes from: (i) subpart F as expanded by the Tax
~~ Reduction Act of 1975 ($250 million); (ii) termination of deferral with worldwide pooling,
an overall foreign tax credit limit, and current dividend distribution rates ($365 million);
(iii) an increase in U.S. investment and the greater use of equity capital in the
United States ($385 million). Detail is shown in Table 11.
5/ This estimate reflects a decline in foreign taxes resulting from: (i) a decrease in foreign
_
investment; (ii) the greater use of debt capital for foreign affiliates.
- 50 by about $210 million.
These revenue estimates, like the
underlying investment impact estimates, are based on the
1/
assumptions of the particular model.
Professor Horst!s model attempts to capture a variety
of interactions between U.S. parent corporations and their
foreign subsidiaries.
Even so, the model requires many
simplifying assumptions.
In particular, the following
complicating factors are not considered.
The model assumes that foreign and domestic investments
are partial substitutes, and then proceeds to calculate the
extent of substitution.
Many observers would dispute the
assumption of a substitute relationship between foreign
and domestic investment.
If the assumption is wrong, the
estimates of additional investment in the United States
and larger U. S. tax revenues are also wrong.
Professor Stobaugh, for example, contends that the
termination of deferral could lead to a cumulative decline
in the profitability and investment both of foreign affiliate
y
and their U.S. parent corporations.
The U.S. multinational
1/ Revenue estimates made under various assumptions are
presented in section 7.
2/ Robert B. Stobaugh, "The U.S. Economy and the Proposed
U.S. Income Tax on Unremitted Earnings of U.S. Controlled
Foreign Manufacturing Operations Abroad," Harvard Business
School, 1975.
- 51 firms would have fewer funds available for reinvestment,
and in order to maintain the same after-tax rate of return,
they might concede some business to competing foreign
firms.
With slower growth and smaller sales, they might
be less able to improve techniques of production, and
they would have a smaller base for spreading research,
administrative, and other fixed costs.
The cumulative
effect could be lower profits and a decline in investment,
both in the United States and abroad.
Apart from investment changes resulting from corporate
decisions, foreign governments might alter their own tax
rules in response to the termination of deferral.
The
changes could be designed not only to offset U. S. revenue
gains, but also to counter any shift of investment towards
the United States.
For example, foreign governments might
provide special investment incentives for non-American
firms.
Through bank financing and other avenues, these
incentives could indirectly attract capital from the
United States.
These considerations suggest that the changes portrayed
in Table 4 should be viewed as upper limit estimates of the
investment impact of terminating deferral.
- 52 6.
Financial impact.
Foreign subsidiaries can finance
their expansion either by issuing debt or by increasing
equity capital (including the retention of earnings). The
funds can be provided either by the parent corporation or
by unrelated investors. A change in deferral would affect
the tax cost of only one source of capital, namely equity
funding provided by the parent corporation. Other sources
of capital would be available on the same tax terms as
before. With a limitation on deferral, the foreign
affiliate thus might find it more advantageous to finance
expansion through external local borrowing, or through
intrafirm debt, rather than through equity capital supplied
1/
by the U.S. parent corporation.
The net effect is that a
larger share of earnings might be paid out as interest and
a smaller share might be retained or paid out as dividends.
Table 5 presents a hypothetical example to illustrate
the case in which local borrowing is increased after the
termination of deferral. For simplicity, a U.S. corporate
tax rate of 50 percent and a foreign corporate tax rate of
25 percent are assumed. Foreign earnings before interest
charges are kept constant throughout the analysis, implying
1/ Financial shifts of this type are included in Professor
Horst's model of investment decisions discussed in the
previous section.
Table ',
1/
The Effect, of Deferral on the Use of Local Debt by a Hypothetical Foreign Subsidiary
With U.S. Deferral
Some Local
All Equity
Debt
Finance
<2>
Without U.S. Deferral
Some Local
All Equity
Debt
Finance
Foreign Subsidiary 2/
1. Foreign earnings before interest charges
2. Interest paid locally
3. Foreign taxable income
4. Foreign corporate tax at 25 percent
5. U.S. corporate tax at 50 percent, after credit
6. Foreign income after all taxes
100
100
100
100
0
20
0
20
100
80
100
80
25
20
25
20
0
0
25
20
75
60
50
40
U.S. Parent
i
7. Domestic taxable income
200
2,30
200
230
8. U.S. corporate tax on domestic income at 50 percent
100
115
100
115
9. Domestic income after tax
100
115
100
115
10. Total income after tax
175
175
150
155
11. Total U.S. tax
100
115
125
135
Consolidated Results
Office of the Secretary of the Treasury
Office of Tax Analysis
February 4, 1976
1/ The following assumptions are made: (a) the foreign interest rate equals 10 percent; (b) the foreign debt
Ln cases (2) and (4) equals 200, and the addition to domestically owned assets also equals 200; (c) pre-ti:ax
earnings equal IS percent of domestically owned assets; (d) no actual distribution of dividends is made from
the subsidiary to the parent.
2/ The foreign subsidiary is 100 percent owned by the U.S. parent corporation.
u>
- 541/
the same real level of foreign activity.
fa
No dividends
are distributed from subsidiary to parent, and thus no
withholding taxes are paid.
The firm can choose between raising a certain amount
of debt abroad, limited to 200 in this example, or financing
the affiliate entirely with equity capital. If it raises
debt abroad, the parent can reduce its equity commitment
to the foreign affiliate and increase its use of equity
capital in the United States. The interest rate on foreign
debt is assumed to be 10 percent, while domestically owned
assets are assumed to earn 15 percent before tax. Domestic
assets thus earn a higher pre-tax return than the cost of
foreign debt. This is a crucial assumption; otherwise it
would not be sensible for the firm to incur the risk of
borrowing abroad.
Under present U.S. law, the firm would be indifferent
between borrowing abroad and financing the affiliate
entirely with equity. In both cases, its total after-tax
2/
income would be 175.
1/ In fact, foreign operations would probably contract in
face of the higher tax burden on foreign earnings.
2/ The tax authorities of the two countries are not, however,
indifferent to the means of finance. The substitution of
local debt for equity capital would reduce foreign corporate tax from 25 to 20 and increase U.S. corporate tax
from 100 to 115.
If deferral is terminated, the picture changes.
The
firm's total income after tax declines, and U.S. tax
collections rise. Equally important, the firm now has an
incentive to borrow abroad. Consolidated income after tax
is 150 with all equity financing and 155 with some local
debt. The hypothetical firm can increase its after-tax
income by redeploying some of its assets to the United
States. The process of redeployment would increase U. S.
tax from 125 to 135. The partial or complete termination
of deferral could place some foreign subsidiaries in the
position of this hypothetical firm. They might find it
advantageous to substitute local borrowing for parent firm
1/
equity.
It is difficult to estimate the potential importance
of tax-induced changes in means of finance. Many firms
may have already borrowed abroad as much as they realistically
can. Foreign debt has advantages, but it also has risks -in particular the risk of credit rationing with a change
in government policies abroad. Likewise, there may be
administrative and other limits on intrafirm debt.
Table 6 illustrates the extent of debt and equity
financing by foreign affiliates in 1972. New foreign debt
1/ A similar example could be devised to illustrate the
effect of substituting intrafirm debt for equity financing.
- 56 ^
Table 6
1/
Financing of Foreign Affiliates, 1972
(Percent of Total Funds)
: Petroleum : Manufacturing : Other
Source of funds:
1. Internal funds:
15.6
Retained earnings
2. External funds:
4.5
Equity capital:
0.1
U.S. owned 2/
Foreign owned
Debt capital!
U.S. owned:
24.2
intrafirm debt 2/
0.7
unrelated financial
institutions
1.9
Foreign owned:
53.0
related firms
unrelated financial
100.0
institutions
Total
Office of the Secretary of the Treasury
Office of Tax Analysis
Source:
45.1
23.8
5.5
3.4
4.1
3.9
5.0
5.9
2.8
5.0
1.8
20.1
36.4
37.2
100.0
100.0
February 4, 1976
U.S. Department of Commerce, Survey of Current Business
(July 1975).
Detail may not add to totals due to rounding.
1/ Estimates are based on a sample of majority-owned foreign
affiliates.
_
2/ The apportionment of funds between U.S. owned equity and
intra-firm debt was based on the ratio of net equity to total
net capital outflows for 1973 reported in U.S. Department of
Commerce, Survey of Current Business (October 1975), p. 47.
supplied a major part of available funds, ranging between
38 percent in the case of manufacturing affiliates to 57
percent in the case of other industries.
Intrafirm debt and
other debt from U.S. sources supplied between 8 and 25 percent of available funds.
New equity capital from the
United States only supplied between 4 and 6 percent, while
retained earnings supplied between 16 and 45 percent of available funds.
There appears to be little scope for the
substitution of fresh debt for fresh equity capital, but
fresh debt might, to a limited extent, replace retained
earnings.
7.
Revenue impact.
In general, revenue estimates are
made to indicate actual or potential U.S. tax collections
resulting from the existing tax structure or a change in
that structure.
The focus here is on changes in tax revenue
resulting from the partial or complete elimination of
deferral, or the selective expansion of subpart F.
Background
estimates are also given for present tax revenues attributable
to subpart F.
The Tax Reduction Act of 1975 substantially
extended the scope of subpart F, and correspondingly reduced
the scope of remaining revenue gains from the termination of
deferral.
These effects are reflected in the comparison
between estimates for 1974 and 1976 in Table 7.
Note that
the collateral tax changes enumerated in Table 1 which would
- 58 -
0
Table 7
Actual Revenue from Subpart F and
Potential Revenue from Termination of Deferral,
with Overall Limitation on Foreign Tax Credit
(Millions of dollars)
1974 Calendar
Year Tax
Liabilities
Changes Resulting
from the Tax Reduction Act of 1975
1976 Calendar
Year Tax
Liabilities 1/
Total actual and potential
revenue from current taxation
of CFC retained earnings
615
n.a.
615
Potential revenue from the
termination of deferral,
total 2/
590
-225
365
0
0
0
Mining
Petroleum and Refining
0
0
0
Manufacturing
577
-215
362
Other
13
-10
3
Actual revenue from subpart F,
total
25
225
250
Pre-1975 revenue
25
n.a.
25
225
225
Tax Reduction Act changes 3/
Office of the Secretary of the Treasury
Office of Tax Analysis
April 6, 1976
n.a. indicates not applicable.
1/ It is assumed that there was no change between 1974 and 1976 in corporate foreign
source income affected by deferral.
2/ These estimates assume: (i) dividends from less developed country corporations
are "grossed up" for purposes of calculating the tentative U.S. tax and the
foreign tax credit; (ii) foreign subsidiary losses are fully offset against
foreign subsidiary profits; (iii) all firms use the overall limitation in
calculating the foreign tax credit; (iv) no behavioral change.
3/ The Tax Reduction Act changes were: (i) eliminate minimum distribution ($100
million); (ii) eliminate the less developed country corporation exception
($15 million); (iii) change the 30-70 rule to a 10-70 rule ($75 million);
(iv) repeal the shipping exclusion ($35 million).
- 59 -
J%7
move the United States closer to a system of capital-export
neutrality are not shown in Table 7. Instead, Table 7 focuses
on the taxation of undistributed earnings viewed in isolation.
The estimates of possible revenue gains from the further
termination of deferral are influenced both by the policy
option chosen and by possible behavioral changes.
(a) Policy options. The revenue estimates obviously
depend on three important policy choices: (i) the extent
to which deferral is eliminated or subpart F is extended;
(ii) whether the overall or the per-country limitation is
applied to the foreign tax credit; (iii) the extent to which
foreign subsidiary losses are permitted as an offset against
foreign subsidiary profits. The policy options are spelled
out in Part IV. Tables 8 and 9 present revenue estimates
for the alternative policies. The revenue estimates are
based on the standard assumption of no behavioral change,
discussed below.
Certain important features should be noted. The great
majority of firms elect the overall limitation in calculating
the foreign tax credit. Under the Tax Reduction Act of 1975,
petroleum firms are required to use the overall limitation
for foreign oil related income in taxable years ending after
December 31, 1975. The Tax Reform Act of 1975, H.R 10612,
enacted by the House and now under Senate consideration,
Table 8
1/
Revenue Changes from Alternative Proposals to End Deferral
(Millions of Dollars)
Required Percentage
Distribution 2/
100
75
50
1976 Calendar Year Tax Liabilities ±1
Earnings and Profits Plus
Earnings and Profits
Branch and Royalty Income
Overall
Per-Country
Overall
: Per-country
Limitation 4_/
Limitation
Limitation
Limitation 4/
$
3 65
215
55
Office of the Secretary of the Treasury
Office of Tax Analysis
$ 630
385
150
$ 365
150
10
$
630
250
50
February 3, 1976
1/ The estimates assume: (i) dividends from less developed country corporations are "grossed
up" for purposes of calculating the tentative U.S. tax and the foreign tax credit; (ii)
CFC profits and losses are consolidated on the same basis as the foreign tax credit limitation
r hat; is, either on an overall or a per country basis; (iii) no behavioral change, in
particular the current dividend distribution rate is maintained.
2/ With a 100 percent required distribution, deferral is totally ended. With a 75 percent
or 50 percent inquired distribution, U.S. parent corporations would be deemed to have
received the differences between 75 percent or 50 percent of income (defined either as
earnings and profits or as earnings and profits plus branch and royalty income) and the
amount actually received
(either dividends or dividends plus branch and royalty income).
3/ These figures represent additions to 1976 revenues collected under subpart F ($250 million).
4/ These estimates assume that the per-country limitation is already in place, and that
~
deferral is then ended. The revenue changes refer only to the additional impact of
eliminating deferral.
ON
o
- 61 -
^ .
Table 9
Termination of Deferral with Alternative
Consolidation Requirements and with Current
Dividend Distribution Rate 1/
(Millions of Dollars)
: 1976 Calendar Year
: Tax Liabilities 2/
Overall limitation on foreign tax credit
Worldwide consolidation of CFCs 365
No consolidation of CFCs 1,100
3/
Per-country limitation on foreign tax credit —'
Country consolidation of CFCs 630
No consolidation of CFCs 1,300
Office of the Secretary of the Treasury April 6~j 1976
Office of Tax Analysis
1/ These estimates are variants of the estimates in Table 5. The
estimates assume: (i) dividends from less developed country
corporations are "grossed up"; (ii) no behavioral change, in
particular, the present dividend distribution rate is maintained
2/ These figures represent additions to the 1976 revenue collected
under subpart F ($250 million).
3/ These estimates assume that the per-country limitation is
already in place, and that deferral is then ended. The
revenue changes refer only to the additional impact of
eliminating deferral.
- 62 would extend compulsory use of the overall limitation to all
1/
firms.
The overall limitation permits extensive tax
averaging between income from high-tax and low-tax
jurisdictions. Thus, the elimination of deferral coupled
with the overall limitation produces less revenue than the
elimination of deferral coupled with the per-country
limitation.
If losses are not allowed as an offset against profits
as between related subsidiaries, the revenue estimate becomes
very much larger. This reflects the substantial losses
experienced by foreign subsidiaries. Contrary to popular
belief, it is not true that the bulk of foreign losses are
concentrated in foreign branches. Rough estimates for 1975
indicate that foreign subsidiaries experienced losses of $2.2
billion while foreign branches had losses of $0.3 billion.
(b) Behavioral change. Revenue estimates are usually
based on a standard assumption of no behavioral change.
The standard assumption is useful in two respects: first, it
1/ The reason for compulsory use of the overall limitation is
to prevent U.S. corporations from offsetting foreign branch
losses incurred in some countries against U.S. source
income, while claiming a foreign tax credit on foreign
source income earned in other countries. However,
transition rules would permit continued use of the percountry limitation for selected hard mineral firms.
Puerto Rico and the U.S. possessions are not included
in the compulsory overall limitation rule.
- 63 -
J/J2,
is helpful to know the initial impact of a tax measure before
adjustment occurs; second, the nature, extent and speed of
behavioral changes are not easily forecast.* Yet behavioral
changes usually accompany any important tax measure. In the
international tax area, not only will multinational firms
adjust their dividend distribution rates, investment decisions,
and financing policies in response to U.S: tax legislation,
but also foreign governments may modify, their own. tax rules.
(i) Foreign subsidiaries might increase their dividend
distributions in order to ensure and accelerate recognition
of the foreign tax credit for dividend withholding taxes.
(ii) The extent of investment in foreign subsidiaries
might be curtailed. At the same time,/U.S. parent firms
might increase their investment in the United States. The
financing of foreign subsidiaries might be modified to reduce
reliance on intrafirm equity, and increase reliance on
intrafirm debt, and more importantly, external debt.
(iii) U.S. parent firms might place greater stress on
minority participation in new ventures and they might
attempt to "decontrol" some existing CFCs. -(iv) Foreign governments might selectively increase
their own taxation of U.S. controlled foreign corporations.
Each of these reactions would affect the revenue
implications of terminating deterral. Some would increase
- 64 U.S. revenue; others would decrease U.S. revenue.
The follow-
ing paragraphs summarize the possible revenue consequences
of these behavioral changes.
(i) Change in distribution rates.
U.S. foreign subsidi-
ries typically distribute approximately 45 percent of their
after-foreign-tax earnings.
The revenue estimates in
Table 7, 8, and 9 are based on this distribution rate. By
contrast, Table 10 shows the revenue effect of increasing the
distribution rate to 100 percent of foreign after-tax earnings.
U.S. revenue gains would be substantially or completely
eroded because foreign withholding taxes creditable under
1/
section 901 would be larger.
In fact, if the termination
of deferral induced a 100 percent distribution rate, with an
overall limitation on the foreign tax credit and worldwide
consolidation of foreign subsidiary income, the U. S. revenue
loss would be $375 million.
Under a per-country limitation,
the revenue loss would be $105 million. The revenue losses
are calculated by reference to tax otherwise collected under
subpart F, as expanded by the Tax Reduction Act of 1975. The
reason for these revenue losses is that additional foreign
withholding taxes would be credited against existing U.S.
1/ The same revenue effects would result if foreign governments imposed withholding taxes on deemed distributions
of foreign affiliates.
J/?
Table 10
Revenue Effect of 100 Percent Dividend Distribution Rate
(Millions of Dollars)
1976 Calendar Year Tax Liabilities
Overall
: Per-Country
Limitation : Limitation £/
Total actual and potential
revenue from current taxation
of CFC earnings
-125 ,
Potential revenue from
100 percent dividend
distribution rate 1/
-375
-105
_5
5
Mining
Petroleum and Refining
' ;'! '• .
145
115
-240
Manufacturing
315*
Other
-55
15
Actual revenue from subpart F,
total
250
250
Pre-1975 revenue 25 25
Tax Reduction Act changes 225 225
office of the Secretary of the Treasury February 3, 1976
Office of Tax Analysis
1/ The estimates assume: (i) dividends * from less developed
country corporations are "grossed up" for purposes of
calculating the tentative U.S. tax and"the foreign tax
credit; (ii) CFC profits and losses are pooled on the
same basis as the foreign tax credit limitation; (iii) no
behavioral change, except that all CFCs increase their
actual dividend distribution rates to 100 percent.
2/ These estimates assume that the per-country limitation is
already in place, and that deferral is then ended. The
revenue changes refer only to the additional impact of
eliminating deferral.
- 66 -
$)j
taxes collected both on subpart F income and on foreign source
interest, rents, royalties, fees, and branch income.
The revenue losses would be more than proportional to
any increase in dividend distributions from the current rate
of about 45 percent to the hypothetical rate of 100 percent.
Most of the loss would occur with the first increments in
the overall dividend distribution rate, since additional
dividends would presumably be distributed first from CFCs
paying the highest foreign taxes.
(ii) Foreign vs. domestic investment.
Tables 11 and 12
present rough and conflicting estimates of the revenue
consequences of changes in investment behavior resulting
from the termination of deferral.
The revenue estimates in
Table 11 are based on Professor Horstfs model which attempts
to measure the investment and financial position of a multinational firm after it has fully adjusted to the termination of
deferral.
The model, described in section 5, assumes that
the firm can to some extent choose between foreign and
domestic investment, and between alternative means of
financing its assets.
The estimates in Table 11 are made from two starting
points: the current dividend distribution rate and a 100
percent dividend distribution rate.
The dividend distribution
rate affects both the division of revenue changes between the
Tcrniln;it Ion of Deferral with Assumed
Changes
in Investment
Location and Means of Finance
(Millions of Dollars)
1976 Calendar Year Tax Liability
Current Dividend
:
100% Dividend
Distribution Rate
:
Distribution Rate
Total actual and potential IJ. S. revenue from current
taxation oi CFC earnings, with specified investment
>i\\d financing changes ]_/
1,000
260
Actual revenue Irom subpart F, total
250
250
Potential revenue from termination of deferral with
no investment or financing changes
365
-375
Potential revenue from possible changes in investment
and financing: 2/
(1) Effects on foreign source income—
(a) Decrease in CFC earnings
(b) Decrease in royalties, fees, and interest
repatriated to the United States
(2) Effects on domestic source income —
(a) Increase in domestic investment
(b) Increase in use of equity capital in the
United States and increase in use of
external debt abroad
Change in foreign revenue from corporate
income and dividend withholding taxes 3/
(1) Effect of 100 percent dividend distribution
rate on dividend withholding taxes
(2) Effect of reduced size and increased use of
external debt by CFCs on corporate income tax
and withholding tax
385
385
-15
-15
-10
-10
90
90
320
320
-210
630
o>
Addenda:
Office of the Secretary of the Treasury
Oft ice of Tax Analysis
1/
2/
840
-210
-210
February 4, 1976
The estimates assume: (i) dividends from less developed countries are "grossed up" for purposes of
calculating the tentative U.S. tax and the foreign tax credit; (ii) worldwide pooling of CFC profits
and losses, and an overall limitation on the foreign tax credit; (iii) specified behavioral changes in
dividend distribution rates, investment and financing. The detail underlying these figures appear in
Tables 7 and 10.
The estimates represent the revenue impact after full adjustments to the current taxation of CFC earnings,
including adjustments to the Tax Reduction Act of 1975. The adjustments would, in fact, take several
years.
The estimates are adapted from a model developed by Thomas Horst, "American Multinational and
the U.S. Economy," Fletcher School of Law and Diplomacy, November 1975.
3/ The estimates assumes no change tn foreign tax laws.
^
^
Table 12
Termination of Deferral with Assumed Adverse Impact on
Competitive Position of U.S. CFCs
(Millions of Dollars)
Calendar Year Tax Liabilities
1976
;
I9BI
Estimated U.S. revenue from corporate
taxation of all foreign source income
with termination of deferral 1/
Estimated U.S. revenue from corporate
taxation of all foreign source income
under current law 2/
Estimated change in U.S. revenue with
termination of deferral
Office of the Secretary of the Treasury
Office of Tax Analysis
2,610
3,200
2,245
3,600
365
-400
April 6, 1976
CO
1/ The 1976 figure is based on estimated 1976 revenues plus the potential revenue
from complete termination of deferral. The 1981 figure is adapted from a model
developed by Robert B. Stobaugh, f,The U.S. Economy and the Proposed U.S. Income
Tax on Unremitted Foreign Earnings of U.S. Controlled Foreign Manufacturing
Operations Abroad," Harvard Business School, 1975.
2/ The 1976 figure reflects the Tax Reduction Act of 1975. The 1981 figure assumes
an annual growth rate of 10 percent in the foreign source of U.S. corporations.
V^
^
- 69 United States and foreign governments, and the total amount
of these changes.
The potential U.S. revenue gain from changes in the
location of investment and the means of finance, after all
adjustments have taken place, is very roughly estimated at
$385 million whether the dividend distribution rate remains
at current levels or increases to 100 percent.
The figure
of $385 million reflects a revenue loss of about $25 million
from smaller CFC earnings and reduced intrafirm payments of
interest, rents, royalties, and management fees, and a revenue
gain of about $410 million from larger U.S. corporate investment and a shift in the means of finance. Foreign subsidiaries
would rely to a greater extent on local debt finance, while
U.S. parent corporations would use more equity capital.
These calculations do not take into account possible
attempts by foreign governments to offset the shift of
investment location and means of finance through modification
of their own tax laws.
Under current dividend distribution rates, the model
suggests that firms would pay an additional $750 million
in U.S. taxes while they would pay $210 million less in
foreign taxes.
The net increase in corporate tax payments
at home and abroad would thus be $540 million.
Under a
100 percent dividend distribution rate, the model suggests
- 70 -
j/j
that firms would pay an additional $10 million in U.S.
taxes and an additional $630 million in foreign taxes. The
net increase in corporate tax payments at home and abroad
would be $640 million under this assumption.
The revenue estimates in Table 12 are based on
Professor Stobaugh's model which attempts to measure the
long-term consequences of placing U.S. controlled foreign
corporations at a competitive disadvantage through the
termination of deferral. Again, these calculations do
not take into account possible offsetting measures by
foreign governments.
The Stobaugh model assumes that higher U.S. taxes on
CFCs will, after a period of time, cause a cumulative
contraction in their market share, profitability, and the
remittance of interest, royalties, and management fees to
the U.S. parent corporations. Moreover, CFCs will find it
advantageous to distribute a larger share of earnings and
rely more heavily on debt finance." The predicted result
is a cumulative reduction in U.S. taxes not only on the
foreign earnings of CFCs but also on the associated types of
foreign income paid to U.S. parent firms. In 1981, five years
1/ Both the Horst and Stobaugh models envisage a larger role
for debt finance if deferral is terminated.
- 71 after the termination of deferral, the model estimates
that U.S. taxes on all foreign source income would be
$400 million less than under present law. In succeeding
years, the adverse revenue impact would be even larger.
(iii) Minority participation and "decontrol11. If
deferral is terminated, some multinational firms might seek
to minimize the impact of current U.S. taxation either by
undertaking new foreign investments through minority ownership in joint venture arrangements or by "decontrolling"
some of their existing CFCs. Either way, the retained earnings
of the foreign corporation would not be subject to current
U.S. taxation. However, decontrol of an existing CFC could
entail substantial U.S. taxes on accumulated earnings and
profits. Moreover, even if decontrol in the tax sense does
not involve the total loss of control, it at least inhibits
managerial flexibility, and makes international business
decisions more difficult. A new minority ownership arrangement raises similar problems.
While the difficulties associated with decontrol and
minority ownership arrangements cannot be quantified, a
useful perspective may be gained by comparing the total tax
burden on U.S. multinational corporations with and without
deferral. In 1976, total U.S. and foreign taxes on foreign
source corporate income, other than income earned by the
petroleum sector, will be approximately $12.3 billion. The
complete termination of deferral might increase the tax
1/
burden by as much as $0.6 billion, or by 5 percent.
Because this figure is relatively modest, and because the
tax costs alone of reorganization are substantial, it seems
unlikely that many multinational firms would reorganize
their corporate structure as a means of avoiding current
2/
U.S. taxation.
Table 13 gives the estimated structure of foreign
affiliate earnings classified by the percentage of U.S.
ownership in the affiliate. -Only 5.2 percent of profits
were earned by foreign affiliates owned less than 50 percent
by U.S. parent corporations. Even if this percentage doubled
or tripled, and the growth were concentrated in low-tax
countries, the tax avoidance would be modest. If deferral
was terminated, and if the proportion of earnings accounted
for by non-CFC foreign affiliates subsequently increased
to 10 percent, the revenue gain would be reduced by $50 million;
at 15 percent, the reduction in revenue gain would be $100
million (Table 14).
1/ This figure, from Table 7, assumes an overall limitation
on the foreign tax credit and includes subpart F revenue.
2/ J.L. Kramer and G.C. Hufbauer, "Higher U.S. Taxation
Could Prompt Changes in Multinational Corporate Structure,"
International Tax Journal, Summer 1975.
- 73 -
jfe2
Table 13
Net Earnings by Extent of
U.S. Ownership in Foreign Affiliates
(Millions of Dollars or Percent)
U.S.
ownership
percentage
1975
:
net
earnings 1/
Percent of
net
earnings
BY AREA
All Areas
17,495
100.0
95-1007.
50-94%
25-497.
10-247.
1-9%
14,290
2,290
584
285
46
81.7
13.1
3.3
1.6
0.3
Canada
2,846
100.0
95-1007.
50-94%
25-49%
10-24%
1-9%
1,904
781
93
44
21
66.9
27.5
3.3
1.6
0.7
Western
Europe
5,957
95-100%
50-94%
25-49%
10-24%
1-9%
4,742
815
176
205
11
79.6
13.7
3.0
3.4
0.2
Latin America
and other
Western Hemisphere
2,628
100.0
95-100%
50-94%
25-49%
10-24%
1-9%
2,387
185
43
9
4
90.8
7.0
1.7
0.4
0.1
. - 74 Table 13 - continued
U.S.
ownership
percentage
Africa, Asia
and Australia
""
-1973
net
earnings 1/
6,065
5,109
514
321
109
7
BY INDUSTRY
95-100%
50-94%
25-49%
10-24%
1-9%
Percent ot
net
earnings
100.0
84.2
8.5
5.3
1.8
0.1
Petroleum
6,183
100.0
95-100%
50-94%
25-49%
10-24%
1-9%
Manufacturing
5,475
560
92
29
26
7,286
88.6
9.1
1.5
0.5
0.4
100.0
95-100%
50-94%
25-49%
10-24%
1-9%
All other industries
5,668
1,138
300
160
19
4,026
77.8
15.6
4.1
2.2
0.3
100.0
95-100%
50-94%
25-49%
10-24%
1-9%
3,145
592
192
26
1
78.1
14.7
4.8
2.4
0.0
Office of the Secretary of the Treasury
Office of Tax Analysis
Source
April 6, 1976
Based on Table B-10 of the Preliminary Draft of
U.S. Direct Investments Abroad 1966 Part Ients Data (U. S. Department of
Balance of Pa^iyme
Commerce, 197u;, pp $3^84; and Table 9 of
J. Freidlin and L.A. Lupo, "U.S. Direct
Investment Abroad in 1973," Survey of Current
Business, (August 1974), Pt. II, pp 16-17.—
1/ Net earnings are after-foreign tax. Foreign affiliates
.include foreign branches, counted as 100 percent owned
by the U.S. parent corporation.
Table 14
Estimated Revenue from Subpart F and Termination of
Deferral with Increase of Non-CFC Earnings
1976 Calendar Year Tax Liability
5% of Earnings : 10% of Earnings : 15% of Earnings
in non-CFCs
: in non-CFCs
: in non-CFCs
Total actual and potential revenue
from current taxation of CFC retained earnings
Actual revenue from subpart F,
total
615
565
515
250
250
250
Potential revenue from termination
of deferral, total 1/
365
365
365
-50
-100
Change in revenue from new minority
participation or decontrol of CFCs 2/
Office of the Secretary of the Treasury
Office of Tax Analysis
February 4, 1976
1/ These estimates assume: (i) dividends from less developed country corporations are
"~ "grossed up" for purposes of calculating the tentative U.S. tax and the foreign tax
credit; (ii) foreign subsidiary losses are fully offset against foreign subsidiary
profits and all firms use the overall limitation in calculating the foreign tax
credit; (iii) no behavioral change other than the specified changes in non-CFC earnings.
2/ Assumes that incremental non-CFC earnings are taxed by the foreign government at a
20 percent rate, including withholding taxes. Non-CFC earnings are defined as the
earnings of those foreign affiliates which are owned less than 50 percent by"U.S.
shareholders."
- 76 The potential revenue loss could be a greater problem
if foreign affiliates owned exactly 50 percent by "U.S.
shareholders" generally escape classification as CFCs.
Under the Garlock and Kraus decisions, U.S. ownership of
exactly 50 percent of a foreign affiliate, coupled with
actual U.S. control of the affiliate, will meet the test
of subpart F.
(iv)
Higher foreign taxes.
If deferral were terminated,
foreign governments could selectively increase the tax
burden on U.S. controlled foreign corporations in situations
where the general foreign tax rate is lower than the U.S.
tax rate.
Alternatively, they could raise withholding
tax rates and treat deemed dividend distributions as actual
dividend distributions for withholding tax purposes.
Such
changes in foreign tax practices would take time, and would
probably not occur as an immediate response to the termination
of deferral, but the long-term result of such changes would
be lower U.S. tax collections and higher foreign tax
collections.
The revenue outcome would be similar to the
estimates presented in Table 10 for a 100 percent distribution
- 77 -
rate.
U.S. taxes collected on the retained earnings of
foreign subsidiaries would be diminished as a result of
higher foreign taxes.
8. Summary of the analysis. Before turning to the
policy options, it might be useful to restate the major
issues and findings. The debate surrounding deferral has
often lacked a clear definition of objectives. The
termination of deferral has been urged at different
times by different groups seeking at least five different
objectives.
(a) To improve tax neutrality;
(b) To eliminate tax avoidance;
(c) To simplify the tax law;
(d) To discourage foreign investment;
(e) To increase U.S. tax revenues.
These different objectives can lead to conflicting policies.
(a) Tax neutrality. The termination of deferral would,
of course, be diametrically opposed to the principles of
capital-import neutrality. However, current taxation of
retained CFC earnings is urged as a step not toward capitalimport neutrality, but rather as a step toward capitalexport neutrality. But the termination of deferral, would
not by itself advance the standard of capital-export
neutrality. With the end of deferral, the U.S. tax system
would on the whole favor domestic investment even more than
- 78 it does now.
Collateral changes would be required in the
investment tax credit, the accelerated depreciation range,
DISC, and other tax practices in order to approach capitalexport neutrality.
(b) Tax avoidance.
In the context of foreign corporate
investment, tax avoidance is sometimes very broadly defined
to occur whenever the realized foreign tax rate is less than
the statutory U.S. rate of 48 percent.
If this broad
definition is accepted, then the termination of deferral
would eliminate virtually all cases of tax avoidance.
However, tax avoidance is often defined more narrowly,
either with reference to realized U.S. tax rates or with
reference to artificial corporate structures and business
arrangements.
When tax avoidance is defined with reference to
realized U.S. tax rates, then its extent is much less
significant.
The investment tax credit, asset depreciation
range, DISC, and other domestic tax preferences all serve to
reduce the realized U.S. corporate tax rate on domestic
income which, in 1974, was about 41 percent. 1/
However, the
termination of deferral would generally subject CFC income
to a tax of 48 percent.
Tax avoidance would be more than
offset, and in fact, foreign corporate income would generally
be taxed at a higher rate than domestic corporate income.
T7 The figure of 41 percent does not reflect the base
broadening measures contemplated in Table 1.
- 79 -
^ ^
When tax avoidance is defined with reference to artificial
corporate structures and business arrangements, then the
appropriate solution might involve an extension and strengthing of subpart F rather than the general termination of
deferral. 1/
(c) Tax simplification. It has been argued that the
termination of deferral would lead to the simplification of
tax law and administration. Subpart F could be repealed,
since all CFC income would be taxed currently. Moreover, there
would be somewhat less pressure on arm's-length pricing rules
(Section 482), on the non-recognition provisions involving
transfers of capital, technology, and other property to foreign
corporations (Sections 351 and 367), and on reorganizations
involving foreign corporations (Section 367).
However, the partial termination of deferral would introduce numerous new complications into the tax code. These complications include the determination of a minimum percentage
distribution and the allocation of a deemed distribution
between CFCs (in the case of partial termination) , the measurement
of a subsidiary earnings and profits and taxable income according
to U.S. accounting standards, the extent of consolidation of
CFCs, and rules to deal with attempted avoidance through decontrol
These complications are discussed in Section 3 of part IV.
(d) Investment and financial impact. Based on one
economic model, it has been calculated that the termination of
y
It should be noted that the overall limitation, which
permits an averaging of taxes imposed by high-tax and lowthL C ?eferra^ " " ^ " ^
m
°re
potential
for
tax
avoidance
- 80 deferral might, over a period of time, cause U.S. corporations
to reduce their foreign assets by as much as $3.4 billion,
and increase their domestic assets by $2.2 billion (Table 4).
These estimates depend on numerous assumptions, and may
represent extreme statements of the investment impact. Other
models suggest that U.S. corporations would reduce both their
U.S. and foreign investment as a result of the termination of
deferral. In general, the estimates do not reflect the
possibility of adverse foreign reaction.
In addition to its impact on real investment, the
termination of deferral might encourage firms to change their
means of finance. Some firms might find it advantageous to
substitute borrowing for parent firm equity. The extent of
such substitution would depend on a variety of considerations,
including tax rules adopted by host countries.
(e) U.S. tax revenue. The effect of terminating deferral
on U.S. revenue depends on several factors. Under the standard
assumption of no change in corporate or foreign government
behavior, the revenue gain could be $365 million (Table 7).
Other assumptions suggest lower revenue gains, or even revenue
losses. For example, under the assumptions that all CFC
earnings would be actually distributed following the termination
of deferral, the U.S. loss could be $375 million (Table 10).
- 81 IV.
OPTICNS
Legislative options on deferral can be grouped into
four broad categories: (1) retain the present system;
(2) broaden subpart F to include more types of income;
(3) partly or completely terminate deferral by requiring
that deemed and actual distributions equal some portion of
all of CFC earnings; and (4) terminate deferral in the
context of repealing domestic tax preferences.
Option (3)
involves secondary questions as to the extent of
consolidation between subsidiaries, and the choice of a
per-country or an overall limitation on the foreign tax
credit.
!•
Retain present system.
It can be argued that no
further legislation is needed on the deferral issue.
The
Tax Reduction Act of 1975 substantially extended subpart F,
and as a result the principal areas of tax abuse have been
closed off.
Further legislative restrictions could prove
counterproductive by accelerating actual distributions,
triggering legislative reactions abroad, reducing the
profitability and growth of American firms, adding
complexity to the Internal Revenue Code and placing
administrative demands on the Internal Revenue Service.
Moreover, while the present tax system favors foreign
- 82 investment in some cases, it favors domestic investment in
many other cases.
2. Broaden subpart F. Subpart F could be broadened
in several respects, consistent with its objective of reaching foreign income with tax abuse characteristics.
(a) The substantial reduction test. Under section 954
(b)(4), a CFC that does not have as one of its significant
purposes a substantial reduction of taxes is generally
excluded from subpart F.— This exemption underscores the
anti-tax avoidance purpose of the statute, but it has been
drafted in a manner that limits the application of subpart
F. The test is basically whether* the effective tax rate
paid by the foreign corporation equals or exceeds 90 percent,
or is not less than 5 percentage points lower than, the
effective foreign tax rate that would have been paid if
the income had not passed through a foreign base company
(Regulations 1.954-3(b)(4), example (1)). Certain foreign
countries impose low rates of tax, while others exclude
certain kinds of income from taxation altogether. Therefore, the CFC can meet the 90 percent or the 5 percentage
point test, yet still be paying far less than the U. S. corporate tax rate of 48 percent. Moreover, the test poses
substantial administrative difficulties, because it requires
1/ Particular items of income may still be taxed under subpart F if the transaction was structured to avoid taxes.
- 83 -
J7371
the Internal Revenue Service agent to have an intimate
knowledge of third country tax laws.
This difficulty could be eliminated in the context of
subpart F by recasting the "substantial reduction" test to
refer not to alternative foreign tax rates, but to the U. S.
corporate tax rate. If the present "substantial reduction"
test obstructs the revenue gains projected under subpart F
as expanded by the Tax Reduction Act of 1975, then very large
amounts of revenue could depend on an appropriate modification,
perhaps as much as $100 million. However, this amount is
not additional to, but rather a part of, the revenue collections already estimated for subpart F.
(b) 50 percent subsidiaries. The present language of
subpart F appears to exclude foreign corporations that are
owned exactly 50 percent by U, S. shareholders. However, the
Tax Courts have found that 50 percent ownership, combined
with actual control, will suffice for subpart F purposes.
The statute could be strengthened to include foreign subsidiaries owned 50 percent by U. S. shareholders, with a
rebuttable presumption of actual control. The revenue consequences of this change are estimated at less than $5
million.
(c) Shipping income. The Tax Reduction Act of 1975
included international shipping income under subpart F, to the
extent it is not reinvested in shipping operations. However,
- 84 -
j &
the earnings of most shipping companies are likely to come
within the reinvestment exclusion. Subpart F could be broadened
to include all shipping income, whether or not reinvested.
Such a provision should be related to other changes in the
taxation of shipping income discussed in the Treasury Paper on
the "Tax Treatment of Income from International Shipping,"
February 1976. The potential revenue gains are estimated at
$70 million.
(d) "Runaway plants" and tax holiday manufacturing. In
1973, the Treasury proposed that tax haven manufacturing corporations, defined to include "runaway plants" and tax holiday operations, should be taxed currently under provisions
similar to subpart F.
A runaway plant would be defined as new investment in a
controlled foreign corporation which realized more than 25
percent of its gross receipts from the manufacture and sale
of products to the United States, and paid a foreign effective
tax rate of less than 80 percent of the U. S. corporate tax
rate. A tax holiday manufacturing corporation would be defined
as any controlled foreign corporation which increased its
investment in excess of 20 percent during or in anticipation
of a foreign tax incentive. Foreign tax incentives would be
broadly defined under regulations prescribed by the Secretary
of the Treasury. The tax haven manufacturing proposal would
increase revenue by about $25 million.
- 85 -
&
(3) Simplification. Although subpart F was based on
the earlier foreign personal holding company statute, no
effort was made to combine the two pieces of legislation or
enact identical statutory tests to define the controlling
group or constructive ownership.
As a result, there is some
overlap between the two statutes, and a foreign personal holding company may also be subject to subpart F.
A foreign per-
sonal holding company can. also be a personal holding company,
with a penalty tax imposed both on the company and on the shareholder.
These statutes could be simplified by taxing foreign
personal holding companies within the framework of subpart
F, and by establishing a mutually exclusive boundary between
personal holding companies and foreign personal holding companies.
Simplification and rationalization of the law would
probably not provoke an adverse foreign reaction.
The revenue
effect would be minimal.
3.
Partial or complete termination of deferral.
Some
observers contend that the separate entity system of taxing
foreign corporations reduces U. S. tax revenue and encourages
foreign investment at the expense of domestic investment.
These observers argue that the remedy lies in the partial
or complete termination of deferral.
Other observers point out that the termination of
deferral might produce only short-run revenue gains, and that,
y
- 86 as an isolated step, it would move the United States further
away from a system of capital-export neutrality.
Moreover,
adverse foreign reaction could be intense, especially from
countries such as Israel, Egypt, and Ireland which promote
industrial development through tax relief.
The complete termination of deferral would clearly
replace subpart F, but the partial termination of deferral
would not serve the same function, since subpart F provides
for current taxation of all CFC income in selected situations.
Partial termination legislation would need to be carefully
coordinated with existing subpart F to avoid overlapping
coverage that could cause very severe administrative problems
for taxpayers and the Internal Revenue Service.
In any
event, partial termination would require very complex legislation.
The revenue estimates for the complete termination of
deferral under the standard assumption of no behavioral
changes range from $365 million to $630 million depending on
whether an overall or per-country limitation is used for the
foreign tax credit.
If allowance is made for behavioral
change, the revenue gains would be less, and there might
even be a revenue loss of up to $375 million from the termination of deferral.
The partial termination of deferral
would involve both smaller revenue gains (under the standard
assumption) and smaller revenue losses (under the worst case
assumption).
- 87 The partial or complete termination of deferral involves
several choices as to coverage and mechanics. The important
choices are outlined in the following paragraphs.
(a) Required minimum percentage distribution. The partial
termination of deferral would involve a percentage test for
the distribution of earnings and profits. To the extent actual
distributions do not meet the minimum percentage, earnings
would be distributed on a deemed basis. The percentage could
be based on after-tax earnings and profits, or on after-tax
earnings and profits plus other categories of foreign source
income, such as interest, royalties, management fees and branch
earnings. The broader the base amount, the easier it is to
meet the test, as illustrated by Table 8.
(b) Allocation of the deemed distribution between CFCs.
The partial termination of deferral would also involve allocation
of the deemed distribution between CFCs. This allocation is
both to trace the foreign tax credit associated with each deemed
distribution and to maintain an inventory of deemed distributions
for each CFC. The allocation could be made on a pro rata basis
with respect to the undistributed earnings of all CFCs, or the
allocation could be made only with respect to the CFCs not meeting
the minimum percentage. The allocation rule should be consistent
with the consolidation rule.
(e) The extent of consolidation. In the case of partial
termination, the question arises whether the minimum percentage
applies to each CFC individually, or to a U.S. parent corporation1
CFCs grouped on a country, on a worldwide, or on some other basis
n
the case of complete termination, the extent of
consolidation's, also important. The wider
- 88 the grouping, the smaller the revenue impact of any given
percentage test, as shown in Table 8.
reflects two phenomena:
This relationship
first, some CFCs have losses, and
these losses increase the apprent distribution rate of profitable CFCs; second, CFCs with high foreign taxes already
tend to distribute a larger percentage of earnings than
CFCs with low foreign taxes, and if high-tax CFCs are consolidated with low-tax CFCs, the average creditable foreign
tax is increased.
There are several possible consolidation
alternatives.
(i) Individual foreign corporation approach.
This
approach would employ the present subpart F mechanism of computing the income to be deemed distributed separately for
each foreign corporation.
There would be no consolidation of
foreign corporations either with other foreign corporations
owned by the same U. S. parent, or with the U. S. parent itself.
Losses and blocked currency already create problems under
this system, and these problems would become more important
if deferral were eliminated.
Under the individual foreign
corporation approach, there are two methods for computing
the amount of income of a lower-tier subsidiary which is
included in the income of the U.S. shareholders:
the so-
called "hopscotch" method; and the so-called "link-by-link"
method.
- 89 (aa) Hop-scotch method. This is the mechanism by which
subpart F presently attributes the income of a lower-tier
CFC to its shareholders. Under this method, the income is
attributed directly to the U. S. shareholders, and cannot be
offset by any loss incurred by intermediate foreign corporations. Under this method there are problems concerning the
source country of a deemed distribution. In addition, if
the intermediate corporation is in a country which restricts
the repatriation of earnings, there can be blocked currency
problems.
Compulsory adoption of the overall limitation for the
foreign tax credit (as proposed in H.R 10612) would render
1/
almost moot the source problem.
However, if the percountry limitation is retained, it would be necessary to establish a source rule for the deemed dividend. Under present law,
actual dividends are sourced in the country of incorporation of
the subsidiary paying the dividend to the U. S. shareholder.
Thus, if lower-tier CFC A distributes dividends to higher-tier
CFC B, which is turn distributes dividends to the U. S. parent
corporation, the dividends are sourced in country B. The
rule more in keeping with the intent of the per-country
limitiation would require that dividends be sourced in the
country of incorporation of the lower-tier subsidiary which
earns the income.
1/ A problem could still arise for a CFC with U. S. source income.
- 90 Blocked currency creates a problem under subpart F, and
the problem would continue if the hop-scotch method were used
more widely.
The problem here is the effect on the lower-
tier corporation if the intermediate corporation's country
of residence restricts distributions so that the lower-tier
corporation cannot distribute up the chain of ownership.
Thus, the U. S. shareholder might be taxed on income which he
could never realize.
One solution is to apply the present
blocked currency rules as if the country of incorporation of
the lower-tier subsidiary restricts the repatriation.
(bb) Link-by-link method.
The link-by-link method was
considered by the Treasury in 1962.
It was rejected partly
because its complexity was not justified in light of the
limited goals of subpart F as then enacted.
The question
now is whether the complete or partial termination of deferral
with its impact on all foreign corporations controlled by
U. S. persons, would justify reconsideration of the link-bylink approach.
Under the link-by-link method, the retained earnings
of a lower-tier subsidiary would be constructively distributed up the chain of ownership.
The profits of a lower-
tier subsidiary would thus offset the losses of a higher-tier
subsidiary in the same chain.
However, there would be no
offset of losses in the lower-tier by profits in the highertier, nor would there be offsets as between different chains
of CFCs owned by the same U. S. parent.
- 91 -
^3/
If the per-country limitation of the foreign tax credit
is retained and the present income source rules are not changed,
the source of the deemed distribution would be the country
of incorporation of the first-tier corporation.
Again,
this result circumvents the purpose of retaining the percountry limitation, and suggests a reconsideration of the
source rules.
If the link-by-link approach is adopted, the computation of earnings and profits must be correspondingly altered.
If the constructive distribution is treated as an actual
distribution, the earnings and profits of the lower-tier
foreign corporation should be reduced by the amount of the
constructive distribution, and the earnings and profits of
the foreign corporation next in the chain should be correspondingly increased.
This process should continue up the
chain to the domestic parent.
Thus each controlled foreign
corporation would keep two sets of accounts:
one set would
reflect actual distributions while the other set would reflect
deemed distributions for U. S. tax purposes.
These two sets
of books are presently kept for CFCs subject to subpart F.
(ii)
Consolidation of foreign operations.
Under this
method, all foreign corporations within a controlled group
would file a consolidated return in a manner similar to that
currently available for domestic corporations.
The consoli-
dated return would presumably reflect only the U. S. parent
corporation's share of the earnings and profits of its CFCs.
- 92 If the consolidated return shows an overall profit on foreign
operations, the U. S. parent corporation would receive a deemed
distribution of the foreign profit. If the consolidated
return shows an overall loss, the parent might be allowed
to claim the loss as a deduction against domestic income, or
at least carry over the loss against future foreign profits.
The purpose of a rule limiting the deductibility of overall
foreign losses would be to protect the U. S. tax base.
Which foreign corporations would be allowed (or required)
to consolidate? Consolidation should probably be limited to
foreign corporations which are members of the same affiliated
group, as that term is defined in section 1504(a). However,
consideration might be given to lowering the required ownership to 50 percent from 80 percent, so that most controlled
foreign corporations would be includable in the consolidated return, or even to 10 percent so that all CFCs would
be includable.
Consolidation could be required, or it could be provided
as an elective alternative to computation of income on an
individual foreign corporation basis. If an election is
provided, it would seem best to make it binding for future
years, revocable only with the consent of the Commissioner.
Standards for allowing revocation could be included in the
legislative history or in the statute.
- 93 Blocked currency would raise problems.
373L
If one of the
foreign corporations in the affiliated group is prevented
by its home country from making a distribution, what is the
effect on the group?
Should that corporation be excluded
from the group, or should it be assumed that the rest of the
group will be able to distribute enough to make up the difference?
A percentage test might be appropriate so that if
the income of the blocked currency corporation is less than
a fixed percentage of the income of the group (for example,
10 percent) then that corporation will be consolidated;
otherwise it will be excluded.
(iii)
Consolidation of worldwide operations.
Under
this approach the controlled group of corporations would file
a single U. S. tax return for its worldwide operations rather
than separate returns for domestic and foreign activities.
Questions concerning corporations to be included, an
elective as opposed to a mandatory system, and blocked currency
exist here as with the consolidated foreign operations approach.
Additional questions arise.
Should an electing corporation
still be treated as a foreign corporation for purposes of
section 367?
tial is gone.
Arguably not, because most tax avoidance potenOn the other hand, high overall foreign tax
rates might make it advantageous to transfer income producing
assets from the United States to tax havens.
Worldwide consoli-
dation clearly raises several difficult issues.
0
(d) The problem of decontrol. The partial or complete
termination of deferral could encourage firms to decontrol
their existing CFCs and to take minority positions in new
joint ventures as a means of avoiding U. S. taxation.
If decontrol and minority positions are a matter of concern, the foreign tax credit for deemed paid taxes (Section
902) might be limited to those U. S. shareholders claiming
"actual control" of the foreign corporation (alone or acting
in concert with other U.S. taxpayers), and thus presumptively
subject to current taxation of earnings retained by the foreign
corporation. Minority U. S. shareholders in a foreign corporation could thus elect either current taxation coupled with
the deemed paid credit, or deferral without the deemed paid
credit.—' Under present law, the deemed paid credit is not
available for passive portfolio investments, generally defined
as investments where U. S. corporate shareholders have less than
10 percent ownership or investments by individuals. The
rationale of the deemed paid credit is to avoid double taxation when a U. S. corporation has an active management stake
in the foreign investments. An explicit link between "actual
1/ In both alternatives, a credit for direct foreign taxes,
for example, withholding taxes on dividends, would still
be available under Section 901.
- 95 -
§(?<f
control" and the deemed paid credit would bring the basic
purpose of section 902 into sharper focus. The estimated
amount of deemed paid foreign tax credit claimed in 1976 for
foreign corporations owned less than 50 percent by U. S.
shareholders is about $250 million. It is uncertain how much
of this amount would be claimed under an "actual control"
election, and it is very difficult to predict the potential
extent of decontrol following the termination of deferral.
4. Terminate deferral in the context of repealing domestic tax preferences. As Table 1 indicates, the termination of
deferral as an isolated measure would move the U. S. tax
system further away from a standard of capital-export neutrality for the non-extractive industries.— The partial or
complete termination of deferral, by itself, would favor
manufacturing and other non-extractive investment in the
United States by comparison with investment abroad. If tax
neutrality between domestic and foreign investment is the
goal, then deferral should be changed only in the context
of a broader program. Specifically, the termination of
deferral should be accompanied by collateral tax changes.
1/ This is true whether capital-export neutrality is defined
by reference to present U.S. taxation of corporate income,
or by reference to U. S. taxation of corporate income in
the absence of domestic tax preferences.
- 96 Certain of the collateral changes would increase tax
revenue, namely, elimination of the Western Hemisphere
Trade Corporation (+ $20 million), inclusion of less developed
country corporations in the gross-up requirements (+ $55
million), and provision of a deduction rather than credit for
foreign taxes comparable to state taxes (+ $450 million).Other collateral changes would substantially decrease
tax revenues, namely, elimination of restrictions on the
foreign tax credit (- $180 million), extension of the investment tax credit to foreign non-extractive investment (- $1,000
million), extension of the asset depreciation range to foreign
investment (- $300 million) , extension of the DISC to export
goods produced abroad (- $1,000 million).
The net decrease in tax revenues from non-extractive
industries under a system of capital-export neutrality could
2/
thus reach $1,590 million.—
Extensive tax cooperation and
negotiation between the United States and foreign governments would be required to achieve a system of capitalexport neutrality. It would not be reasonable for the United
States alone to absorb the entire revenue loss. On the other
1/ The first two changes are proposed in H.R
10612.
2/ This figure is calculated in reference to present U. S.
taxation of domestic corporate income. The net figure
calculated in reference to U. S. taxation of corporation
income with no tax preferences would be $2,990 million
(Table 1). Both figures assume no change in corporate
behavior.
St*
hand, the United States could not increase its own revenues
through the termination of deferral and reasonably expect
other countries to undertake all the revenue losing changes
required to achieve a system of international tax neutrality.
JV7
FOR IMMEDIATE RELEASE
April 9, 1976
TREASURY REFERS COLUMBIA MINT CASE TO FEDERAL TRADE COMMISSION
David Macdonald, Treasury Assistant Secretary for Enforcement,
Operations and Tariff Affairs, today referred a two-dollar bill
advertising promotion by the Columbia Mint, of Washington, D . C ,
to the Federal Trade Commission.
"The Columbia Mint", Macdonald stated, "has run several
full-page advertisements in nationally-distributed newspapers
over the past two weeks, beginning March 28, advertising the sale
of 'official', 'first day issue1, $2 bill philatelic folio
collector's items. The items offered by the Columbia Mint are
in no way connected with the Department of the Treasury and the
Treasury Department neither encourages nor endorses the sale of
these items."
"Because the Columbia Mint's advertisements state that they
are issuing the $2 bill 'through the cooperation of the Treasury
Department1 , I have referred this matter to the Federal Trade
Commission for their consideration and review of the possibility
of misleading advertising."
oOo
WS-779
FOR RELEASE ON DELIVERY
STATEMENT OF THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
ON MAJOR TAX REVISIONS AND EXTENSION
OF EXPIRING TAX CUT PROVISIONS
BEFORE THE SENATE FINANCE COMMITTEE
WASHINGTON, D.C, TUESDAY, APRIL 13, 1976, 10:00 a.m.
Mr. Chairman and members of this distinguished Committee:
On March 17, 1976 I presented to this Committee a comprehensive statement on major tax revisions and the extension
of expiring tax cut provisions. All of our proposals are
fully spelled out in that statement. This morning, I will
simply highlight briefly some of the more important aspects
of our program, and answer any questions you may have.
Fairness of Tax System
In my March 17 statement, I indicated that a major issue
before you concerns the way to enhance the fairness of the
tax system. We are fortunate to have a highly successful
tax system which over the years has commanded widespread
respect and a high degree of voluntary compliance. We can
be sure that Americans will continue to support this system
so long as they have confidence that all are paying their
fair share and as long as they feel they are getting their
moneys' worth. Many people today feel that taxes are being
imposed upon them without their consent, and that too many
of their fellow taxpayers are escaping their responsibility
through dozens of loopholes.
We all believe that our tax system should be fair and
equitable, that it should be simple, and that it should
promote efficient use of our resources. But we cannot move
toward these goals if we continue to have a system which permits individuals with high economic incomes to pay little or
no tax. Unabated, this practice not only undermines seriously
the progressivity of the income tax, but equally important,
undermines its perceived fairness.
WS-780
-2-
09
In my previous testimony, I urged you to adopt our
LAL (Limitation on Artificial Losses) proposal. The House
has already done so. We believe that LAL effectively limits
the principal tax benefit associated with tax sheltersdeferral of tax liability--by applying the fundamental
concept that the income and the expenses of generating that
income should be matched.
I also referred to the problem of high-income taxpayers
who do not pay their fair share of the tax because of sub- ^
stantial exclusions from income. We renewed, in modified
form, our 1973 MTI (Minimum Taxable Income) proposal to de$l
with this problem. MTI is an alternative tax which will
subject taxpayers to progressive income tax rates.
I am, of course, aware that over the past few weeks
you have received testimony on LAL and MTI. I am generally
pleased that many of the witnesses have supported the MTI
alternative tax concept as opposed to the present minimum
tax. There have also been proposals that would apply an 0
alternative tax such as MTI as the sole vehicle to deal with
the dual problem of deferrals of tax liability and exclusions
from taxable income. The claim is made that this is simpler
than the combination of LAL and MTI. I am not convinced
that this is the case, but in any event, this is not the real
issue. The real question for you to consider is whether these
proposals deal as effectively as our recommendations with the
two distinct problems of deferrals and exclusions. If these
proposals are not at least as effective as ours, are you
willing to say to those millions of Americans who correctly
perceive tax shelters to be a tax break for sophisticated
and rich taxpayers that we have opted for a less effective
remedy because it may be simpler?
In this context, we should not lose sight of the fact
that an ineffective solution simply means that our income tax
is not as fair as it should be and that low- and middleincome taxpayers are bearing a heavier tax burden than
would otherwise be possible. We continue to believe that
LAL, in combination with MTI, will solve effectively the two
distinct problems of deferrals and exclusions which have
undermined
progressivity
of the tax Iand
its like
perceived
In the the
area
of capital formation,
would
to
fairness.
asize again how important it is that we make some
Capital Formation
g&
progress in removing the impediments to the process of
investment in our economy. The rapid development of the
U.S. economy over the years has resulted from the favorable
combination of the Nation's natural resources, our productive labor force, and the efficient application of capital
which has emphasized reliance on competitive market forces
and profit incentives to stimulate growth and efficiency.
The allocation of human and material resources has generally
been left to the market rather than to unwanted government
controls, although such intervention has unfortunately
increased. The resulting decisions about prices and output
are not the result of central planning; instead, they reflect the long-term balance between what we want and what
can be supplied. The market system has served us well and
it remains the key aspect of our productive economy. We
must assure that the flow of new capital and its effective
use are not hampered by the tax system for in the long-run
we shall all be the losers if we do not.
Several of the proposals before you are designed to
offset the drag on capital formation now built into the
tax system. Among the steps which should be taken toward
this objective are:
-- Make permanent the investment tax credit at
its present level of 10 percent, to increase
the incentive for enterprise to invest;
-- Reduce the top corporation tax rate from
48 to 46 percent and make permanent the other
rate and exemption changes effected in 1975
to encourage investment in this sector, and
to offset slightly the tax bias against
corporate investment;
-- Adopt the President's Broadened Stock Ownership Plan to reinforce the objective that all
Americans participate in the free enterprise
system and thereby strengthen its economic,
social and political base of support;
-- Adopt the sliding scale treatment for capital
gains to increase the rate of capital formation and to reduce the "lock-in" effect
which prevents investments from flowing
to their most productive uses.
-4-
3?)
-- Adopt our proposal for the integration of
the corporate and personal income taxes
to remove fully and permanently the tax
bias against corporate investment arising
from the double taxation of corporate
income.
We should not neglect to make progress on integrating
corporate and personal income taxes. This is a very
fundamental change which directly confronts the distortive
effects of the tax system on the financial structure of our
corporate sector, which removes fully the bias against
corporate investment and which honestly recognizes that
the burden of taxes is ultimately borne by people. Let us
also catch up with our competitors in the world marketplace
by taking the step that most of them have already taken-integration of corporate and personal income taxes.
These measures are not designed to produce mere shortrun stimulus. They should themselves be regarded as investments--investments in a prosperous future of higher wages,
better jobs, and an economy with the muscle we shall need
to do the things we want to do as a Nation.
Broadened Stock Ownership Proposal
More specifically, we are very enthusiastic about the
prospect of adoption of our Broadened Stock Ownership Proposal
which I discussed in detail on March 17. By allowing deferral
of taxes on certain funds invested in common stocks, we
would be encouraging broadened stock ownership by low- and
middle-income working Americans and thereby enabling them to
demonstrate their faith in the free enterprise system. It
is only as we strengthen the public support for our free
enterprise system that we can begin to find the much needed
sources of capital for our corporate sector. We believe that
our proposal will at once engender a greater sense of participation in the free market system by thie large group of lowand middle-income Americans and give them an opportunity to
build a reasonable estate for themselves and their heirs.
Capital Gains and Losses
The sliding scale proposal for the taxation of capital
gains and losses which I also discussed on March 17 is designed to promote capital formation and make sure that investments flow to their most productive uses. At the same time,
the proposal will reduce the unwarranted taxation of
inflationary gains.
J&
Under our proposal, the amount of capital gain which
may be deducted in computing adjusted gross income will
increase the longer the asset has been held by a taxpayer.
If an asset has been held for less than one year, the gain
would be fully taxable; if held between one year and five
years, 50 percent of the gain would be taxable. If the
asset has been held from five up to 25 years, the percentage of the gain which is taxable will decrease by 1 percentage point for each year that the asset has been held. Thus,
if an asset has been held for 25 years only 30 percent of
the gain would be taxable.
The sliding scale proposal represents a sensible rule
ofcthumb to avoid converting the income tax into a capital
levy on shifts in investments and, as I mentioned earlier,
it will reduce the unwarranted taxation of inflationary
gains. As I explained in my March 17 testimony, we have
assumed that our proposal will not have an impact on Fiscal
1977 receipts.
DISC With respect to DISC, I am pleased to announce that the
1974 Annual Report on DISC has now been completed by Treasury.
This morning I have distributed to you copies of the report.
In my March 17 statement I discussed the DISC provisions,
emphasizing that the Administration supports DISC in its
present form and opposes the cutbacks contained in the House
Bill.
Total U.S. exports have increased dramatically in recent
years, from $43 billion in 1971 to $106 billion in 1975,
and the U.S. share of the exports of industrialized countries
has grown from 18.2 percent to 20.2 percent in this period.
DISC has contributed to this growth in U.S. exports, and has
helped expand our position in world markets. Treasury
estimates suggest that the total DISC effect in the period
covered by the Report was an export stimulus of $4.6 billion.
Projections indicate that the effect of DISC on exports in
1976 could be as large as $9 billion. The employment associated with these additional exports in 1976 is estimated
at as much as 300,000 jobs. These additional exports and
jobs come at a time when we are experiencing unutilized
economic capacity.
The repeal or reduction of the DISC program would
adversely affect exports and the associated employment.
DISC has encouraged firms to invest in the United States
-6-
£r3
rather than abroad and we must continue to meet foreign
competition. DISC helps U.S. firms achieve this goal.
The contributions made by DISC provide persuasive
arguments not only for the continuation of DISC, but also
for making no changes in DISC at this time. Moreover, it
must be remembered that DISC has been in place for only a
short time. Many companies have made significant investments in reliance upon it. DISC, like the investment credit,
should not be turned on and off, depending on the whim of
the moment. We must resist the temptation to adopt stopand-go policies which create a climate of great uncertainty
for business planning.
Foreign Withholding
Finally, I would like to urge you again to eliminate
the existing withholding tax provision on foreign investments in U.S. securities. Our present withholding system
is counterproductive. It hampers our economy, impedes the
competitive position of U.S. financial markets in the international capital markets, denies access to foreign capital
markets, favors short-term foreign debt investment, and
needlessly complicates our tax law, in order to raise an
insignificant amount of revenue. It should be repealed
promptly.
Elimination of the withholding tax will increase investment by foreigners in the United States. It will also improve the relative attractiveness of long-term securities
and reduce the present imbalance favoring short-term securities
and bank deposits (which are presently exempt from withholding)
Access to foreign funds will permit the United States to continue its role as a capital exporter, including the recycling
of funds flowing into and out of the oil producing countries.
Further, elimination of the tax will assure our financial
markets of maintaining their preeminence in the international
_ so
equity and other rules
relative to source of income. Finally, repeal of the withholding tax will eliminate what has become a complex patchwork of legislative and treaty provisions and thereby simplify
one area of the tax law. The basic point is that the many
benefits of eliminating the tax outweigh the small revenue
loss.
- 7 -
S
r
Conclusion
This morning, I have merely emphasized the highlights
of our tax program. As I mentioned in my March 17 testimony you have before you an extremely challenging agenda.
Let us take the steps I have urged upon you in the direction of a better income tax code, but let us not stop there.
Let us have these steps represent a part of the process
of continuing true tax reform which will take us eventually
to a tax system which looks as though someone had constructed it on purpose, a simple progressive tax on a broad
base which adequately reflects individual taxpayer's ability
to pay. That is the tax break all Americans are waiting for
o 0 o
Y
3&
April 12, 1076
SUMMARY OF THE INVESTIGATION INTO THE HANDLING BY THE
INTERNAL REVENUE SERVICE OF THE INCOME TAX RETURNS OF
SENATOR JOSEPH M. MONTOYA AND RELATED MATTERS
In October, 1975, the Inspection Division of the Internal
Revenue Service commenced an investigation into allegations
that Senator Joseph M. Montoya had received preferential
treatment by the Internal Revenue Service in connection with
matters pending before the Service, as a result of directives
issued by the national office. Following publication of an
article in the Washington Post on October 19, 19755 Secretary
of the Treasury William E. Simon directed that an inquiry into
the allegations contained in the article be conducted under
the supervision of the General Counsel of the Treasury independent
of the Inspection Division investigation. This is a summary
of the report prepared by Richard R. Albrecht, General Counsel
of the Treasury, with the assistance of two staff attorneys,
and submitted to Secretary Simon.
The report documents a series of instances in which our
system of taxation appears to have been influenced by fears
and concerns over the effect that proposed Internal Revenue
Service action might have on an influential elected official.
At the time of the actions that were the subject of this
investigation, there existed among a number of senior IRS
officials a noticeable concern for the potential power that
Senator Montoya had over the IRS. This concern stemmed from
the Senator's position as Chairman of the Treasury appropriations
subcommittee and from the adverse publicity the Service received
during oversight hearings chaired by the Senator. It was
intensified during 1973 by the Watergate hearings and the
publicity about IRS "enemies" lists and the Special Services
staff.
Some of the actions and decisions by IRS officials may
be characterized as reflecting questionable judgment. However,
any conclusion that is critical of that judgment can be made
only with the benefit of hindsight. Most of the actions that
may now be called into question were taken in the good faith
belief that they were necessary to protect the IRS from further
WS-781
allegations
ofthe
improper
conduct
time. that
Those
actions
have
administering
combined
beenwith
reasonably
tax
complex
foreseeable
system
structure
to at
create
atthat
the
andresults
outset.
procedures
for
may
not
-2-
3*r
The investigation upon which the report is based focused
on six specific issues, five of which involved alleged preferential treatment accorded Senator Montoya or members of his
family by the Internal Revenue Service. The sixth involved
the question of improper disclosure of information from the
Senator's tax returns by present or former government employees.
In each of the five instances there were found examples of
deference to Senator Montoya and his potential power over
the Internal Revenue Service, in some instances involving a
considerable number of IRS employees.
Chronologically, the first allegation of preferential
treatment involved improper interference by officials of the
IRS national office with attempts by the Albuquerque district
office to collect delinquent taxes from two taxpayers located
in Senator Montoya?s home state. The report reached the
following conclusions based upon the investigation of this issue
Following an inquiry by Senator Montoya, the
Albuquerque District Director concluded, and reported
to the Senator, that the seizure of a dry-cleaning
business for unpaid withholding taxes was proper and
should not be changed.
About ten days later, after contacts with IRS
officials in the Southwest Region by the Deputy
Commissioner, who was scheduled to testify before
Senator Montoya in a few days, the seized business
was released.
Further, after a subsequent discussion between
regional officials and the Deputy Commissioner, action
on the tax delinquency of another taxpayer in New Mexico
was postponed.
It appears that the release from seizure and the
postponement of proceedings were directed by the Deputy
Commissioner. Although the then Deputy Commissioner
does not acknowledge issuing such an order, the Acting
Regional Commissioner and the Albuquerque District
Director reasonably interpreted his instructions as
requiring the release and postponement.
-3-
s&
Although Senator Montoya expressed the opinion to
the District Director that the seizure was a mistake,
the orders for its release were not the result of
direct action by the Senator, but rather the result of
unfavorable publicity combined with the pending appearance
of IRS officials before a subcommittee chaired by Senator
Montoya.
At no time did the District Director or anyone
else affected by the orders to release the seizure
report the fact to the Inspection Division of the IRS,
although established procedures required the reporting
of any improper order.
The second matter investigated concerned the alleged twoyear delay by national office officials of an attempt by the
Albuquerque district to audit certain of the Senator's tax
returns. The report reached the following conclusions based
upon the investigation of this issue:
The Albuquerque District Director wanted to pursue
an Intelligence Division investigation of Senator Montoya
in mid-1973.
The Commissioner and Deputy Commissioner concluded
the Intelligence Division investigation should not go
forward at that time and issued instructions to that
effect.
Their decision was based in part on a concern that
the IRS not undertake an investigation that would appear
to be motivated by a desire to "punish" Senator Montoya
as an "enemy" of the IRS or of the administration.
There was some justification for such a concern,
based on Senator Montoya!s oversight hearings, his
membership on the Watergate Committee, current publicity
about "enemies" lists and other accusations against the
IRS, as well as the Albuquerque District Director's previous expressions of dislike for the Senator. There also
existed noticeable concern among many senior officials of
the IRS for any reaction the Senator might have, as a
member of the IRS appropriations committee, to any IRS
inquiry or investigation into his income taxes.
Although the Intelligence Division investigation
was stopped because of the above concerns on the part
of national officials, and this course of action was
^
accepted by the region and district because of an
inadequate development of evidence, no routine audit
was commenced in its place.
Senior officials of the IRS were hopeful that the
Senator's 1972 return would be selected by computer
for audit review, thus providing a vehicle for initiating
an audit.
Actions taken with an eye to speeding up the
possible selection of the Senator's 1972 return for
audit had the opposite effect and virtually assured
that the return would not be selected for audit. Due
to an unusual sequence of events, many of them related
to technical IRS procedures for dealing with tax returns
and selecting them for audit, the return was never
processed through the normal audit selection procedure.
Subsequent reviews of whether the Senator's returns
were improperly by-passed by the audit process did not
second-guess the initial decision but considered whether
an audit should have been initiated at that later time.
There are legitimate audit issues on at least two
of the Senator's returns that should be reviewed.
No stigma should be attached to such a review since
the purpose of an audit is to review and verify the
information submitted by a taxpayer on his return.
The Senator was unaware of any proposed or threatened
audit or investigation of his tax returns, and none of
the actions of the IRS resulted from direct action by
the Senator.
Although IRS procedures called for reporting of
any improper interference with a tax matter, and
several individuals believed the investigation into
the Senator's taxes was being improperly thwarted, none
of them reported that fact to the IRS Inspection Division.
The third series of events investigated concerned alleged
improper interference by national office officials with district
and regional intelligence gathering activities involving the
Senator and members of his family. The report reached the
following conclusions based upon the investigation of this issue
-5-
Jif
Officers in the national office denied a request
for surveillance of a meeting between an IRS confidential
informant and members of the Montoya family because they
believed the facts did not justify the method of surveillance requested. They also erroneously believed that
the Commissioner had ordered that no action be taken
with regard to the Senator without the Commissioner's
prior approval, and believed this case did not warrant
the Commissioner's attention.
Based upon the mistaken belief of certain officials
that they had instructions to that effect, two packages
of information, possibly relevant to any review of the
Senator's returns, were withheld from the Albuquerque
district, at least temporarily. This was done without
the knowledge of either the Commissioner or Senator
Montoya.
The fourth event investigated concerned the allegation
that the Albuquerque District Director was transferred due
to his actions in dealing with matters related to Senator
Montoya. The report reached the following conclusions based
upon the investigation of this issue:
There was an attempt by some IRS official or
officials to arrange the transfer of the Albuquerque
District Director because of his actions with respect
to Senator Montoya's tax returns, but their actions
did not result in his transfer.
The District Director's transfer, which occurred
almost two years later, was probably based upon and
justified by the personnel and managerial problems
which existed then and which had long plagued the
Albuquerque office. Although the Senator knew of the
managerial problems in the Albuquerque office and of
an IRS review of these problems, he did not request
the District Director's transfer.
The fifth allegation involved interference by regional
officials with the commencement of an Intelligence Division
investigation by the Albuquerque district of a member of Senator
Montoya's There
family.
The report
reached
the following
conclusions
existed
a strong
difference
of opinion
between
basedofficials
upon the in
investigation
of this
issue:
the Southwest
regional
office and Albuquerque
$S1
-6-
district office as to the proper procedure for initiating
an inquiry into the tax filing status of a member of
Senator Montoya's family.
Regional officials eventually directed the district
to use the procedures advocated by the region, in part
because of concern for embarrassing the IRS and offending
Senator Montoya.
Although several officials in the district believed
the region's actions were improper, none reported that
fact to the Inspection Division as required by IRS
procedures.
Senator Montoya was unaware of any proposed audit
or investigation of one of his family members, and none
of the actions taken by IRS officials resulted from
direct actions of the Senator.
The final allegation covered by the report concerned the
improper disclosure to the Washington Post of income tax
information from Senator Montoya's tax returns by present or
former Internal Revenue Service officers or employees. The
report reached the following conclusions based upon the investigation of this issue:
The Washington Post story included information of
the nature contained on tax returns. Since such information is not readily available from other sources, it
is reasonable to assume there was an improper disclosure
of information from Senator Montoya's tax returns.
Although the investigation is continuing, it has
not been possible to ascertain the persons responsible
for the disclosure.
*
*
The report concludes with comments on the results of this
investigation and recommendations for action.
It is imperative that the Internal Revenue Service operate
in an even-handed manner, treating all taxpayers alike regardless of their station in life. It is equally important to our
self-assessment tax system that the public perception of our
tax system is that all will be treated alike. The IRS must
not appear to show either favoritism or antagonism towards any
taxpayer or group of taxpayers.
-7-
J3d
In order for the image of the IRS to be maintained on
this plane, it is doubly important that the tax treatment of
public figures be above reproach. The allegations in recent
years that the IRS was used to reward friends and punish enemies
certainly tarnished that image. It is possible that the adverse
publicity resulting from those allegations has prompted some
IRS officials to be overly cautious out of a genuine and wellmotivated desire and concern for the Service's reputation for
fair play. It would be unfortunate, however, if it appeared
to the public that people in high places could receive favorable
treatment because of their position or by using their influence
over the IRS.
It is not only direct or conscious action that can result
in uneven treatment or the appearance of a double standard.
However, the Internal Revenue Service cannot tolerate any
actions that result in or appear to result in anything less
than objective, even-handed treatment, regardless of whether
the action was intentional or unintentional.
The IRS does have procedures and systems to deal with the
risks discussed above. Proper management supervision and
internal controls should avoid most instances of harassment
of a taxpayer by the Service. Any IRS employee who is told
to do something he considers improper is under orders to report
that fact to the Inspection Division. The Inspection Division
is independent of the management chain of command—except at
the very top—and an employee's complaint should not result
in any jeopardy of his job or prospects for advancement.
Investigations by the Inspection Division have effectively
policed the conduct of IRS employees in prior cases.
But, in this instance, the system did not work properly.
Perhaps it failed because many of the decisions were made by
top management at the national office—an unusual place for
decisions to be made involving the conduct of an individual
tax case. The involvement of high officials may have deterred
some employees from reporting to Inspection. Participation
by the Commissioner may have had a particularly deterring
effect because the Assistant Commissioner (Inspection) reports
to the Commissioner.
But it is just this situation—involvement of senior
officials—that is likely to occur when an important public
figure is involved. Therefore, we recommend that consideration
be given to the adoption of new techniques or systems—as well
as developing a greater awareness of the present systems—to
overcome the weaknesses demonstrated by this report.
IVc spec J I'lca I ly ri.voimiuMid the following:
1. A review should be made of the organization and
procedures for reporting and investigating allegations of
misconduct by supervisory officials in the IRS. Such a study
may be expanded to include a review of such procedures
throughout the Treasury Department.
2. In the meantime, current policy should be well publicized
within the IRS to encourage employees to report immediately
any attempts to influence or interfere with a pending audit,
investigation or review.
3. Consideration should be given to the feasibility of
adopting a policy of automatic audits of all elected Federal
officials and Presidential appointees periodically if they
have not been selected for audit by other means. This subject
should be discussed with the Joint Committee on Internal
Revenue Taxation.
4. Efforts should be made to educate the public concerning
the fact that an IRS audit is principally an effort to verify
information submitted on a taxpayer's return, and that no stigma
should be attached to being selected for audit.
5. Senator Montoya's personal income tax returns for
all open years should be promptly reviewed by the IRS for
audit potential. All information concerning the Senator the
IRS has in its possession, from whatever source derived, should
be made available to the persons in charge of the review.
oOo
STATEMENT BY THE HONORABLE
WILLIAM E. SIMON, SECRETARY OF TREASURY
ON THE RELEASE OF A JUSTICE DEPARTMENT
INVESTIGATION OF IRS COMMISSIONER
DONALD C ALEXANDER
Secretary of the Treasury. William E. Simon today
expressed pleasure at the Attorney General's announcement that
the Justice Department investigation has cleared Internal
Revenue Service Commissioner Donald C Alexander of any
wrongdoing. Secretary Simon said he was tremendously pleased
that, after an intensive investigation by the FBI and Justice
Department attorneys, they were able to conclude that there
was no evidence to support any of the allegations of improper
conduct by the Commissioner.
Simon noted that, although the charges turned out to be
unfounded, he believed it was important that they were thoroughly
investigated in order to maintain public confidence in government officials and institutions. Secretary Simon reaffirmed his
prior expressions of confidence in the honesty and integrity of
Commissioner Alexander and described Alexander as a dedicated,
capable public servant.
Secretary Simon also released today a summary of the
investigation conducted by the Treasury Department into the
handling by the Internal Revenue Service of the income tax
returns of Senator Joseph M. Montoya of New Mexico and related
matters. The Secretary noted that some of the actions and
decisions by IRS officials described in that report appear to
have involved questionable judgment. He pointed out, however,
that any conclusions critical of that judgment can now be made
only with the benefit of hindsight, and it is clear that the
very actions that might now be questioned were taken at that
time in the good faith desire to avoid further allegations of
improper conduct by the IRS. Simon also noted that the investigation produced no evidence that Senator Montoya at any
time sought favored treatment from the IRS, and none of the
matters reported resulted from direct action by the Senator.
The Treasury investigation report made a number of recommendations to the Secretary. Simon indicated that all of those
Recommendations have been accepted, and steps are being taken to
implement them.
WS-782
J^-3
- 2 Secretary Simon stated that he believes that American
taxpayers are entitled to a tax administration system that
is not only efficient and effective, but also has the highest
integrity. He stated that he and Commissioner Alexander would
continue to work to provide a tax system deserving of the
public's confidence.
0O0
ASURY
partmentofth
INGTON, D.C. 20220
TELEPHONE 964-2041
J**
FOR IMMEDIATE RELEASE
April 12, 1976
RESULTS OF TREASURY*S WEEKLY BILL AUCTIONS
Tenders for $2.7 billion of 13-week Treasury bills and for $3.4 billion
of 26-week treasury bills, both series to be issued on April 15, 1976,
were opened at the Federal Reserve Banks today. The details are as follows:
26-week bills
maturing October 14, 1976
RANGE OF ACCEPTED
13-week bills
COMPETITIVE BIDS: maturing July 15,- 1976
Price
High
Low
Average
Discount
Rate
98.786 a/4.803%
98.777
4.838%
98.779
4.830%
Investment
Rate 1/
Price
Discount
Rate
Investment
Rate 1/
4.93%
4.97%
4.96%
97.449
97.432
97.438
5.046%
5.080%
5.068%
5.25%
5.29%
5.27%
a/ Excepting 1 tender of $100,000
Tenders at the low price for the 13-week bills were allotted 19%.
Tenders at the low price for the 26-week bills were allotted 5%.
TOTAL TENDERS RECEIVED AND ACCEPTED BY FEDERAL RESERVE DISTRICTS:
District
Received
Boston
55,665,000
$
New York
,004,490,000
Philadelphia
48,170,000
Cleveland
43,925,000
Richmond
53,975,000
Atlanta
35,440,000
Chicago
343,670,000
St. Louis
63,745,000
Minneapolis
40,605,000
Kansas City
61,915,000
Dallas
35,395,000
San Francisco 457,830,000
T0TALS$6,244,825,000
Accepted
$
22,260,000
2,296,825,000
46,905,000
39,255,000
22,455,000
31,450,000
59,085,000
30,430,000
10,365,000
43,015,000
24,795,000
77,230,000
Received
Accepted
$
38,480,000
5,367,135,000
94,745,000
60,055,000
49,890,000
30,955,000
181,115,000
67,500,000
58,400,000
30,475,000
52,835,000
285,365,000
$
11,480,000
3,086,235,000
10,995,000
48,465,000
13,540,000
21,455,000
57,215,000
40,500,000
25,400,000
22,275,000
14,835,000
48,725,000
$2,704,070,000 b/ $6,316,950,000
$3,401,120,000 c/
V Includes $411,510,000 noncompetitive tenders from the public.
= Includes $225,095,000 noncompetitive tenders from the public.
y Equivalent coupon-issue yield.
WS-783
NGTON, D.C. 20220
TELEPHONE 964-2041
Scr
FOR RELEASE U P O N D E L I V E R Y
STATEMENT BY THE HONORABLE GERALD L. PARSKY
ASSISTANT SECRETARY OF THE TREASURY
BEFORE THE
SENATE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS
WASHINGTON, D.C.
WEDNESDAY, APRIL 14, 1976, AT 10:00 A.M.
Mr. Chairman and Members of the Committee:
I am pleased to be here today to discuss the President's
proposal for an Energy Independence Authority (EIA). This
initiative should be seen as part of the President's comprehensive energy policy -- a policy that is aimed at removing
our country's excessive dependence on others for our energy.
Specifically, the President has set as our goals:
-- In the near-term, 1975-77, halt our growing
import dependence by reducing oil imports by
2 million barrels per day (MMB/D) before the
end of 1977.
-- In the mid-term, 1975-85, attain energy
independence by achieving invulnerability to
oil import disruption; this means a 1985 import
range of 3-5 MMB/D, replaceable by stored supply
and emergency measures.
WS-784
"2 "
3*6
In the long-term, beyond 1985, mobilize U.S.
technology and resources to supply a significant
share of the Free World's energy needs.
To achieve these objectives we cannot rely on government
alone.
We must, in large part, depend on our private sector
for the large capital investment necessary to develop energy
supplies.
The task of mobilizing the needed private capital
would be very challenging under the best of circumstances.
However, the government has compounded the difficulties through
its regulation and control of the energy industry; and for a
variety of reasons, the private sector is having difficulty
financing certain types of important energy projects. Most of
these difficulties could be overcome through timely and innovative regulatory actions and through removal of other impediments
to the development of oil, coal and gas and the growth of
nuclear power.
The fact that we must face, however, is that these needed
regulatory actions and policy decisions will be too slow in
evolving.
The President has determined that we can't wait and,
accordingly, has proposed the EIA in order to ensure the
timely development of important sectors of our energy industry.
If EIA is viewed as a substitute for taking the needed regulatory reforms, or if it is seen as a substitute for the
private sector, its purpose will have been defeated and
it will be counterproductive.
If, however, it serves as a
temporary bridge to the time when regulatory impediments are removed and evolves as a supplement to the private sector, then
it can play an important role in bringing a sensible energy
policy to this country.
- 3In my testimony today, I will concentrate on the
financial considerations which led to the EIA proposal and
some of the more important consequences of EIA operations.
In particular, I would like to discuss with you (1) the
expected capital requirements of our energy industry, (2)
the reasons why many important energy projects may not be
financed by the private sector, and (3) the capital market
impacts of EIA.
Energy, Industry Capital Requirements
A number of studies have been made concerning the capital
requirements of the energy industry. In most cases1these
studies have analyzed the requirements based on several
assumed scenarios, and the resulting estimates of the overall
levels of capital requirements for the energy sector for
1975-85 produced by these studies range from about $480 billion
to about $680 billion in 1975 dollars. A $580 billion figure
would seem reasonable to us.
In order to assess the relative size of this figure, it
should be compared with estimated business spending on new
plant and equipment of roughly $2,000 trillion in 1975 dollars
over the,1975-85 period. When viewed in this light, the $580
billion energy investment figure would constitute roughly
30 percent of estimated- business fixed investment over the
period, which would be well within the range of historical
- 4experience.
Over the 1965-74 period, for example, energy
investments as a percentage of total business fixed investment
averaged 29% and ranged from 24% to 33%.
Despite the fact that capital needs for energy are not
out of proportion to historical trends, an important concern
is the extent to which private investors will be willing tn
finance the necessary investment in energy.
Historically,
the energy sector financed a relatively small percentage of
its investment from funds raised externally.
For example,
it is estimated that during the early 1960fs about 25% of
fossil fuel investment was financed externally while the
investor owned electric utilities financed about 35% of their
capital needs this way.
However, over the past decade the energy sector and
business in general has tended to rely more and more on
external financing, especially debt.. During the late 60's
and early 70's the fossil fuel industry financed roughly
30-40% of its requirements externally; and the level of
external financing for investor owned utilities ranged
from 50-70%.
The result has been that the energy sector
has taken an increasing share of total funds supplied by
the private capital market.
Over the 1961-65 period the
energy industry's share of the total amount 6f funds raised
by business in U.S. capital markets averaged 18 percent.
The energy sector's share rose to 21 percent for the 1966-70
period and then to. 28 percent in 1975, a year when other
capital market demands were depressed.
Estimates for the
1975-85 period suggest the U.S. capital market will provide
some $1.1 trillion
(in 1975 dollars) to the business sector
and that the energy industry will require on average 25% of
these funds.
We believe that the capital market will have the capacity
to provide this level of funding to the energy industry. However,
given the current uncertainties and regulatory climate, we do not
believe that all of the necessary funds will actually flow to
the energy sector in the needed amounts.
Energy projects will
have to compete with projects from other sectors; and the
capital will normally flow to the most economically attractive
projects--that is, where it can be most profitably employed
in terms of private market criteria.
Most of the needed
conventional energy sector investments would be able to
attract the necessary financing from private sources without
Federal financial assistance such as that contemplated by EIA.
There are, however, some types of projects which, for various
reasons, are less likely to be able to attract funds from the
private markets during the next 10 years without some form of
government assistance.
It's for this very reason that the
President decided to propose EIA.
To more fully appreciate
0
- 6the need for EIA, I would like to look briefly at some of
the reasons why the private sector may not finance such
projects.
Reasons Why The Private Market May Not Finance Certain
Types of Energy Projects
There is no single all pervasive reason why certain types
of energy development projects are not being financed in the
private markets.
In most cases where Federal assistance may
be required, there is a combination of factors which create
uncertainty in the minds of potential investors and prevent
them from committing funds without some form of Federal participation.
(1)
The most* important of these reasons are the following:
Some energy projects included in our national energy
program are marginal and, in some cases, not economic at current
market prices.
For example, synthetic fuel plants are at best
only marginally economic at current prices; and because of
uncertainty over future world oil prices and government regulation, most synthetic fuel projects are not attractive to private
investors.
Federal financial assistance will be needed if we
are to accelerate the commercialization of synfuels and other
promising emerging energy technologies.
which is necessary to improve the financial viability of
-7-
J?/
certain segments of our energy industry and to provide
requisite assurances to potential investors. As a prime
example of this regulatory neglect, I would cite the
inadequate rate increases granted to electric utilities by
•
,
•
••>
. •>
state commissions which have resulted in straining the
financial condition of these utilities and in the deferral
or cancellation of large amounts of new generating capacity.
Almost half of the energy sector's projected capital requirements in the 1975-85 period are in the electric utility sector.
Electric utilities are faced with the need to raise more
capital than the oil companies over this period, but will have
less than half the revenue base of these companies. While
recent regulatory actions have resulted in some improvement
in the financial situation of electric utilities, these
companies can be expected to face future financial difficulties
unless additional action is taken to provide for adequate
rates and for a stronger cash flow. Without innovative regulatory actions such as including construction work-in-progress
in the rate base, we may continue to have periods during which
the financial condition of the electric utilities retards the
undertaking of needed investment.
In the natural gas industry, if private financing is to
be arranged for certain needed major projects, deregulation
.of new gas prices and still other types of innovative
- 8regulatory actions may be needed.
These include approval of
"all events full cost of service" tariffs which pass some
of a project's risk to gas consumers and, possibly, consumer
surcharges, which could be used to help finance exploration
and development of new gas supplies.
Lastly, decontrol of crude oil prices would substantially
improve the ability of the petroleum industry to finance
energy projects and would also provide needed incentives for
conservation and for the development of new supplies. As you
know we are phasing such controls out over a 40 month period.
The President has made it clear that we should do whatever we
can to assure decontrol takes place as rapidly as possible.
We must all make sure that the 40 month program will be fully
implemented so that we can once and for all do away with that
set of government regulations which encourages wasteful consumption of oil and discourages needed investment that will
result in additional supplies.
(3) Some energy projects have special risks which the
private market may not be willing to bear without innovative
regulatory devices and/or some form of government assistance.
Examples of these tynes of projects are those involving the
commercialization of technologies untested in the private
market. The technological risk is often compounded by
regulatory uncertainty^, and private investors may not be will
373
to bear these risks without Federal assistance. In many
cases, these special risks are compounded by long construction lead times which also make investors reluctant to commit
funds.
Synthetic fuel plants, for example, have a lead time
of at least five years; and the typical nuclear power plant
has a 10 year lead time.
Basic Federal Government and Regulatory Actions to Assure
Adequate Energy Investments
The basic long run solution is to move forward as rapidly
as possible with policy changes and regulatory reforms which
will strengthen the ability of private firms to attract
needed capital. " For example, decontrol of energy prices would
materially assist in financing of energy projects by improving
cash flow and providing needed incentives to marginal projects.
In the tax*area, there are a number of measures which the
President has proposed which would facilitate capital
formation in general or would improve in particular the
financial strength of the electric utilities industry.
We also
need to encourage the-private sector to adopt innovative
approaches to ^arranging'the financing of needed major energy
projects.
- 10 These kinds of actions must be taken.
The problem, however,
is that many of these will take time, and we simply can't wait.
As the President has repeatedly emphasized our dependence is
growing and we must do whatever we can now to reverse this
trend. Therefore, the President has proposed the Energy
Independence Authority as a temporary measure which will assist
the energy sector over the next 10 years in drawing^capital to
needed energy projects which might not otherwise obtain financing
from the private capital markets.
The Scope of the EIA
As we evaluate the EIA, I think it is important to focus
on precisely what EIA is designed to do and, as importantly,
what it will not do. EIA is not intended to provide government
assistance to all energy projects and it is not meant to substitute the government for the private sector, which will continue to provide the bulk of the funds for our energy development.
It is a supplement to the private market and aimed essentially
at some of the critical bottlenecks in the energy finance field
which may not be overcome in a reasonable time period by the
private sector without Federal assistance.
The Energy Independence Authority is designed to provide
up to $100 billion of financial assistance to energy projects
which:
-n (1)
37?
Will contribute significantly to energy
independence, and
(2)
Would not otherwise be undertaken by the private
sector without governmental financial assistance.
The EIA would have a limited life of ten (10) years
(subject to a single three-year Presidential extension).
The
financial outlays and commitments of the EIA are intended to
be recovered by the government and will be used in conjunction
with private sector financing to the maximum possible extent.
The legislation requires EIA to use loans and loan guarantees
to the maximum extent practical; but EIA is also permitted to
provide guarantees of price, purchase and leaseback
facili-
ties, and purchase convertible and equity securities.
Grants in aid would be excluded.
The projects that could be
supported by the EIA range across the full spectrum of the
energy field and include emerging energy technologies, energy
supply infrastructure, major conventional energy projects and
emerging energy conservation technologies.
In addition, through the EIA legislation, the Federal
Energy Administration would be empowered to certify projects
as being of critical importance to achieving national energy
goals.
The EIA would establish new procedures for coordinating
and expediting Federal regulatory proceedings that affect
3K
- 12 energy projects and require sound and expedited regulatory
responses from regulatory Commissions having authority over
EIA-financed utility projects.
The Energy Independence Authority will be, in short, a
Federal undertaking of large scope and magnitude and result
in substantial Federal involvement in financing certain types
of energy projects. Some would argue that the Federal
Government should not be so involved. I would agree if I
felt that the needed regulatory changes would take place in
a timely fashion. However, we have not seen evidence that
this will happen and because of the overriding national
importance of meeting our energy policy objectives in a timely
manner, some Federal involvement is necessary. In 1973, we saw
what could happen to us because of our heavy reliance on foreign
energy sources. That experience, coupled with the continuing
control that others exert over the price of oil, has resulted
in a determination to reduce our reliance on insecure supplies
which create an unacceptable danger to our economic prosperity
and our national security. In order for this goal to be
achieved, we must increase domestic energy supplies, diversify
sources of imports, create strategic stockpiles, and reduce
the excessive demand for energy. EIA will provide critical
assistance in meeting these objectives.
$77
- 13 However, the EIA legislation should not be considered
as a substitute for the needed regulatory and energy policy
actions which,over the long run,are essential to achieving
our energy objectives.
This is not the intention of the EIA
proposal, and we must do everything we can to assure that it
will not happen.
In this regard, I think that the Committee
should pay special attention to those provisions of the
proposed legislation which are intended to encourage and
facilitate needed regulatory reform.
Specifically, Section
304(c) of the Act requires, as a condition of assistance to
a regulated utility, sound and expedited regulatory response
from state regulatory commissions.
For example, the legis-
lation requires that the relevant regulatory commission agree
with the EIA and the regulated firm to a rate covenant that
assures adequate earnings to protect EIA's investment.
In
addition, Title VI of the legislation provides a procedure
to expedite Federal regulatory decisions with respect to
energy projects.
By reducing the time needed for regulatory
action, the legislation would help remove some of the
regulatory uncertainty which prevents private capital from
flowing to many energy projects.
-14 -
J;/
Impact on the Capital Markets
I would now like to turn to an assessment of the impact
that EIA assistance will have on our capital markets.
In providing financial assistance to the energy sector
through the EIA, we believe that every effort should be made
to minimize the cost of the EIA program to the general taxpayer, and to maximize the efficiency of this program.
Minimizing the level of financial support requires flexibility
in the forms of support that can be provided.
In addition,
the exact form of the most appropriate financial assistance
will vary from situation to situation depending on the technology, the regulatory environment, the nature of the
companies involved, and competitive market considerations.
Accordingly, we believe that it is desirable to allow EIA
to have a broad range of methods for providing financial
assistance.
Even with such flexibility, concern has been expressed
about the impact of EIA on the capital markets.
I believe
that we must face the fact that there may be considerable
market impact.
The central question is whether the urgent
need for energy development outweighs any adverse capital
market impact.
Any type of Federal financial assistance
which results in projects which would not have otherwise been
undertaken will lead to some redirection of resources within
the capital markets.
This is as true for EIA as for any
other government program.
If EIA is to be effective in
377
- 15 helping to solve our energy dependence problems, the EIA
will have to divert capital from other areas of our economy
into the energy sector.
Moreover, because the financial
incentives provided by EIA will have little or no effect on
the
overall supply of capital, EIA loans or loan guarantees
will increase the demand for capital and tend to raise both
private and government borrowing costs.
This is also true
of other government lending and loan guarantee programs.
There is nothing unique about the EIA program in this respect.
In this regard, the net annual flow of funds in the U.S.
credit markets is expected to be about $239 billion in fiscal
year 1976.
Of this amount, $137 billion, or 57 percent,
will be required to finance the federal budget deficit and
net borrowings for off-budget federal programs, leaving only
$102 billion to finance the private sector.
Further, total
government borrowings this fiscal year will have an even
greater impact on the long-term securities markets. We expect
that such borrowing will absorb 82 percent of funds available
in the long-term securities market.
The funding of the EIA
would add to the already large government presence in the
capital markets and have an important impact on both the
overall allocation of credit and the financing costs of both
government and private borrowers.
We must, however, remember that some redirection of
capital flows is the intended effect of EIA and an inevitable
consequence if we a_re to assure priority to energy development.
Furthermore, the EIA assistance will be spread over
a relatively long time period.
The EIA would provide an
average of $10 billion per year in the late seventies through
the mid 1980's, with the largest part of such assistance likely
to be provided in the period from 1980-1986 when the overall
economy will have grown by 25-30%.
This would represent
roughly 13% of the projected yearly energy investments of
$70-80 billion and roughly one-third of the external finance
raised for energy sector investments during that period.
The precise nature of EIA's impact on interest rates
and the allocation of capital is impossible to predict with
any certainty.
The aggregate size and the precise mix of
the demand for capital will be influenced by the size of federal
deficits, government fiscal and monetary policy, the rate
of inflation, the strength of and duration of our economic
recovery, the financing needs of the private sector and of
state and local governments.
Any one of these factors could
have a substantially greater effect on capital markets than EIA
activity.
In addition, the bill contains a number of provisions
designed to minimize the impact of EIA operations on the
capital markets.
First, Section 303 of the bill requires
in
- 17 -
^
the EIA to seek the maximum amount of financing from nonEIA sources in connection with any project which EIA
undertakes. Second, Section 306 requires the concurrence
of the Secretary of the Treasury as to the timing and substantial terms and conditions of each security issue backed
by the Federal Government. This provision is, in my view,
an absolutely essential part of the EIA proposal in that it
not only helps minimize the impact on the capital markets but
reduces the effects of EIA activities on government borrowing
costs. Third, Section 314 of the proposed legislation
contemplates an advisory panel which would review the effects
of EIA financial activities on the functioning of the capital
markets, including the effects on the volume and distribution
of capital flows to and within the energy development sector
of the economy. Such a panel could keep continual watch on
the effect of EIA activities on our capital markets and
ensure that the impact was minimized. Fourth, Section 801
of the proposed legislation gives the members of the Energy
Resources Council an opportunity to comment on any financial
assistance granted by EIA. This would give the Secretary of
the Treasury and other members of the ERC concerned with the
financial implications of the program an opportunity to give
their advice on the capital market impacts of EIA assistance
to any given project.
- 18 Cost of the EIA Program to the Taxpayer
The fact that EIA is designed to provide assistance
to projects which are too risky for the private sector to
undertake has led many to conclude that EIA will lose
billions of dollars for the U.S. taxpayers. This will not
be the case. The mere fact that a project involves risks
greater than those which the private sector is willing to
assume does not mean that the project will necessarily lose
money. Many inherently sound projects are not financed by
the private sector because of regulatory delays and uncertainty,
or the long lead times of certain energy projects. EIA
assistance in such cases does not mean that EIA would be
financing a "losing project." In structuring this authority,
we have tried to provide safeguards so that there will be no
cost to the taxpayer from EIA operations. As you know, EIA
is designed to be self liquidating. The loans it makes are
expected to be repaid, appropriate guarantee fees will be
changed, and EIA is expected to pay a return to the Treasury
on its equity capital.
It is, of course, possible that EIA might sustain
losses -- particularly in its programs to encourage new
energy technologies. However, the legislation has built-in
special provisions to limit certain types of riskier financial
assistance. Specifically, Section 308 provides that high
- 19 -
373
risk loans, direct investments, product price guarantees
or other direct financial assistance may not be provided
if reserves established to meet contingent liabilities
created in connection with such assistance exceed the sum
of EIA's paid-in capital, earned surplus and gains on
disposition of property. In such a case, the maximum loss
to the taxpayer would be the initial equity contribution,
unless Congress provided further equity capital.
Conclusion
In conclusion, it is clear that EIA operations will
impact on our capital markets. It is also clear that EIA
will result in the reallocation of capital toward the energy
industry. However, the proposed legislation contains a
number of provisions to minimize adverse market effects.
Furthermore, inherent in the EIA proposal is the belief that
some reallocation or diversion of capital is needed if we
are going to achieve our energy goals. Also central to the
proposal is the belief that EIA is not a substitute for
market solutions and regulatory reform but a temporary
supplement to the private market. It is with these two objectives in mind that we are calling for the creation of EIA.
jvy
April 13, 1976
FOR RELEASE AT 4:00 P.M.
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites tenders for
two series of Treasury bills to the aggregate amount of $5,900,000,000 , or
thereabouts, to be issued April 22, 1976,
as follows:
91-day bills (to maturity date) in the amount of $2,500,000,000, or
thereabouts, representing an additional amount of bills dated January 22, 1976,
and to mature
July 22, 1976
(CUSIP No. 912793 ZZ 2), originally issued in
the amount of $3,392,765,000, the additional and original bills to be freely
interchangeable.
182-day bills, for $3,400,000,000, or thereabouts, to be dated April 22, 1976,
and to mature
October 21, 1976
(CUSIP No. 912793 B6 2).
The bills will be issued for cash and in exchange for Treasury bills maturing
April 22, 1976,
outstanding in the amount of $ 10,608,010,000, of which
Government accounts and Federal Reserve Banks, for themselves and as agents of
foreign and international monetary authorities, presently hold $3,081,580,000.
These accounts may exchange bills they hold for the bills now being offered at
the average prices of accepted tenders.
The bills will be issued on a discount basis under competitive and noncompetitive bidding, and at maturity their face amount will be payable without
interest. They will be issued in bearer form in denominations of $10,000,
$15,000, $50,000, $100,000, $500,000 and $1,000,000 (maturity value), and in
book-entry form to designated bidders.
Tenders will be received at Federal Reserve Banks and Branches up to
one-thirty p.m., Eastern Standard time, Mondav, April 19. 1976.
Tenders will not be received at the Department of the Treasury, Washington.
Each tender must be for a minimum of $10,000.
multiples of $5,000.
Tenders over $10,000 must be in
In the case of competitive tenders the price offered must
be expressed on the basis of 100, with not more than three decimals, e.g., 99.925.
Fractions may not be used.
Banking institutions and dealers who make primary markets in Government
WS-785
(OVER)
-2-
M
securities and report daily to the Federal Reserve Bank of New York their positional
with respect to Government securities and borrowings thereon may submit tenders
for account of customers provided the names of the customers are set forth in
such tenders.
Others will not be permitted to submit tenders except for their
own account.
Tenders will be received without deposit from incorporated banks
and trust companies and from responsible and recognized dealers in investment
securities.
Tenders from others must be accompanied by payment of 2 percent of
the face amount of bills applied for, unless the tenders are accompanied by an
express guaranty of payment by an incorporated bank or trust company.
Public announcement will be made by the Department of the Treasury of the
amount and price range of accepted bids.
Those submitting competitive tenders
will be advised of the acceptance or rejection thereof.
The Secretary of the
Treasury expressly reserves the right to accept or reject any or all tenders,
in whole or in part, and his action in any such respect shall be final. Subject
to these reservations, noncompetitive tenders for each issue for $500,000 or less
without stated price from any one bidder will be accepted in full at the average
price (in three decimals) of accepted competitive bids for the respective issues.
Settlement for accepted tenders in accordance with the bids must be made or
completed at the Federal Reserve Bank or Branch on April 22, 1976,
in cash or
other immediately available funds or in a like face amount of Treasury bills
maturing April 22, 1976.
ment.
Cash and exchange tenders will receive equal treat-
Cash adjustments will be made for differences between the par value of
maturing bills accepted in exchange and the issue price of the new bills.
Under Sections 454(b) and 1221(5) of the Internal Revenue Code of 1954 the
amount of discount at which bills issued hereunder are sold is considered to
accrue when the bills are sold, redeemed or otherwise disposed of, and the bills
are excluded from consideration as capital assets.
Accordingly, the owner of
bills (other than life insurance companies) issued hereunder must include in his
Federal income tax
return, as ordinary gain or loss, the difference between
the price paid for the bills, whether on original issue or on subsequent purchase,
and the amount actually received either upon sale or redemption at maturity
during the taxable year for which the return is made.
Department of the Treasury Circular No. 418 (current revision) and this notice,
prescribe the terms of the Treasury bills and govern the conditions of their
issue.
Copies of the circular may be obtained from any Federal Reserve Bank or
Branch.
oOo
3ft>
BIOGRAPHICAL NOTES
ROBERT A. GERARD
ASSISTANT SECRETARY OF THE TREASURY
CAPITAL MARKETS AND DEBT MANAGEMENT
Robert A. Gerard signed the oath of office as Assistant
Secretary of the Treasury for Capital Markets and Debt Management
on April 14, 1976. Nominated to the newly established Treasury
post by President Ford on March 19, his appointment was confirmed by the Senate on April 13.
Mr. Gerard joined Treasury in December 1974, as the
first Director of the new Office of Capital Markets Policy.
He was appointed Deputy Assistant Secretary for Financial
Resources Policy in September 1975, continuing in that position until becoming Assistant Secretary.
Earlier, 1970-1974, Mr. Gerard specialized in banking
and securities law as an Associate with the Washington firm
of Wilmer, Cutler & Pickering. From 1969 to 1970, he was
Law Clerk to Judge Carl McGowan of the United States Court
of Appeals for the District of Columbia Circuit.
He is a graduate, magna cum laude, of Columbia University
Law School, 1969, and cum laude, of Harvard College, 1966,
and a member of the Bar Association of the District of Columbia.
At Columbia he was Notes & Comments Editor of the Law Review,
and a Harlan Fiske Stone Scholar.
As Assistant Secretary, Mr. Gerard is responsible for
all domestic financial market matters. He serves as principal
advisor to the Secretary, Deputy Secretary, and Under Secretary for Monetary Affairs on debt management, federal financing, the financing of non-federal sectors of the economy, and
general capital markets policy.
In addition, Mr. Gerard oversees policy and control
of Treasury operations in relation to the Federal Financing
Bank. He is directly responsible for Treasury functions
under the New York City Seasonal Financing Act of 1975 and
for overall policies relating to state and municipal finance
and capital markets.
WS-786
- 2 His other responsibilities include policy direction and
control over staff work on the substance of proposed legislation on regulation, lending, investment, and deposit powers
of private financial institutions, the operations of other
private financial intermediaries and analysis of activity
in all financial markets.
Also, his office is responsible for development of
legislative and administrative principles and standards for
federal credit activities, working closely with federal credit
agencies in the evaluation and design of new credit programs
and legislation.
Born October 19, 1944 in New York City, Mr. Gerard is
married to the former Elizabeth Coolidge Gallatin. They
have two children, Celia Coolidge and Robert Gallatin, and
reside in Washington, D. C.
-oOo-
4-14-76
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WASHINGTON, D.C. 20220
FOR IMMEDIATE RELEASE
April 19, 1976
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SUMMARY OF LENDING ACTIVITY
March 16 - March 31, 1976
Federal Financing Bank lending activity for the period
March 16 through March 31, 1976 was announced as follows by
Roland H. Cook, Secretary:
The Student Loan Marketing Association (Sallie Mae)
borrowed $30 million on March 16 at an interest rate of
5.235%. The loan matures June 15, 1976. Sallie Mae used
the proceeds of the loan to repay a $30 million note
maturing with the Bank. Sallie Mae borrowings are guaranteed by the Department of Health, Education and Welfare.
On March 17, the FFB purchased a $500 million 5 year
Certificate of Beneficial Ownership from the Farmers Home
Administration. The maturity is March 17, 1981. The
interest rate is 7.92% on an annual basis.
The United States Railway Association borrowed against
the following Notes guaranteed by the Department of Transportation:
Interest
Date
Note
Amount
Maturity
' Rate
4/1/76
5.239%
12/26/90
8.055%
1,000,000
4/1/76
5.093%
5
400,000
4/1/76
5.093%
3/31
3
500,000
4/1/76
5.207%
3/31
5
242,000
4/1/76
5.207%
3/17
5
$10,000,000
3/25
6
795,000
3/25
3
3/25
3
On March 30, the U.S. Railway Assoc, signed Note #8
with the Bank. The note allows USRA to borrow up to $228
million. The Association will loan the funds to the Consolidated Rail Corporation (ConRail) under section 211 O J of
the Railroad Revitalization and Regulatory Act of 1976. The
final maturity of the note is April 30, 1979. The USRA borrowed $20 million against this note on March 31, 1976 at a
semiannual interest rate of 7.328%.
WS-787
3&
2The National Railroad Passenger Corporation (Amtrakl
made the following drawings from the FFB:
Maturity
Interest
Rate
12,000,000
6/14/76
5.194%,:
7
10,000,000
6/14/76
5.131%
3/30
6
130,000,000
6/29/76
5.207%
3/31
7
5,000,000
6/14/76
5.207% '
Date
Note #
3/19
7
3/29
Amount
On March 31, 1976 Amtrak borrowed $120,000,000 against
Note #9, a $120,000,000 renewable line of credit with the
Bank. The interest rate is 5.343%. The line is renewable
on July 29, 1976. The final maturity of the line is 4/30/77.
Proceeds of the loan were used to repay Amtrak Note #4.
On March 19, the Bank advanced $1,045,918.13 under a November 25,1975 agreement with Amtrak and others to finance
26 GE electric locomotives. This agreement provides for
^oon
p P a y m e n t s wi th a final maturity date of July 15,
interest rate
X ;™
is 8.125%. Amtrak borrowings from
the FFB are guaranteed by the Department of Transportation.
The Federal Financing Bank made the following loans to
utility companies guaranteed by the Rural Electrification
Administration:
Interest
Date
Borrower
Amount
Maturity
Rate
3/19 South Mississippi $5,235,000 3/27/78 6.9641
Electric Power
Association
3/31 Oglethorpe Electric 3,855,000 12/31/10 8.0651
Membership Corp.
3/31 Associated Electric 4,000,000 12/31/10 8.065%
Coop., Inc.
3/31 Southern Illinois 900,000 3/31/78 6.9051
Power Corporation
Interest payments are made quarterly on the above loans.
- 3The FFB made the following advances to' borrowers guaranteed by the Department of Defense under the Foreign Military Sales Act:
Interest
Date
Borrower
Amount
Maturity
Rate
3/19 Republic of $17,314,463.10 6/30/83 7.555%
Korea
3/26 Government of 1,049,700.00 4/30/83 7.524%
Argentina
3/29
Government of
Morocco
11,649,070.00
6/30/83
7.485?
3A29
Government of
Israel
22,365,109.96
6/10/85
7.624 Q,
•o
0,
3/31 Government of 685,357.15 9/30/85 7.526
China
On March 23, the Bank purchased $2,483,000 of notes
from the Department of Health, Education and Welfare, The
Department had previously acquired the notes which were issued by various public agencies under the Medical Facilities
Loan Program. The notes purchased by the Federal Financing
Bank are guaranteed by the Department of Health, Education
and Welfare and mature on July 1, 2000. The interest rate
.is 8.081%.
On March 24, the Bank purchased the following debentures from Small Business Investments Companies:
Interest
Company
Amount
Maturity
Rate
Capital Investment, Inc.
(Wisconsin)
3,000,000
3/1/86
7.905
Louisiana Equity Capital 100,000 3/1/86 7.905
Corp.
These debentures are guaranteed by the Small Business
Administration.
On March 31, the Tennessee Valley Authority borrowed
$140 million at an interest rate of 5.207%. The loan matures
on June 30, 1976. Proceeds of the loan were used to repay
$110 million of notes maturing with the Bank and to raise
additional funds.
- 4On March 23, the Federal Financing Bank entered into an
agreement with the Rural Electrification Administration to
purchase up to $600 million in Certificates of Beneficial
Ownership in insured notes and other obligations of the
Rural Electrification and Telephone Revolving Fund. The
obligations in the Fund are loans made by REA pursuant to
the Rural Electrification Act to entities which own or contemplate owning rural electric and telephone systems. The
first CBO sale to the Bank in the amount of $166,374,000
took place on March 31, 1976. The CBO matures on March 31,
2006. The rate of interest is 8.205%.
Federal Financing Bank loans outstanding on March 31,
1976 totalled $21.7 billion.
\tUtpartmento\
HINGTON, D.C. 20220 '
EASURY
TELEPHONE 964-2041
397,
ADDRESS BY THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE THE
SOUTHERN METHODIST UNIVERSITY
DALLAS, TEXAS, APRIL 15, 197 6
Thank you, Dean Coleman, Chancellor Tate, Ladies and
Gentlemen,
It is a pleasure and D0. honor for me to participate in
this S.M.Uc "vote1' pixgrsia ano I v:elac:n tbic opportunity to
meet with a crcos section of you" outstanding- student body
ana the convYRinrtY it is par:, of.
1 r*.
nave a specia:. sen.>e or purpose today, aa a guest
£•; eaker ia the Lone Star State in an election yea." with a
Li
V4. o
i.".:? c - J-
to hear from at lease one cut-er-etate speaker who wasn * t
rumvinc; for President.
I world lire ...o anqaoe
I am not attar your votest \v
nut soiiie of the grave
is your shared concern and thoughts about
issues that will still
economic issues facing our couiv
be with us long after the dust of the 1976 campaign trail has
settled and issues that will help to snape the kind of lives
you live long after you have left your college days behind.
For this reason, I was glad to learn ••'•rem your program
sponsors that you wanted to hear about the econon.y
So often,
m an election yea:-:, secondary issues -- everything from nofault insurance to abortion-on-demand -~ elbow the really
major issues off-stage. Yet it is israer like the economy ; —
• -> W O: >oi. ou: "
niPueaee every C- ooect;
especially
'the
economy
™
thalives, day in and out, every year instead of once every four years
Here, then is a capsule review of where we have been
economically, where we stand today, and some of the crucial
decisions we still face.
Economists generally aoree -[.hat the recenrbori hit bottom
i-w vpriJ-' that the recovery began sooner than expected, and
ha
f it has been stronger than expected, Only a few months
a
3°, we began to see light at the" end o f the tunnel. Today,
we are nearly out of the tunnel and on our way to recovering a
ru
U head of steam. For example:
393
— 1975 opened with inflation raging at nearly 13 percent.
That rate has been cut in half to approximately 6 percent.
— Last spring, unemployment had reached nearly 9 percent.
It has now dropped to 7.5 percent and our forecasts indicate
a continuing downward trend..
Other signs point to an economy that is regaining its
vitality: Real GNP, the stock market, personal income,
industrial output, housing starts, retail sales — all are
registering gains and this reflects a rising public confidence
about the economy that contrasts sharply with the deep pessimism
reported by polltakers only a few months ago.
But although we made considerable headway in 1975 and we
are making even more in 1976, this i s no time for complacency.
Inflation is not yet under control and the jobless rate is
still too high.
That is why the Administration is urging Congress to
adhere to a brood-gauged plan to further nurture and stimulate
the natural forces of growth in our private enterprise economy.
An essential element of this plan is to put the brakes on the
dizzying momentum of Federal spending — to slow the rate of
increase to about 5 percent this fiscal yeare contrasted with
40 percent the past two fiscal years. This will allow us to
continue to make progress on inflation and, at the same time,
will make additional tax cuts possible for businesses and
individuals and set the stage for a balanced budget within
three years.
Further, the President has urged tax measures designed
to stimulate job creation generally, encourage the building
of sorely-needed electric power facilities, and increase construction of plant and equipment in areas where unemployment
has topped 7 percent.
Finally, the Administration has proposed elimination
of the unfair double taxation of dividends that retards
capital formationc This is the only major proposal I know
about that, seeks to correct the imbalance between corporate
debt and equity. We must redress this imbalance to allow the
financial markets to channel societyfs savings more efficiently to the more promising investment opportunities. And,
as you also know, improving our lagging capital investment pictv
is absolutely essential to meet our long-term goals of more
jobs, higher incomes, greater productivity, lower inflation and
susta ined crrowth.
- 3 -
w
These steps and the balanced program we have pursued thus
far are designed to fight inflation and unemployment simultaneously and strenghthen the private sector of our economy.
We firmly believe that this course is working, that it
is right for the nation, and that it is leading us back to
the position of robust growth and expanding opportunities.
And yet you will hear a mournful chorus of rhetoric
out of Washington, especially "as the election campaign draws
closer, claiming that we aren't spending enough, aren't
pressing hard enough, aren't pushing enough panic buttons to
solve our problems. Despite our steady gains, many of these
critics assume there must be a basic flaw in the system and
they cast about for other remedies: governmental control over
economic planning •-- guaranteed jobs for everybody at government
expense — a new round of wage and price controls •-- and many
other encroachments on the market place.
Frankly. I believe that many of these critics suffer
from that Park Twain called "loyaJty to petrified opinions."
They faj.l to see that efforts- to strengthen the public sector
at the expense of the private sector are a large part of
the problem, not part of the solution. They refuse to recognize that the same excessive cfove.rnment fiscal,- monetary
and regulatory policies they call for today have led to abase
of our economy and helped trigger, first,- a storm of inflation
in the early 1970s and, second, the severe recession from which
vre are now recovering. And they fail to comprehend a gathering
mood in this country against the further expansion of big
government. They suffer from the economic variety of Potomac
Fever — the delusion that all economic cures must originate in
Washington with the Federal government. As President Eisenhower
once remarked, "There are a number of things wrong with Washington,
and one_of them is that everybody has been too long away from home.
However, public disenchantment with big government does
not mean that all Americans are necessarily immune from the
superficial appeal of quick-fix government programs whose
short-term benefits are well publicized but whose long-term
impact in terms of inflation and economic stagnation is
carefully masked from view.
It may seem strange,and it is certainly ironic, but
a
t a time when the vast majority of Americans are enjoying
such^ abundance and opportunity, too many of us have lost
sigat of the principles and institutions that have made our
W
*Y of life possible.
-4 -
This is certain]y not true in many countries abroad.
I was reminded of this fact during my recent two-week trip
to the Middle East. Israel and the Arab states have sharp
differences, of course. But on one thing they are agreed.
They all have a profound admiration for the achievements and
performance of the American economy. The leaders of the
Middle East believe, as I do, that the United States has
developed the most dynamic and efficient economic system
ever devised.
Largely because of this, they see the United States as the
major source of strength and stability in today's unstable
world.
But here in the United States, somewhere along the line
there seems to have been a dangerous breakdown in communication. Secretary of Commerce Elliot Richardson put it
succinctly the other day when he said that producers and
consumers in this country tend to view each other as antagonists — despite the fact that neither can thrive without
the other.
Too many Americans — especially those born into an
affluent society which seemed to have no beginning or end,
no cause and no effect -- have lost sight of, or have never
been taught, the actual dynamics of prosperity in a free
society.
Today, when nearly everybody takes the fruits of the
free enterprise system for granted -- the abundance, the
opportunities, the freedom of choice, and the chance for
learning, travel ana general upward mobility -•- not everyone
understands the basic economic facts of life that have produced these benefits.
Because of this, I believe that the time is ripe for
an economic heart-to-heart talk with "the American people;
And I believe that the men and women who make up our free
enterprise economy — in business, in the professions, in
the factories — must do even more than they are now if such
a national dialogue is to succeed.
What is at stake is not simply the future of this or
that company, or even this or that industry. At stake is
the survival of the private sector, and, because of the interlocked nature of our freedoms, the survival of the individual
liberties which can never long endure after the collapse of
a societyfs free enterprise system.
ThL; problem of communications exists, as I have had
ample opportunity to observe in my job as Secretary of the
Treasury, and it is getting worse, not better. It is a
question of both policy and perception, for a faulty view or
understanding of the economy makes faulty economic policymaking almost inevitable.
-6-
tyf
Part of the problem is a matter of image. Frequently,
those who support bigger government spending and more government domination of the private sector are perceived as concerned and socially progressive individuals who "care," who
are champions of persecuted underdog.
On the other hand, people who warn that the government
should not and cannot effectively solve every new problem
that comes down the pike, and who advocate instead the
strengthening of the free enterprise system, are seen as
either outdated ideologues or a new generation of economic
exploiters — indifferent to human suffering and only out to
make a fast buck for themselves or their companies.
This stereotype wouldn't matter if it were not so
misleading — so blatantly phoney. My experience in Washington
has convinced me that almost every man and woman in a position
of high public trust cares deeply about the well-being of
our citizens, especially those who are
impoverished or face
disadvantages because of artificial bairriers of sex or color
or national origin.
The central question is not who cr=res the most •»•- we all
care. It is rather the method we choose to broaden prosperity,
reduce human hardship and meet, our other national goals without sacrificing our freedoms or destroying the most successful economic system that, man has even known.
We can talk about the free enterprise system until we
are blue in the face, but it still won't mean much to those
who do not understand what it really means and what makes it
work. It's like trying to discuss the birds and the bees
sensibly with with somebody who is unshakable in his belief
that babies are delivered by the stork.
People who have never seen what happens to countries with
state-controlled economies simply have no standard for comparison.
&
They have never witnessed the long lines of workers
and housewives who have to cue up for hours to buy a poor
selection of over-priced food and state-manufactured
clothing and merchandise. They don't realize what a miracle of variety, economy
and productive competition an average shopping center found
anywhere in the U.S. would represent to most of the world's
people.
They have never asked themselves why a country like
the Soviet Union, with some of the richest grain land in
the world — but with an agricultural system owned and
operated by the government — cannot even feed its own
people without turning to American farmers who own their own
land, make their own decisions and feed not only their
fellow Americans but millions of others as well*
vhry have n"-var lived in cou.n-tr.ies whore the seemingly
idealistic dream of a society witonr private •proparoy or
profit::- has burned into a nightmare reality: where the
state and the state alone dictates what kind of education
you will receive., whether or not you will be allowed to
travel, what kind of jot you can have, what you will be
paid, what you can buy with your own earnings, where you
will live and, ultimatel}7; where you will be buried.
The truth is that regimented societies inflict upon
their citizens not only a political regime that reduces
the individual, in Churchill's phrase, to a mere fraction
of the state, they also inflict an economic regime that smothers
enterprise and breeds inefficiency. Let's face it: Without
the individual profit motive, people simply do not work as
hard, produce as much, or bother to come up with as many
fresh ideas and new improvements. Whether we like it or not,
this is an immutable law of human nature.
Unfortunately, like clean air, economic freedom is
something most people don't really appreciate until it
begins to run out — and then it is often too late.
So I submit to you today that if America continues
down the road toward greater governmental spending and
greater governmental control over our economy and over our
lives -— a road that we have been traveling for several
decades — then all of us will be condemned to an economy
riddled by chronic inflation and incurable unemployment and
those who come after us will be robbed of their personal
and economic freedoms. 'that is really what is at issue
underneath the semantics" and the misleading labels.
-8-
V1
Let me be specific about how our private enterprise
economy has been undermined by excessive government policies.
Just before the New Deal, government spending at all
levels — Federal, state and local — was about 10 percent
of our total national output. Today, because budgets have
mushroomed, government accounts for almost 40 percent
of the GNP. And if recent trends prevail, the government's
share of the total economy will reach 60 percent before the
end of this century.
Let's put present spending in dollar•signs. Today,
and every day during this fiscal year, the Federal Government
will spend $1 billion. And this week and every week this
fiscal year it will go into debt an additional $1 billion.
Since 1962, when the federal budget hit the $100 billion
mark, it has almost quadrupled, and has been in the red for
all but one of those years.
The interest on thr federal debt alone try the end
of fiscal 1913 will have climbed to $36 billion. The amount
in fiscal 1977 will reach $45 billion. That's more than we
spent in any one year on the war in Vietnam. It is almost
half of what we will be spending on total national defense
next year. And it is money, I'm sure you will agree, that
could better be spent on improvements in health care, public
transportation, rebuilding our cities or any of a dozen
other national needs.
Anyone who has ever kept a checking account or managed
the smallest household budget.v^ww^ that
^^^ it
^^ spells
^^^.^^ disaster
^_^
idget knows
to borrow and spend more than you take in for too long.
Heavy government borrowing has fueled inflation and driven
up interest rates so that strains have developed in money
and capital markets. Businessmen feel these strains when
they try to get loans to expand their businesses and create
new jobs: Consumers feel the pinch when they try to buy a
new home without paying an arm and leg in mortgage interest,
and some of you have probably realized the problem when you
have tried to secure low interest student loans in a tight
credit market.
Throughout the nation, we see signs that taxpayers,
who have so long borne the burden of heavy government
spending, are close to open rebellion. In the 19 7 4 elections,
f
or example, voters across the country turned down more
than 75 percent of all bond issues on the ballot. And eight
state legislatures, fed up with rising national debt, have
now adopted resolutions calling for a constitutional
amendment requiring a balanced national budget. As one
state representative put it: "I don't want the government
spending my grandchildren into a poorhouse."
T
1
. 1
n
1
—.: 1
-9-
J/*4
So our major concern as we work our way to a sound
and durable recovery is to avoid another dose of the
same poison which brought on the recession in the first
place: rampant inflation fed by runaway federal spending.
But spending isn't the whole problem. As government
spending has grown by leaps and bounds, so too have
government controls, regulettion and red tape.
Did you realize that government agencies, with an army
of 100,000 on the payroll, exercise direct regulation over
10 percent of everything bought and sold in the United States
and indirect control over almost every other sector of the
private economy?
The avalanche of paperwo?/:k required by this regulatory
network is a tremendous burden on smal.l and big businesses
alike. Business spends an incredible $20 billion a year
just to fill out government .terms. General Motors recently
calculated that it spent more, than $*•«.? billion in 1974
just to comply with existing government regulations o:c get
ready for new ones. This is more than it cost to run the
entire Federal Government for all of the first 75 years of
our history —- and that includes the Louisiana Purchase.
Some of these regulations are, of course, necessary and
in the public interest. But many more of then are counterproductive, wasteful, and obsolete. And as President Ford
has repeatedly stated, those regulations and regulatory
bodies that no longer serve a useful purpose should be
abolished, before we strangle in our own red tape.
Consider the case of natural gas. Because of the
unwillingness of some politicans to deregulate natural gas,
many areas of the country will continue to experience gas
shortages that will cost them jobs, inflict individual
discomfort and inconvenience and slot7 the pace of economic
recovery. All this because a handful of politicians refuse
to deregulate natural gas and let the simple but crucialfree market principle of the profit motive come into play.
The economic fact of life is that products which people are
willing to pay for will be produced, as an adequate price
will insure an adequate return. Things for which people
are not willing to pay an adequate price — or which
government does not allow to be sold at an adequate price —
will not be produced. This is not only the essence, but the
genius of free enterprise.
So today, when so many of America's rich energy
resources remain untapped, and when the need for energy
independence is greater than ever, much of our natural
gas potential goes undeveloped because politicians refuse
to admit that you cannot take'away the incentive to produce
and encourage production at the same time.
We still have the choice of acting in our own best
energy interests instead of reacting to decisions made by
foreign countries. We must start thinking of the energy
challenge in terms of American jobs, homes, food and
financial security.
Our economic well-being and national security depend
upon American control of the American economy. We cannot
jeopardize the future by avoiding the tough energy choices
terry. But we must pay the price necessary to give us
cammand of our own economic destiny.
bet me give you another example of hew big government,
if
•wed to get out of control, threatens the best interests
not -'-dy of businesses but. consumers. Today, many politicians
and y lits are calling for the massive dismantling of the
Ame:
•;. petroleum industry through divestiture.
At a time when we should be encouraging domestic oil
pr-v- ration to make America less dependent on foreign imports,
they advocate a wholesale disruption of the complex and
highly productive free enterprise structure that still makes
it possible for Americans to drive their cars, heat their
homes and turn the mighty wheels of industry at a lower
cost than in any other major industrial nation.
It seems to me that those who urge divestiture have a
moral obligation to show us how — if at all — divestiture
will benefit the consumer and the nation. So far, they have
utterly failed to do so, relying instead on anti-business
rhetoric and the vague promise that somehow, if they are
allowed to go after American oil corporations with a hatchet,
the price of gas will go down.
This is illogical and self-destructive. It makes about
as much sense as asserting that you can get better mileage
out of your car by chopping it up into tiny pieces. In fact,
You will probably get no mileage'at all. And it will cost
you more — not less —- to get the mechanism repaired and
back in working order again. But, in an age when imagery is
often more persuasive than the facts, people sometimes lose
sight of the basic truths.
1/6H
Speaking in 1865, Lincoln said, "I have faith in
the people... the danger is in their being misled. Let
them know the truth and the country is safe," What I
have been trying to emphasize.here today is the need
to hammer home the truth — the economic facts of life -to the American people, especially the young Americans like you
who must lead us in the years ahead.
It is a story that cannot be vividly portrayed on
television like the war in Vietnam or the urban riots of
the sixties. Yet it is the one thing that affects every
aspect of our lives.
And I am convinced that the American public — and
young Americans — have not irrevocably closed their ears
to this story. The polls tell us that businessmen themselves
rank low in public confidence; and yet the principles of
private enterprise rank high. A. majority of Americans say
they want more regulation of businesses, and yet business is
the most popular major field of study among college students ~—
above education., science cava the humanities. Vie can strike
a responsive chord in telling this story to the American
people if we tell it in human, comprehensible terms.
For when we talk about our free enterprise economy we
are talking about food on the table, goods on tne shelves
and services at the counter. We are talking about medical
breakthroughs that have added 10 years to our lives in tne
past generation. We are talking about labor-saving devices
that have freed millions of women for productive careers
and the pursuit of self-enlightment. We are talking about
five out of every six jobs in America and wages and benefits
that stagger the imagination of the rest of the world.
We are talking about a productive base that pays for government
support of the elderly, the jobless, the poor, the dependent
and the disabled. And we are talking about basic freedoms;
to choose a career, to choose what and where we buy, to
choose where and how we live, and yes, to swim against the
tide — as did Fulton and Ford and Edison — things you could
never do living in the gray shadow of conformity under a
regimented society.
And this is the heart of what I am trying to express to
you — the vital human importance behind all those gray, boring
facts and figures that litter the financial page each day.
J/63
No man can be free and a slave at the same time.
No society can sacrifice its economic freedoms and
responsibilities and still expect to preserve the individual
economic rights of its citizens. This is particularly
important to those of you who are just beginning your adult
lives. Whatever happens to me down the road, I have already
had the opportunity to live and prosper as a free man. It is
an experience that nothing can take away from me, no matter
what the future may hold. So I am not very worried for my
own sake.
But I do worry about what the future holds for my
children — some of whom are the same age as you. For as
I have tried to show here today, there are a number of
alarming economic trends already at work that are undermining
your futures. They aren't inevitable and they can be stopped.
But they must be recognized and under: cood before they can
be mastered. And until they are mastered; your future
freedoms are in jeopardy, along with the very essence of
the independent competitive *-.. pirit that has made Pmerica
the richest, freest country in the world.
In this Bicentennial year, if we Iceep alive the spirit
that infuses our national character ~~ the spirit of personal
freedom and free enterprise — then we can be certain that
it will endure for another 20 0 years and more.
But, if we let free enterprise wither away, we 3iiay be
sure that our other freedoms and individual liberties will
expire as well. We must not, we will not, allow this to
happen.
Thank you.
-0O0-
wm*^—-™" " • »
——m* •
^Department of theTREASURY
SHINGTON, D.C. 20220
TELEPHONE 964-2041
ADDRESS BY THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE THE
HOUSTON CHAMBER OF COMMERCE
HOUSTON, TEXAS,. APRIL 15, 1976
J/&Y
Thank you, Mr. Walbridge, Mayor Welch, distinguished
members of the Chamber of Commerce committees, ladies and
gentlemen:
It is a tremendous pleasure for me to be here in Houston
again. The recollection of your hospitality is still warm
from my visit vrith you la.:,t December at the 13 5th Annua .1
Meeting of the Houston Chamber. That occasion was a memoraoj.;
one for me and I have been looking forward to a return
engagement ever since.
And on th: par i.n
occasion, I have an aidded sense
of mission. I feel that, in this -busy election vear, with
key presidential primary coming up h^re in Texas, you
deserve a little change of pace; you deserve to hear from
at least one out-of-state speaker who' isn't running for
President.
• So here I am, asking not for your votes, but for a few
minutes of shared thoughts on some of the basic facts and
problems facing America — the sort of thing that sometimes
gets buried in the political rhetoric of an election year.
Let me begin with a subject of enormous importance to
the country and, even more so, to the Houston area —
energy. Houston is not just the sixth largest city in the
nation and one of our major refining centers. It also
houses our largest concentration of chemical and petrochemical ^ industries and is our largest manufacturer and
distributor of petroleum equipment. So, to a considerable
extent, when we talk about eneroy in America, we're talking
about Houston.
^And, lord knows, there's been an awful lot of talk
about energy lately, much of it dancerously misinformed
ori • : l u a r l Y misinformed have been some of the loud,
Politically .motivated cries for divestiture and furthergovernment controls in the energy field.
#oS~
-2
These cries may yield a few short-term political returns
in an election year, but they are not in the best interests
of the country- Our whole economic system is based on the
simple market principle that products which people are
vailing to pay for will be produced, and an adequate price
will insure an adequate return. Things for which people are
not willing to pay an adeouate price will not be produced.
This is not only the essence, but the genius, of free entertris
Arbitrary controls and politically motivated regulations
that strangle the profit motive can only, in the long run,
make the consumer as well as the producer suffer.
That is why the Administration I serve feels so strongly
about deregulation in general and deregulation of natural
gas in particular. It is also why we continue to oppose
those who would inject more federal interference into the
energy field.
For the facts show that free enterprise is the strongest
force we have going for us in our efforts to meet the energy
challenge. Consider the record to date. Despite inflation
ami the oil embargo, Americans still pay 3.ess to heat tre.-.r
homes, fuel their cars anc Keep the mighty wheels of industry
turning than ant ether major industrial power •— thanks to
our free enterprise system of energy production.
Unfortunately, this hasnVt stopped some people from
trying to make a scapegoat of the energy industry. Imagine,
this is the only sector of our economy that is still under
price controls. What a monumental con job on the part of
political demagogues who have convinced a naive public that
you can control prices and encourage production at the same
time — that you can take away the incentive to drill and
still expect efficient development of America's untapped
energy abundance.
Yet Jba sorry to say that the enemies of the free
enterprise system seem to be winning the propaganda war.
One recent result was the passage in Congress of energy
legislation that neither I nor President Ford felt compietely
comfortable with. However, given the current political
climate and the composition of the Congress, the president
had to choose between a comoromise or no energv leqisjation
J
at all.
This ^Administration fully recognizes the dangers post
y excessive government controls. And we w:i 11 continue to
everything we can to eliminate unnecessary controls and
• revent the establishment or new ores.
*/&£>
-3~
Speaking from personal experience, I know all too well
how an originally small, temporary bureaucracy can take on
a life of its own and spread its tentacles. During the
energy crisis I was called on to head the federal government's
effort to cope with the problems raised by that national
emergency.
Little did I suspect that, in becoming the so-called
"Energy Czar" I would also be present at the creation of a
vast new federal energy empire. The energy crisis ended and
we weathered the storm. I went on to another job. But the
Federal Energy Administration is still with us. It has
taken on a life of its own and is-still a large and growing
part of the Washington scene a striking example of the
cancer of big government..
Another striking example of heedless government interferer.ee
is the growing chorus of politicians and pundits calling for
divestiture" of the oil industry.
those who urge the fractionaliratiov
c\'\
iridi" r:trhave
-~v h a vae moral"
a m o r aobligatio
1 oVdiaotion
of this complex and crucial
incustry
to show us hot — if at air — divestiture till benefit the
consumer and the nation. So far, they have utterly failed
to do so, -relying insterd on anti-business slogans, political
rhetoric: and the vague promise that somehow, if we go after
the oil companies with a hatchet, the price of gas will go
down.
This is illogical ana self-destructive. It mates about
as much sense as asserting that you can get better mileage
out of your car if you chop it up into small pieces. In
fact, you may get no mileage at all. And it will cost you
more — not less — to get the delicate mechanism repaired
and back in working order once the damage has been done.
So I repeat to you my personal commitment to the
Principles of free competition and minimum government
interference in the energy field. But I also remind you
that neither I nor the Administration I serve can win this
battle alone.
We still have tire choice of acting in our" own best
nergy interests instead of reacting to decisions made by
"oreign ^countries. We must start thinking of the energy
isis in terms of American jobs, homes, food and financial
security.
T"!
Cf.:?iHC
i- r -
T' OS -\'\^r•
Our economic well-being and national security depend
-4upon American control of the American economy. We cannot
•jeopardize the future by avoiding the tough energy choices
today. We must pay the price necessary to give us command
of our own economic destiny.
We need your help in getting our side of the story
across to the public. And I hope that each of you as
individuals and as businessmen and women with a strong
personal stake in the energy industry, will devote more of
your time and efforts to getting that story across.
If you don't do it, who will?
Energy, of course is an international as well as
national matter. A few weeks ago I returned from a two-wee]-:
tour of the Middle East. That fascinating and turbulent
part of the world has many dangerous protlems. however, I
came away from my trip with one positive impression. Today,
despite old animosities and conflicts, both the 7-rrabs and
the Israelis, rega?~dless of their political opinions; reali.m
that the United States had developed, the most dynamic
and efficient economic system the world has eve'r 'known.
They sot the United States as the "major source of strength
and stability — economically as well as politically — in
an unstable world. As Secretary of the-Treasury, I found
this encouraging because I am convinced that the way to a
peaceful world political order is through a strong stable
world economic order. For the Middle East, peace and
prosperity can and must, go hand in hand.
As I look around this room,- 'i re^ili.te that there are
some among you whose businesses were hard-hit by the recent
recession and simultaneous double-digit inflation. Perhaps
you might think that the leaders of the Middle East have the
vaiong impression in viewing the United States as being
super-strong economically. Perhaps you would think that, on
the contrary, our economy is in trouble and our economic
future uncertain.
I would agree certainly, our economy has undergone
some trials in the last few years that have made for some
unpleasant results both in unemployment and. inflation. But,
despite this, our country remains the world's greatest
economic power -- and, believe me, the tor id knows it. 3::ven
pociay, we are proving our basic strength by the speed and
e security of our recovery from the recession as compared
h ot
her industrial nations around the world.
We still have a long way to go, but we are on the road
o recovery and we can all take heart from the first round
.Progress that was made during 197 5.
4
J/d!
-5— Nineteen seventy five opened with inflation raging
at 13 percent; we have cut that rate in half •— to about six
percent.
— During the spring of 1975, the unemployment rate
reached nine percent; today it is down, to 7.5 percent.
— Over the past year over 2 million people have found
work and the number of people employed today is at a record
high.
— During the third quarter of 1975, we registered the
biggest single jump in the GNP in 25 years and the fourth
quarter's pace, while slower, still indicates the recovery
is maintaining its momentum.
Thus we made considerable heacVay in 1975, and we will
make even more in 1976. But it's not good enough and this
is certainly no time for corrolacencv. The unenroiovment rate
is still far higher than we can tolerate. And inflation is
by no means completely under control. In fact, it remains
the most dcingerous anem^ of real economic growth. And ail
of us — especially there with a ray in feccral spending -—
must do everything we can to prevent another inflationary
spiral. The ruinous inflation that crested in 197i was the
chief cause or the severe recession of 197 5; if we embark
once again on excessive fiscal and monetary policies resulting
in double-digit inflation, I guarantee you we will have an
even worse recession than before. Let us hope that
it will never be said that the pain and suffering of the
1974-7 5 recession were i]r vain because tno politicians in
Washington refused to face the economic facts of life.
But the problem is not confined to politicians alone.
It may seem strange, and it is certainly ironic, but at a
tune when Americans are enjoying such great, abundance end
such great opportunity, too many of us have lost sight of
the principles and institutions that have made our way of
life possible. Somewhere along the line, there has been a
dangerous breakdown in communications.
Too many Americans -~ especially those born into can
aniuent society which seemed to have no beginning or end,
no cause and no effect
have lost sight of, or have never
-en taught,-*the dynamics of prosperity in a free society.
^ ^ Today, when nearly everyone takes the fruits of the
^ee enterprise system for granted — the abundance, the
PPortuiuty, the freedom of choice, the unprecedented
-6opportunities for learning, travel, and general upward
mobility — not everyone understands the basic economic
facts of life that create all these benefits.
Small wonder then, that when economic difficulties like
the recession hit. millions of otherwise reasonable people
fall for the quack nostrums of politicians who arc more
interested in promising than performing:, and for quick-fix
government spending that provide some short-term relief but
only aggravate the long-term economic ills of inflation and
stagnation in the private sector.
Because of this, I believe that the time is ripe for an
economic heart-to-heart talk with the American people. And
I believe that organizations like the Chamber must do even
more than they are now doing if such a national dialogue is
to succeed.
V?hat is at stake is not just the future of this or that
industry. At stcike is the survival of the private sector, and
the individual liberties which have never long survived the
collapse of a society: s free enterprise system.
Unless we get the facts across today, the America of
tomorrow — of cur children and Grandchildren — will be
doomed to* a system cf economic and political bondage that is
the very opposite of all thatpwe hole dear.
The problem already exists, as I have had ample opportunity
to observe, and it is getting worse, not better. It is a
question of both policy and perception, for faulty perception
of the economy makes faulty economic policy almost inevitable.
And I am firmly convinced that, taken together, misunderstanding and misdirection of the American economy have
become the central, underlying problem of our times.
Part of it is a matter of image. Frequently, and
especially to youthful idealists, those w7ho support bigger
government spending and more government domination of the
Private sector are perceived as concerned, socially progressive men and women who "care" in a nutshell, they are
seen as the humane champions of the Persecuted underdog.
~7~
On the other hand, those who warn that the government
should not — and cannot — effectively solve every new
problem that comes down the pile, and who advocate instead
the strengthening of the free- enterprise system are seen as
either outdated theorists or a new generation of economic
exploiters, indifferent to human suffering and only out to
make a fast buck for themselves and their companies.
To make matters worse, surface appearances often tend
to confirm this inaccurate impression. .Advocates of big
government are able to wax eloquent for hours about the ills
they imagine they can cure by cranking out more currency and
soaking up more credit through massive deficit spending.
They have as many arguments as there are social, economic
and political problems — even though the spending
they advocate, as we have seen with the great society's war
on poverty, is often part of the problem rather than part of
the solution.
Those of us who recognise the fallfcy of the big
government approach have only one argument. lib; the right
one, hut, by dint of repetition, people are getting tired of
hearing about it. For we constantly in voire foe free entarp:
system, too often without defining the freedoms and the
opportunities that it, and it alone, provides. We chant a
slogan, a label, without defining it in comprehensible:
human terms.
We can talk about the free enterprise system until we
are blue, in the face, but it still won't mean anything to
those who do not understand what it really is and what mares
it work. It's like trying to sensibly discuss the birds and
the bees with someone who is unshakable in his belief that
babies are delivered by the stork.
People who have never seen what happens to countries
with state-controlled economies simply have no standard for
comparison.
They have never witnessed
nousewives who have to cue
food and department stores
of overpriced food stapler
anu merchandise.
the long lines of workers and
up for hours outside state-owned
in order to buy a poor selection
and state-manufactured clothing
They don't realize what a miracle of variety, economy
productive competition the average American shopping
-enter would represent to nine-tenths of the earth's people.
0
-8~
They have never asked themselves why a country like th
Soviet Union, with some of the largest, richest tracts of
qrainland in the world, but with a government-owned and y;\.\n
agricultural system,' cannot even feed its people withoutturning to American farmers who own their own land, make
their own decisions and feed not only our own people, but
millions of others as well.
Too often they have been taught to scoff at the very
profit and property motives which make our prosperity
possible.
They have never lived in countries where the seemingly
idealistic dream of a non-profit, propertyless society has
turned into a nightmare reality — where the state ana the
state alone dictates what kind o7 education you wi_P_ rec-~-"vwhether or not you will be allowed to travel; what kind or
job you can have; what you will be paid; what merchandise
you can buy with your earrings; there vou will lime; vi.rm
you will receive medical treatment; and; ultim. temp, the:-'-.vou will be buried.
They have not seen first.--hand the politic. *. . . .
aftermath in societies where the government has oertrovrr
free enterprise. For the personal rights all American:;cberirh — freedom of \7O37>}0rr) r freedom of speetn T-:ud rrtr
of association — have never long endured once
economic freedom has been destroyed. As Alexander !
cr -'- o
warned so long ago, "power over a man's substance a:
power over his will."
Without the individual profit motive, people simply d'
not work as hard, produce as much, or bother to come up wi
as many new improvements. Whether we like it or not, it i:
an immutable law of human nature.
Unfortunately, like clean air, economic freedom is
something most people don't really appreciate until it
begins to run out —- and then it is often too late.
So we have reached the point where, although the free
enterprise system works, and Works better than any othereconomic system in effect anywhere, in the world — and
although it^eeds, clothes and houses more people tore
^fluently than any other while serving as the unoerpiittrn
° ur fr ee society -~ it is somehow losing the war to an
-len philosophy of government control and"
i
M'
-9economic irresponsibility that has never worked but has
somehow managed to preserve ah aura of idealism and altruism
that attracts many young idealists.
All of these misconceptions would be unimportant if
they were not so misleading — so blatantly phoney. My
experience in Washington has convinced me that almost every
man and womrn in position of high public trust cares deeply
about the well being of our people, especially those who
are impoverished or face disadvantages because of their sex
or the color of their skin.
The central question is not who cares the most, but
rather how we broaden prosperity and reduce human hardship
without sacrificing our freedom or destroying are most
successful economic system that man has ever known.
I subm.it to you today that if America, continues down
the road toward greater governmental spending and greater
governmental control over our economy and our lives ~~ a
road tiirt \ve have been moving steadily down for several
decades — then our children will be robbed of their personal
and economic freedoms. And, in the meantime, all of us will
be condemned to an economy riddled by chronic infratio?-; and
incur^hie unemployment.
That is really what is at issue underneath the semantics
and the misleading labels, and of course young .Americans
have an even greater stake in the outcome than che rest of
us.
Let's look at a few facts about government spending.
For most of our history, the Federal Budget staved somewhere
below the $100 billion mar]; ™ usually way below it.
Then, in 19G2, we finally hit $100 billion — and that
was only the beginning. Seven years later, the budget broke
the $200 billion barrier and then, only four years after
that, we hit the $300 billion mark. And new, in our bicentennial
year, we have reached the point where the Federal Government
^ spending $1 billion a day.
The veryi. size of such numbers makes them almost meaningess to the average American. But there are ways of getting
Chr'™r S a g e a c r o s s * F o r trample; suppose that^on the day
S
as
born, a man had iron given $1 billion on the
pnn ! ;/'
<-onori 11 nn -'-h-*4- \
,. , .
l
- -on moat no or has he:rs spent $1,000 every day.
0
-10seven days a week. How long would- that $1 billion last?
Adding it up, I think you 1 11 find that today, almost 200
years later, the grandchildren would still not have spent
the full billion dollars. .
Yet our Federal government is spending $1 billion every
single day, and going into debt another $1 billion every
week.
And as the budget grows, the government comes to occupy
a more and more dominant role within our society.
In 193 0, government spending at all levels — Federal,
state and local — amounted to about ] 0 percent of the Gross
National Product. Today, because budgets have mushroomed,
government accounts for nearly 40t of our entire national
o't-rtt
and
if rcco v, r
t r e n d s "eta-vat"*
the ^^--r.o-- -~ -- ---g ; r- 5pm'1 a
of the total economy could reach 6 0 percent before the end
of this century.
For taxpayers, the bard! on of paying the gover: -men t' a
bills has become co heavv that many are row in ore?! rebellion
In the 1974 general elections, for example, voters across
the country turned down some three quarters of c:tl bond
issues on, the ballot. But too many get around this public
opposition by voting more federal spending without increasing
taxes.
The result has been a string of Federal Budget deficits.
that are unparalleled in our history. In 16 of the last 17
years, the budget has been in the red. And now, just when a
balanced, healthy economic recovery has begun, the advocates
of hig spending would have us launch another round of
reckless spending and runaway inflation.
It is up to us to stop them.
I wish that there was some way for television cameras
to portray this story as vividly as they did the war in
Vietnam or the race riots of earlier years. For, while the
visual images are less dramatic, the problem is every bit as
Pressing and important.
But, as the groat 19th century hislorirn Thomas Carlyl.e
once said- rhl \ \ \ r-;-< '] c« ( ^^r<p,r
-• <- 4-^« "pp~—-1
^r^^-nrr- "
On
"he surface, it seems nothing more than a pile -of charts and
lumble of numbers so large as to be incomprehensible in
everyday terms. To put it mildly, economics seloom makes
sexy' news stories. And yet the economy is the cue thing
fo^ , a f f e c t s Gv cry other aspect of American life — the
freV^ ° a t ' t h G quality o f o u r education, our mobility, our
^•edom of choice in careers, services and merchandise, and
material anct personal sense of-pride and independence.
a
M
-11The smallest shock to the economy is felt in every limb
of the body politic.
And that is a big story, if only a
graphic gripping way of telling it could be found.
Consider the case of the Federal debt and its impact.
As the debt climbs rapidly u p w a r d s , we have to pay higher
and higher interest cost on it. By the end of fiscal year
1976 we will have spent $36 "billion in interest payments
alone.
That's more than we spent in any single year on the war
in Vietnam.
I t f s more than a third of our national def- Q ^ i
budget. And it is money that could be better spent on nee;
such as public transportation, health care or airy of a dcz
worthy purposes.
This heavv borrowing by the government has also aggra"
inflation and increased interest r a t e s , creating strains i:
money ? n d c a p i t a 1 ma r}: e t s « T h i s , i n tu r n ,' affects e v e r y o rfrom the businessman interastod in expanding his plant to
create new jobs, to the young couple trying to buy their
first home without paying an. arm and a leg in mortgage
interest.
Reckless government spending is the basic cause of
inflotiojr, and inflation was the underlying cause of the
worst recession our country has experienced in a generatio:
a recession we are only now beginning to recover from.
It was inflation that cuased a loss of real income an
the confidence of consumers, prompting the sharpest droo i
consumer spending since World War I I . And it was infratio:
that helped dry up the flow of savings into our thrift
institutions, driving up interest rates and causing the
housing industry to collapse.
i -{-"h t h e
So one of our prime concerns as we proceed wit!
economic recovery is to avoid another dose of the poison
that brought the recession on. in the first place - ramparr
inflation fed by runaway federal spending.
B 3t s endirj
l
P
9 isn't the whole problem. There is also
'he matter of government control and regulation for, as
government spending has grown by leaps and b o u n d s , so too
nas
federal j;ed tape.
Did
3. ^. a y ° u realize that
sol^Cr r e g u l a t - o n over ]0
simo ln t h e U n i t e d States
st every other sector
government agencies now exercise
percent of everything boucht arc
and indirect regulation over
of the private economy?
-12Did you know that it costs private industry — and that
means each one of us as consumers — approximately $2 0
billion a year just to do the. paper work demanded by Federal
bureaucrats?
Some of these regulations are, of course, necessary.
But many of them are counter-productive, wasteful, or obsolete.
And as President Ford has repeatedly stated, those regulations
and regulatory bodies that no longer serve a useful purpose
should be abolished, before we strangle in our own red tape.
Let me conclude with these few observations:
As we enter our third century as a nation, I believe
the time has come not to reappraise our dedication to a
better life for all — that dedication is clear •-••• bat to
reappraise what we can pay for and how we can do it. The
current plight of New York City, the disease that afflicts
the British economy, and the overwhelming sire of our c-wn
Federal deficits are al i grate varnirgr to us. We can pay
for what we now have and provide for the future only if cur
great capi.taiist economy does its job
•-- procuces goods in ii
V
free market and makes a sufficient p
I am.sick and tired of people apologizing for the free
enterprise system. It has given this cou.ntry the highest
standard of living and the greatest prosperity ever known,
and of most importance, has helped to give us the greatest
freedom ever known to man. And it will continue to do that
unless it is crushed by the juggernaut of big Government.
What we need are not fewer but more capitalists in the
United States — more people with a real and direct stake in
the profits generated by a productive economy. be cannot
continue to have more and more of our citizens involved only
m receiving benefits from the government and fewer and
fewer people responsible for paying for the benefits. We
must broaden the base of those who work and narrow the base
of those who are able but don't want to work.
President Ford urged that we strike a "new balance" in
our national life:
— A balance that favors greater freedom and vitality
-or our private enterprise system,
-x -.- -x -» -
-. - -
A balance that favors greater honesty and realism in
baling with the challenges of* our time.
-13These are great goals — goals worthy of the greatest
nation on earth. We should not begin our Bicentennial year
by retreating into the past, but by going forward into the
future with a common combination of patience, realistic
hope, courage and common sense.
If we work together with common purpose and conviction —
with pride in ourselves and "our nation —- the goals we share
today can become the first achievements of our third century
together.
President Ford has set a course which points us in the
right direction and will permit us to get a grip on these
problems, but it will take several years, not months, to
bring this about. Unfortunately, the election is only a bit
over seven months away. There will be calls from the opposition
for "sweeping charges" and "broad new initiatives" which
will really mean bigger spending, bigger deficits and ultimately
bigger governmental control of the. economy. We mrtet persuade
the hmaricar people that this course is wrong' and that the
other approach is much sounder :.. n the long run.
The reai. choice is between greater government control
or greater individual freedom. That is the decision before
us.
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Ik Department of the TREASURY
HINGTON, D.C. 20220
TELEPHONE 964-2041
4/7
FOR IMMEDIATE RELEASE
April 19, 1976
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $2.5 billion of 13-week Treasury bills and for $3.4 billion
of 26-week Treasury bills, both series to be issued on April 22, 1976
were opened at the Federal Reserve Banks today. The details are as follows:
RANGE OF ACCEPTED
13-week bills
COMPETITIVE BIDS: maturing July 22. 1976
High
Low
Average
Price
98.802
98.793
98.796
Discount
Rate
26-week bills
maturing October 21. 1976
Investment
Rate 1/
4.739%
4.775%
4.763%
4.86%
4.90%
4.89%
Price
97.442
97.420
97.427
Discount
Rate
Investment
Rate 1/
5.060%
5.103%
5.089%
5.26%
5.31%
5.30%
Tenders at the low price for the 13-week bills were allotted 27%.
Tenders at the low price for the 26-week bills were allotted 36%.
TOTAL TENDERS RECEIVED AND ACCEPTED BY FEDERAL RESERVE DISTRICTS:
District
Received
19,435,000
Boston
$
New York
,526,525,000
Philadelphia
84,745,000
Cleveland
59,995,000
Richmond
32,110,000
Atlanta
53,740,000
Chicago
259,280,000
St. Louis
73,915,000
Minneapolis
46,310,000
Kansas City
33,700,000
Dallas
34,260,000
San Francisco 277,280,000
TOTALS$5,501,295,000
Accepted
$
16,435,000
2,159,480,000
28,615,000
28,345,000
20,700,000
44,740,000
47,815,000
35,065,000
11,310,000
27,725,000
14,260,000
68,170,000
Received
Accepted
$
10,500,000 $
8,000,000
4,510,680,000
2,866,880,000
5,805,000
5,805,000
87,885,000
41,485,000
39,080,000
34,065,000
31,525,000
29,225,000
305,270,000
181,410,000
66,890,000
48,890,000
47,065,000
37,065,000
18,665,000
18,665,000
25,185,000
18,685,000
217,890,000
109,890,000
$2,502,660,000 a/$5,366,440,000
$3,400,065,000 b/
£/ Includes $353,295,000 noncompetitive tenders from the public.
^ Includes $181,005,000 noncompetitive tenders from the public.
1/ Equivalent coupon-issue yield.
WS-788
<f> i n
a> ,-«
'E vo
o
u
l
nnancing
DQIIK
WASHINGTON, D.C. 20220
FOR IMMEDIATE RELEASE
ES
£8
April 19, 1976
J//?
SUMMARY OF LENDING ACTIVITY
March 16 - March 31, 1976
Federal Financing Bank lending activity for the period
March .16 through March 31, 1976 was announced as follows by
Roland H. Cook, Secretary:
The Student Loan Marketing Association (Sallie Mae)
borrowed $30 million on March 16 at an interest rate of
5.235%. The loan matures June 15, 1976. Sallie Mae used
the proceeds of the loan to repay a $30 million note
maturing with the Bank. Sallie Mae borrowings are guaranteed by the Department of Health, Education and Welfare.
On March 17, the FFB purchased a $500 million 5 year
Certificate of Beneficial Ownership from the Farmers Home
Administration. The maturity is March 17, 1981. The
interest rate is 7.92% on an annual basis.
The United States Railway Association borrowed against
the following Notes guaranteed by the Department of Transportation:
Interest
Date
Note
Amount
Maturity
Rate
4/1/76
5.239%
12/26/90
8.055%
1,000,000
4/1/76
5.093%
5
400,000
4/1/76
5.093%
3/31
3
500,000
4/1/76
5.207%
3/31
5
242,000
4/1/76
5.207%
3/17
5
$10,000,000
3/25
6
795,000
3/25
3
3/25
On March 30, the U.S. Railway Assoc, signed Note #8
with the Bank. The note allows USRA to borrow up to $228
million. The Association will loan the funds to the Consolidated Rail Corporation (ConRail) under section 211 (h) of
the Railroad Revitalization and Regulatory Act of 1976. The
final maturity of the note is April 30, 1979. The USRA borrowed $20 million against this note on March 31, 1976 at a
%.
semiannual interest rate of 7.328a
WS-787
- 2The National Railroad Passenger Corporation (Amtrak)
made the following drawings from the FFB:
Amount
Maturity
Interest
Rate
Date
Note #
3/19
7
12,000,000
6/14/76
5.194%6:
3/29
7
10,000,000
6/14/76
5.131%
3/30
6
130,000,000
6/29/76
5.207%
3/31
7
5,000,000
6/14/76
5.207%
On March 31, 1976 Amtrak borrowed $120,000,000 against
Note #9, a $120,000,000 renewable line of credit with the
Bank. The interest rate is 5.343%. The line is renewable
on July 29, 1976. The final maturity of the line is 4/30/77.
Proceeds of the loan were used to repay Amtrak Note #4.
On March 19, the Bank advanced $1,045,918.13 under a November 25,1975 agreement with Amtrak and others to finance
26 GE electric locomotives. This agreement provides for
serial repayments with a final maturity date of July 15,
1989. The interest rate is 8.125%. Amtrak borrowings from
the FFB are guaranteed by the Department of Transportation.
The Federal Financing Bank made the following loans to
utility companies guaranteed by the Rural Electrification
Administration:
Interest
Date
Borrower
Amount
Maturity
Rate
3/19 South Mississippi $5,235,000 3/27/78 6.964%
Electric Power
Association
3/31 Oglethorpe Electric 3,855,000 12/31/10 8.065%
Membership Corp.
3/31 Associated Electric 4,000,000 12/31/10 8.065%
Coop., Inc.
3/31 Southern Illinois 900,000 3/31/78 6.905%
Power Corporation
Interest payments are made quarterly on the above loans.
* / &
• 3The FFB made the following advances to' borrowers guaranteed by the Department of Defense under the Foreign Military Sales Act:
Interest
Date
Borrower
Amount
Maturity
Rate
3/19 Republic of $17,314,463.10 6/30/83 7.555%
Korea
3/26
Government of
Argentina
1,049,700.00
4/30/83
7.524
3/29
Government of
Morocco
11,649,070.00
6/30/83
7.485%
3A29
Government of
Israel
22,365,109.96
6/10/85
7.624%
3/31 Government of 685,357.15 9/30/85 7.526%
China
On March 23, the Bank purchased $2,483,000 of notes
from the Department of Health, Education and Welfare, The
Department had previously acquired the notes which were issued by various public agencies under the Medical Facilities
Loan Program. The notes purchased by the Federal Financing
Bank are guaranteed by the Department of Health, Education
and Welfare and mature on July 1, 2000. The interest rate
.is 8.081%.
On March 24, the Bank purchased the following debentures from Small Business Investments Companies:
Interest
Company
Amount
Maturity
Rate
Capital Investment, Inc.
(Wisconsin)
3,000,000
3/1/86
7.905%
Louisiana Equity Capital 100,000 3/1/86 7.905%
Corp.
These debentures are guaranteed by the Small Business
Administration.
On March 31, the Tennessee Valley Authority
_w n
. .
m u ^ x ^ u rate
x«uv, wx.
*~~
•140 million at
an
interest
of ^.*-v,,u.
5.207%. The
Jun
30, 1976
t?i ?
- Proceeds of the loan were used
•110 million of notes maturing with the Bank and
additional funds.
bo rrowed
.jan m a t u r e s
lo
to repay
to raise
- 4 On March 23, the Federal Financing Bank'entered into an
agreement with the Rural Electrification Administration to
purchase up to $600 million in Certificates of Beneficial
Ownership in insured notes and other obligations of the
Rural Electrification and Telephone Revolving Fund. The
obligations in the Fund are loans made by REA pursuant to
the Rural Electrification Act to entities which own or contemplate owning rural electric and telephone systems. The
first CBO sale to the Bank in the amount of $166,374,000
took place on March 31, 1976. The CBO matures on March 31,
2006. The rate of interest is 8.205%.
Federal Financing Bank loans outstanding on March 31,
1976 totalled $21.7 billion.
4£z
R$¥t'$W of
ECONOMIC AND FINANCIAL
DEVELOPMENTS
April 9, 1976
THE COMING INVENTORY BOOM
On top of the continuing strength in consumer spending (the primary
force in the current economic expansion), prospects now point to an
inventory boom — one that might carry the economy to higher economic
growth rates later this year and next than were officially forecast last
January.
Indeed, the prospective huge volume of inventories that businesses
may wish to accumulate to achieve a desired relationship with sales
might be frustrated — because of limited resource capability.
Otherwise, an "inventory explosion" could well develop.
Real Nonfarm Inventories and Final
Sales of Goods and Structures
Inventory-Sales Ratio
.40-
.38
.36
•Long-term Trend
.34
i i i i i i i i i
10^_
i i i i i
i i i
Percent Change
(from 4 quarters earlier)
Inventories
' ' I l I I I i I I-i i i I i i i I i i i I i i i I i
1968 1969 1970 1971 1972 1973 1974 1975 76-1
est.
Changes in inventory
investment typically represent an important swing
element in rates of change
in GNP during economic
contractions and expansions.
During periods of decline in
economic growth, inventories
accumulate because production
cannot be curtailed quickly
enough in reaction to the
decline in "final sales"
(i.e., GNP less inventory
change). In contrast,
periods of economic upswing
typically are characterized
by under-accumulation of
inventories — because
production cannot be expanded
quickly enough to provide
for the deficiency of stocks
resulting from rapid advances
in final sales.
That pattern is being
repeated in this latest
business cycle experience.
As real final sales
declined during the
course of 1974, the
inventory-sales ratio for
the economy reached a
443
- 2 -
postwar high by the end of that year, as shown in the chart on page
one. In the subsequent economic expansion that has now proceeded
into the first quarter of 1976, real final sales rose dramatically,
an increase that has not only absorbed the inventory overhang which
had developed, but also has created shortages in stocks in some
areas.
During this period, the inventory-sales ratio (the real value of
stocks in relationship to the real value of final sales of goods and
structures) plummeted from a postwar high of .41 in the fourth quarter
of 1974 to an estimated .38 in the first quarter of 1976. Allowing
for trends in this ratio, the estimated first quarter 1976 value
indicates, at the very least, the restoration of some balance in the
aggregate. (As indicated below, the ratio appears low at retail and
somewhat high at the manufacturers ' level.)
The decline in the inventory-sales ratio primarily registered an
advance in final sales for the economy at large at a rate of about
4 1/2% from the first quarter of 1975 to the first quarter of 1976
(consumer spending increased at a more rapid pace over this period — about
5 1/2%, while other elements of final sales, business fixed investment,
net exports and Government, rose somewhat less) .
It was this accelerated rate of expansion in final sales that has
erased much of the inventory overhang and set the stage for 1976 as
a year of an inventory boom.
The magnitude of that boom that might be expected is indicated by
the experience of other postwar expansions. Advances in inventories
have roughly matched increases in final sales of goods and services
(though on occasion the change of stocks might lag the change in sales
by a few quarters) .
This has been the invariable postwar pattern — swings in real
inventory holdings roughly follow swings in real final sales,
as shown in the lower panel of the chart on page one; the magnitude
of the fluctuations in inventories over most of the post-Korean war
period has roughly matched that of final sales of goods and services.
It is this relationship which promises to provide the basis for an
inventory boom later this year and in 1977. Real final sales might be
expected to rise 5%, or somewhat more, over the four quarters of 1976.
This expectation would rely on the average experience in the rate of
growth in final sales during the four previous economic recoveries;
and on an analysis of expected demands by the consumer and business
sectors.
42.V
- 3 -
If this rate of final sales is realized, then inventory accumulation
could be expected to be very sizeable. In 1972 dollars, inventory
investment that would be associated with this rate of final sales
increase would average in the neighborhood of $16 billion per quarter.
If that $16 billion were to be realized, real economic growth in
1976 would amount to 7% — nearly 1% more than had been projected in
the Budget and the Economic Report.
However, that rate of accumulation in inventories wouldappear
unlikely because:
• Acceleration of production could not feasibly proceed quickly enough
to satisfy an already rapid rate of consumer spending, as well as to
build inventory.
• Inventory accumulation may be limited by business caution, due to
memories of the excesses in stock building in 1974.
• Some overhang of excessive inventory remains — especially in the
metals.
• For a while, the composition of expected output would be weighted
toward consumer goods, which requires relatively less time in production than capital goods or defense equipment, which means that
a smaller buildup of goods-in-process inventories might be expected.
Nevertheless, some markup in the rate of real growth from the
January 1976 projections appears in order.
That correction might be in the neighborhood of an accumulation
of $10 billion — which would raise total GNP real growth in 1976
by additional 1/2 percent more than in the January estimates.
The principal source of that correction might be expected at retail. As shown in the chart on the next page, the level of inventories
in relation to retail sales has been pared drastically. Despite the
strong rebound of retail sales in 1975 and early 1976, merchants' ordering to restock shelves has been extremely cautious. By the last
quarter of 1975, the constant dollar value of retail inventories to
consumer goods purchases had reached the lowest level since 1969,
while early reports for the first quarter of this year point to a
further decline. If retailers do not restock soon, sales gains will
be smaller than they otherwise would be. Presumably, ordering for
re-stocking will grow stronger, contributing to the inventory expansion
to be expected in 1976 and 1977.
- 4 -
Ratio of Retail Store Inventories
to Consumer Purchases of Goods
150r(Constant dollars)
In contrast, some overhang of production materials and supplies still
exists at the manufacturing level, especially
among durable goods manufacturers. (Some of
this overhang has been
masked by shifts in
accounting methods,
which have distorted the
commonly cifce4 ratios of
book value inventories
to sales.)
Expectations
of an
.130inventory boom in 1976 rest
on the assumption that some
.125
balance of stock-sales
1969
1970
1971
1972
1973
1974
1975
ratios/ in the aggregate,
had been reached by the end
of the first quarter of this
year; and that re-ordering has begun and will be showing up in figures
not yet calculated. Already, some indicators which normally lead swings
in inventory stocks would suggest that the boom will be developing.
Among them are:
• The proportion of manufacturers reporting inventories to be too
high had fallen by the fourth quarter of 1975 to that averaged
during 1972, prior to the inventory scramble of 1973.
• By year-end 1975, manufacturers who characterized inventories as
too low were about the same proportion as in mid-1973. Only 1.1%
of the dollar value of manufacturers' inventories were reported as in
excess, about the same as late 1973, and down from 4.4% in late
1974.
In the first quarter of this year, the proportion of companies reporting 60 day or more commitments to purchase production materials
had already returned to rates of early 1973.
The proportion of firms reporting slower deliveries has mounted
sharply to 50% midway in the first quarter of this year, up sharply
from 16% a year ago, which was the lowest level since just prior to
the Korean War.
- 5 -
All these indicators would appear to signal that rebuilding of
stocks is ahead. Indeed, the return of many of these indicators to
late 1972 or early 1973 levels may foreshadow the eventual emergence
of some market congestion should the recovery proceed at too rapid a
pace.
Initiator: Russel
Reviewer:
OFFICE OF THE SECRETARY OF THE TREASURY
OFFICE OF FINANCIAL ANALYSIS
Liebling
Department of theTREASURY
U
OFFICE OF REVENUE SHARING
WASHINGTON, D.C. 20226
TELEPHONE 634-5248
7-/127
FOR IMMEDIATE RELEASE
FRIDAY, APRIL 23, 1976
CONTACT: PRISCILLA CRANE (202) 634-5248
The amount of General Revenue Sharing money to be
paid each of nearly 39,000 states and local governments
for the period 7/1/76-12/31/76 (Entitlement Period Seven)
was announced by the U.S. Treasury Department's Office of
Revenue Sharing today. A total of $3.3 billion will be
distributed to all general governments in the United States
in two quarterly payments, in October 1976 and January 1977.
These allocations of shared revenues in the General
Revenue Sharing Program have been made using data provided
by the U.S. Bureau of the Census, the Bureau of Indian Affairs,
the Bureau of Economic Analysis and the Internal Revenue Service
as required by law. Fiscal year 1975 data on local tax effort
and intergovernmental transfers and estimated 1973 population
and 1972 per capita income figures were used in making the
new allocations for local governments. Data used for the
interstate allocations were: 1975 population; 1970 urbanized
Population; 1972 per capita income; FY 1974 state and local
taxes; 1974 general tax effort factor; 1975 state individual
income taxes; and 1974 Federal individual income tax liabilities.
These data have been published and are available from the
Office of Revenue Sharing today, as well.
-more-
-2-
+&?
Amounts to be paid for Entitlement Period Seven also
reflect adjustments to fiscal year 1976 amounts, based on
calculations made with verified and improved data obtained
during the current year.
The amounts that states and local governments may expect
to receive have been printed on Planned Use Report forms
mailed today to each recipient State, county, city, town,
township, Indian tribe and Alaskan native village in the
United States.
On the Planned Use Report form, due to be returned to
the Office of Revenue Sharing by June 25, 1976, the Chief
Executive Officer of each recipient government must report
that government's plans for uses of the revenue sharing money
it will receive in October and January.
The Planned Use
Reports must be published locally in newspapers of general
circulation.
In addition, the news media in each area --
including bi-lingual news media -- must be informed about the
report.
A copy of the report and supporting documentation
must be made available for public inspection at a location
announced on the published report form.
The publication requirement in the revenue sharing law
was intended to provide citizens with information about the
General Revenue Sharing Program as it affects their communities.
Citizens may suggest changes in proposed uses of the money
before it has been spent.
-more-
-3-
^>f
Governments that fail to file Planned Use Reports with
the Office of Revenue Sharing will not receive their quarterly
checks on schedule.
The funds will be held by the Office
of Revenue Sharing until the forms have been properly published
and filed.
Title I of the State and Local Fiscal Assistance Act
of 1972 authorized and appropriated $30.2 billion to be
distributed to all units of general government in the United
States over a five year period, from January 1972 through
December 1976.
Thus far, the Office of Revenue Sharing has
made payments totaling $25.1 billion.
President Ford has requested the Congress to renew
General Revenue Sharing past its present deadline of December
1976.
-30-
Attachment (Summary of amounts by state)
GENERAL REVENUE SHARING
ENTITLFMFNT PERIOD T
REVENUE SHARING SUMMARY
NAME
REVENUE SHARED
EP1 - EP 6
REVENUE TO BE
SHARED EP 7
TOTAL
ALABAMA
447(662*946
53*655*635
501*318(581
ALASKA
35*954*661
6*163*852
42(118(513
ARIZONA
270*566*622
31*568*633
302(135(455
ARKANSAS
277*650*786
35*184*413
312(835*199
CALIFORNIA
2*833*814**30
355*937*060
3*189(751*890
COLuHADO
283*428.418
36*952*898
320(381.316
CONNECTICUT
344*574*611
42*338*167
386(912*778
DELAtfAHt
80*389,615
10*593,740
90,983.3*5
HIST OF COLUMBIA
117*663.975
13*937*679
131*601*654
FLOKIOA
797.944.296
100.068.236
898.012*532
GEOHGIA
559*788,105
70.155*647
629.943.752
HA»AlI
117*813.980
15*093*313
132.907,293
IDAHO
107,452.155
12*106*000
119,558.155
ILLINOIS
1.364.075.043
171.003.774
1*535.079*717
INDIANA
561.025.278
70.477.608
631*502*886
IUMA
371,152,194
41,020.818
412*173*012
KANSAS
253*986*584
29.780.133
283.766.717
KENTUCKY
435*773,556
55.764.577
491*538.133
LOUISIANA
604.741,704
73.221,373
677.963.077
"AINE
165.105.P44
20*362*152
185.467,996
MAWYLANn
530,112.786
66*700*249
596,813.035
MASSACHUSETTS
851,6*4,962
105.127.729
956.772.691
*1CHIGAN
1,133,423.308
136.985.459
1*270.408*767
MINNESOTA
537,702.337
66.863.683
604*566*020
MISSISSIPPI
429,362,420
50,541,781
479.904,201
"ISSOuwi
504,773,4^9
62,791,007
567,564,506
MONTANA
104,415.853
12,314,508
116,730,361
VE6-JASKA
188.283.919
20,996*442
209,280,361
NEVADA
59.492.^24
8,341,504
67,834,028
NE* HAMPSHIRE
65.349,^03
11.111.869
96,461,472
NE» JERSEY
839.008,455
104.703.165
943.711,620
Nt> Mfc'xICO
168,696,409
21.475.863
190,172,272
\t« ruRn
2,992.504,147
377.918.901
3,370,423*048
N(!"1M CAROLINA
678.b28.827
83.446,756
762,075.583
NORTH OAKOTA
99.761 ,666
9,427,804
109,189,470
"Hlu
1.073.421.551
134,452,879
1,207,874,430
OKLAHOMA
298.880,685
36,356,454
335,237,139
OHtbO^
269.272,210
35.843,413
305,115,623
PENNSYLVANIA
1, 409.223.986
176,000,540
1,585,224,526
•^HOJE ISLANO
119,201.645
14,321,168
133,522,813
SOUTH CAKOLINA
368,988,870
46,187,186
415,176,056
SOUTH DAKOTA
115,804,732
10,631,185
126,435,917
TENNESSEE
505,594,163
62,208,572
567,802,755
TEXAS
1,275.788,21?
165,025,582
1,440,813,794
UTAH
157,659,236
18,748,068
176,407,304
VERMONT
77,094,«82
8,817,077
85,911,959
VIRGINIA
532,979,151
67,500,587
600,479,738
••ASHINGTON
386*953,353
50,782,459
437,735,812
WEST VIRGINIA
258,028,119
30,607,715
288,635,834
WISCONSIN
673*921,526
80,488,915
754,410,441
WYOMING
47,702,700
5,424,767
53,127,467
° NATIONAL TOTALS *
26,804,241,859
3,327,529,195
30,131,771,054
FOR IMMEDIATE RELEASE
Remarks of David F. Bradford
Deputy Assistant Secretary of the Treasury for Tax Policy
at the National Association of Manufacturers Conference
Washington, D. C.
April 20, 1976
Feedback Effects and Tax Policy Analysis
The title of this conference, "The Economic Impact
of Tax Proposals: Are Revenue Estimates Enough?" is, I
hope, a rhetorical question. Certainly academic students
of the economics of public finance will find it a curious
one. I'm sure one would have difficulty finding the
subject of revenue estimating on a course syllabus, or
discovering any significant writings on the subject in
the vast volume of economic literature about taxes.
In saying this, I do not intend to belittle the
importance of high quality analysis of the revenue
consequences of tax policy choices. Clearly this is a
proper component of intelligent decision-making, and the
skill with which this function is carried out by the
Treasury staff members is extraordinary. However, the
economic analysis of tax policy by and large treats the
revenue aspects as secondary, a matter of the constraint
within which the objectives of fairness and efficient
resource use are to be pursued.
In the legislative process, however, revenue effects
of tax law changes seem to have a disproportionate
importance. Often whether or not a proposed tax change
is accepted turns on the estimated revenue consequences,
and revenue effects are often used as a measure of the
degree to which a reform serves the objective of equity,
which is essentially unrelated to revenues.
WS-790
- 2 I am not sure why this is so, but I can suggest two
reasons.
One is the budgetary setting within which tax law
changes are necessarily made. While year by year budget
balance is no longer considered necessary, the terms in
which budget objectives are set tend to emphasize the
revenue total. The budget represents an important
component, perhaps the most important one, of the plan
of action by which resources are directed to government
use. And because the Federal Government is such a large
actor in the system this plan must account as well for
the influence of government actions on the private
economy. In the budget-making context this means especially
the consequences for the level of employment of labor and
capital resources and the rate of price inflation.
We all know, or we should know, that the budgetary
aggregates — spending and receipts — represent very
imperfect measures of the influence of the government on
the private economy, even on such gross aggregate measures
of the performance of the private economy as the level
of employment and rate of inflation. Tax policy is bound
to affect differentially different sectors of the economy.
Further, policy alternatives which have the same tendency
to stimulate or retard the aggregate level of activity
are bound to have different implications for tax receipts
in a given period.
However, it is exceedingly difficult to describe a
budget's total effects, and I think most people regard
it as a heartening advance that Congressional procedures
have been developed which attempt to deal with this issue
at all. Still the principal instrument by which budget
control is exercised in that procedure is the overall
revenue constraint. That is, the main method by which
Congress attempts to coordinate its fiscal program to the
budget horizon is an aggregate which cannot recognize
the subtleties of the effect of the composition of the
revenue picture.
In my view, given the state of the forecasting art,
the dullness of this instrument of control is not very
serious. However, it does put a tremendous burden on the
revenue estimates of tax alternatives, since these
estimates have a crucial bearing on the package of tax
proposals which "fits" the revenue target in the budget.
4&
-
3 r-
I noted that two^possible reasons for the great
emphasis on revenue estimate^^in^the legislative process
had occurred to me. * The first; is the budgetary setting
of tax legislation. The; second is the considerable
ignorance that exists about the functioning of the market
system and the way in which taxes impinge on it, The
result is a tendency to regard revenue effects as the
most important ones. The ignorance is by no means confined
to legislators, and I do not wish ±o exaggerate the
accomplishments d£ economic science. However, I think
it is clear that economists have thus far failed to
communicate /peV^uasivefy what they have learned//at least
about the appropriate questions which should be raised
in making tax policy choices.
It is useful to, distinguish several types of responses
of the economy^ to tax changes. First, changes in total
revenue may resiilt in "a change in ,total spendable income,
thereby altering total demand forTgoods and servicer and
the rate of uhemployment. Second, altered tax rules may
cause changes in behavipr directly, by. reducing the incentive
to pay dividends, to hire\'constructiQn iajaor, to buy
particular pr6du6ts,^aLnd the like. Third, changes in the
structure of the" tax4system' may,alter the future potential
productive capacity of the economy: by affecting-, throughout
the economy, the-desire to accumulate new capital, to
undertake education and advanced training, or to employ
labor and capital efficiently.
Income and Employment Effect's of Tax Changes
The first type of feedback is the short-run
consequence of tax changes for unemployment, inflation,
and revenues that accompany budgets in preparation.
A
good part of the recent attention paid the subject of
feedback effects, or secondary, tertiary, and "ripple"
effects of tax proposalston the national economy has
concerned revenue estimates in the context of budgeting
for Fiscal Year 1977. It has been said that traditional
estimates made by Treasury staff of tbe revenue gains and
losses of various proposed tax revisions are poor guides
to policy because they fail t(^ account for-the changes in
income and employment which occur :as^the private economy
adjusts to these tax,changes. <If a proposal to broaden
the tax base, for\example,, causes consumers to spend less
and businesses to curtail capital expansion, these
- 4 behavioral responses will tend to reduce the tax base.
The result, the argument goes, is a smaller increase in
revenues than revenue estimators had predicted. In
extreme cases, it is argued that tax revenues will
actually fall, and, more importantly, there will be a
waste of resources through unemployment.
For example, the question is asked/ does the estimate
of $3.3 billion of revenue pick-up in FY 1977 attributable
to the increase in social security tax rate proposed by
President Ford take into account the dampening effect
such a tax increase will have on the economic recovery?
The answer is "sort of."
To explain that answer, let me refer to the revenue
estimates included in the Budget of the United States
Government for Fiscal Year 1977. According to the
projections there, the total receipts in FY 1977 under
existing and Administration-proposed legislation were
anticipated to be $351.3 billion. The budget document
provides, as well, the effects on tax receipts of each of
a series of legislative changes, such as the proposed
social security tax rate increase ($+3.3 billion) or the
already-enacted Revenue Adjustment Act of 1975 ($-1.3
billion). An example of such a breakdown is given by the
following table, taken from the budget document.
Changes in Budget Receipts
[In billions of dollars]
1977
estimate
Receipts under tax rates and structure^in
371.3
effect January 1, 1974
Increase in import fee on petroleum products
administrative action
Enacted legislative changes:
Social security taxable earnings base increases:
$13,200 to $14,000 effective Jan. IV 1975 r
$14,100 to $15,300 effective Jan. 1, 1976
$15,300 to $16,500 effective Jan. 1, 1977 1/
Tax Reduction Act of 1975
Revenue Adjustment Act of 19 75
+ 2.1
+ 2.4
+ .8
+ .4
-1.3
0^
- 5 Liberalized deduction for individual contributions to pension-plans
-.5
Reduction in telephone excise tax -.9
Increase in SMI (medicare) premium +. 3
Total, receipts under existing legislation 374.6
Changes due to tax proposals:
Individual and corporation income tax
reduction effective July 1, 19 76
-2 8.1
Financial Institutions Act -.3
Stock ownership" incentives -.3
Accelerated depreciation on investment in
high unemployment areas
'
Social security tax rate increase from 11.7%
to 12.3% effective Jan. 1, 1977 1/
Unemployment tax tateand base increase
Jan. 1, 1977
'
' Other ; *
;
+3.3
+2.1
+.1
Total, receipts under existing and
proposed legislation
Source:
-.3
351.3
Budget of the United States for Fiscal Year 1977.
Some figures are revised.
1/ The effect of the taxable earnings base increase is
calculated using a tax rate of 11.7%. The effect of
the tax rate increase is calculated using a taxable
earnings base of $16,500.
The meaning of the revenue aggregate for FY 1977 is
clear enough, but to what questions are the other numbers
the answers? i think most of us would like them to be
of the following sort:
- 6 "Question: What will be the effect on FY 1977
social security tax receipts if the rate
increase proposed by the President (from 11.7
to 12.3 percent) is not adopted and if the
Government does everything else as planned in
the budget?" (The underlined phrase is often
left unstated, but something of the sort must
be assumed.)
Unfortunately, the answer is "It depends." It depends
on the meaning of "everything else as planned."
— Will the Federal Reserve make no adjustment
to the change in Government debt outstanding?
— If revenues are reduced after accounting for
feedbacks, how is the greater deficit to be
financed? Will an offsetting change be made
in some other tax? Will debt be retired or
expenditures increased?
-.,
Thus, the question of the effect*of making changes >
in apparent isolation is not well specified—some assumption
must be made about the decisions made about other policy
instruments available to the Government, (including for
this purpose the Federal Reserve System).
What are the assumptions about other policy instruments
underlying Treasury projections? While they are not spelled
out, they amount to this: that Government will tend to
adjust its plans in light of developments to keep the
economy on the path set as the objective in the budget.
Thus, Treasury methods of projecting tax receipts do take
into account the effect of tax law changes on the course
of the economy in the short run.
The question to which such estimates are addressed is
of the following kind:
"Question: What will be the effect on FY 1977
receipts from the social security tax if the
increase from 11.7 percent to 12-3 percent
proposed by the President is not adopted by
Congress and if instead the Government takes
other measures to assure the attainment of the
path of the
economy projected
in the budget?"
"Answer:
A decrease
of $3.3 billion."
^J7
- 7 As we have seen, such estimated receipt changes do incorporate
feedback effects in that they are consistent with the path
of the economy expected to result from adopting the budget.
To calculate the effect of the entire "package" of tax
and expenditure plans contained in the budget requires a
kind of simultaneous determination—we cannot estimate
receitps until we know GNP; we cannot know GNP until we
know receipts and expenditures (which are also sensitive
to GNP) . The approximation to this simultaneous determination
is carried out by coordinated staff work of the so-called
"Troika," consisting of the Office of Management and Budget,
the Council of Economic Advisors and the Treasury.
The expected course of the economy under a variety of
alternative fiscal and monetary options is calculated in
the course of developing overall economic oolicy recommendations
by the Administration and the Congressional budget committees.
However, it seems most appropriate that decisions about the
structure of taxes assume that the overall objectives of
fiscal policy are realized. With respect to the structure
of taxation, i.e., deductions, depreciation rules, credits,
and the like, we should aim for a system which we regard as
fair and which promotes the efficient use of the nation's
resources. The level of taxes can in principle generally
be adjusted in a way which does not alter any given desirable
structure.
Price Effects of Tax Changes
The second of the feedback effects, the price effects,
consist of changes in behavior attributable to the direct
impact of the tax. While often there is no sound empirical
basis for calculating these effects, traditional revenue
estimates incorporate such responses in those selected cases
where there is broad agreement on the direction and size
of the change. Examples of such estimates are (1) the
change in purchases of gasoline that would accompany a
change in the gasoline excise tax rate, (2) induced dividend
payout accompanying the corporate integration proposals
or (3) projected use of a new statutory plan, such as DISC
or the proposed BSOP, which did not exist before the change
m the tax law. These estimates could be improved, given
more resources and greater knowledge of the relationships,
and this is one source of "feedback" controversy.
- 8 Considerable interest is often focused on these
allocative effects of tax changes. For example, the
application of proposed tax shelter limits to investment
in real estate may be expected to alter the amount of
such investment, affecting first the construction industry
and then the level and price of real estate services.
Another example is the investment tax credit. By making
this feature of the tax system permanent at the 10 percent
level we can anticipate that the level of investment in
machinery and equipment will be somewhat larger than would
otherwise be the case, and we may be interested in estimating
the effect of this on employment in the capital goods
construction industry and on the division of output between
sectors more or less favored by this incentive.
The methods available for this analysis are different
from those used in projecting aggregate output and the
associated employment and tax receipts. Short-run forecasting models, which have been designed to give the best
possible estimates of the aggregate effects, have not been
refined to the point where they can be used to give reliable
forecasts about the composition of income and
employment. As a result, the short-run projections made
by Treasury staff are generally developed by starting with
a long-run analysis and then using estimates of the rate
at which the adjustment to the long run takes place.
However, the rate of unemployment and near term level
of tax collections do not depend upon these sectoral changes
alone, as some other estimates of feedback effects imply.
Unemployment and other measures of short-term economic
health depend upon the overall fiscal and monetary posture.
If that posture is unchanged, reduction in demand for
output in one sector will be offset, perhaps completely,
by increased demand elsewhere.
Long-Run Analysis
The emphasis of long-run analysis is on questions of
the level and composition of productive potential in the
economy, since the degree of slack cannot be forecast very
far into the future. The long-run questions are also
significant, however, and the tax system profoundly affects
the answers.
- 9 Asking "long-run" questions also makes certain guides
to tax policy more clear. It is not the real object of
tax policy to minimize or maximize revenue flows. The
basic long-run fiscal policy issue is the fraction of the
nation's resources which should be devoted to collective
consumption and how much of the resources left in the
private sector should be redistributed through welfare
and similar transfer programs. The tax system to finance
this policy should be designed to harmonize with the
distribution objectives while interfering as little as
possible with the efficient allocation of resources. The
fact that a tax change would raise $X of increased revenue
in 1985 is not necessarily a virtue. What is important
is whether it improves the functioning and fairness of
the economic system.
The central concern of long-run analysis is with the
effects of the fiscal system on the rate of capital
accumulation and the efficiency with which the available
capital stock and labor force are used. Economic analysis
provides us with some presumptions about the relative
effects of different policies on capital formation and
efficiency.
For example, because an income tax introduces a
differential between the total yield from an investment
and the "after tax" yield on which the investor bases his
decision there is a presumption that the capital stock is
"too small." In the choice between consumption and
investment, the balance is tilted toward consumption.
There are investment opportunities with yields sufficiently
attractive to induce people to forego some consumption,
but these go unexploited because of the tax.
Another and equally serious problem is the effect of
the tax system on the allocation among sectors of the
investment which is made. For example, it has long been
recognized that the existence of a separate corporation
income tax results in a differential between the before tax
yield on investment in this and the noncorporate sector.
By reallocating the present investment from the lower
yield noncorporate to the higher yield corporate form, a
gain in output could be obtained at no cost to the economy.
- 10 Let me give some examples of the sort of conclusions
which have been reached by economists who have studied
these questions. In a 1966 study Professor Arnold Harberger
concluded that the extra tax on income from corporate
capital resulted in the equivalent of a loss of approximately
one-half percent of GNP per year due to the divergence
between the before tax yield in that sector compared to
the noncorporate sector. More recently, in a calculation
similar in spirit, Professor Martin Feldstein concluded
that the result of shifting the tax on capital income fully
onto labor income would lead to an increase of about one
percent in effective output. This gain would be due to
closing the gap between before tax and after tax yield on
investment.
Such calculations are surrounded with qualifications
by their authors, and I run a danger of misrepresenting
them by presenting their carefully derived and largely
illustrative results as "conclusions." One qualification
which these and other authors would strongly emphasize is
that such calculations do not attempt to evaluate the
distributional consequences of the changes being analyzed.
However, even here the work of economists suggests
that apparenetly obvious propositions may be incorrect.
For example, by now many people recognize that "good jobs"
require the support of capital investment in the form of
machines, education, etc. But it would come as a surprise
for most that a shift of taxes from capital to labor income
could lead to an increase in the after-tax earnings from
labor. A parameter of the economic system, known in the
jargon as the "elasticity of substitution of capital for
labor," plays a crucial role in this possibility.
Michael Boskin has recently estimated the value of this
parameter for the United States economy to be around .5,
a value which makes distinctly possible such an apparently
paradoxical result.
Calculations of the sort just described provide reason
to think about redesign of our tax system to achieve some
of the long term gains they suggest are possible. Unfortunately, at this point we do not have at our disposal
quantitative models of the U.S. economy which permit us
to trace with confidence the path of productive capacity
over time under different tax policy consequences. However,
I think we know enough about the economy to conclude it
is not a perpetual motion machine. To decrease the rate
w
- 11 -
of tax on capital income will require us to finance the
change with other taxes '(e.g., by a move toward a
consumption-based tax) or.by a reduction in the trend of
government spending^
To obtain a sense for the alternatives which might
be available we constructed a highly simplified model
of the growth of the United States economy. It incorporates
speci fie relationships:
. between the fraction of income saved and
the rate of returns to the saver,
. between the after-tax wage and labor
effort supplied,
. between the rate of saving and net
accumulation of capital,
. between the taxes levied on wages and
capital income and government outlays,
. between input of labor and capital services
and GNP.
To this model economy we
in taxes on income from
by an equal decrease in
resulting effect on the
in the following table:
applied a $30 billion cut
capital. This cut was financed
government expenditure. The
path of the economy is described
Estimated Changes Due to $30 Billion Initial Tax
Reduction on Capital Income —
As Compared to 19 76 Levels
Low Estimate
High Estimate
• Pnl 1
•
•
•
Fill 1
'V7
' 1977
:Effeet:
* 1978
:
' 1979
:
'VT^
: Effect
1977
Capital stock
($ billion)
; 1978
:
' 1979
:
5.7
11.2
16.4
119.6
13.8
27.1
39.5
278.2
GNP
($ billion)
0.5
1.0
1.5
10.5
1.6
3.2
4.7
32.3
Employment
(thousands)
0
0
0
0
31.2
60.3
82.8
602.3
Revenue
(
$ billion)
-29.9
-29.7
-29.6
-27.0 -29.5
-29.1
-28.7
-20.9
- 12 A model of this kind, while fitted with parameters
which are intended to be "realistic" serves much more
importantly the function of enforcing consistency. In
thinking about the effects of tax change over the long
run on such variables as capital stock, it is essential
that all of the relationships just summaried be taken
into account.
I draw two lessons from the exercise:
(1) Even a fairly large reduction in tax on
capital income may have a relatively
modest effect on the long-run capital
stock. The change in this example is
about 1/6 in the tax and leads to a
change of between 3 and 6 percent in
the ultimate stock (relative to trend).
(2) Even under optimistic estimates of the
responsiveness of saving and labor force
participation, the induced changes in
revenues do not come close to covering
the initial cut.
Conclusions
From all this I draw two basic conclusions about
feedback. First, on the negative side, I believe that
there has been too much attention paid to the revenue
estimating aspects of this subject. If, on the other
side, discussions such as this one will lead all of us
to refocus on the real issues of long run tax analysis—
the effect of the tax system on the distribution of the
output of the economy and the efficiency of resource use—
I think we shall have been well served by the debate.
oOo
043
Contact: J.C. Davenport
Extension 8585
April 20, 1976
FOR IMMEDIATE RELEASE
ANTIDUMPING INVESTIGATION INITIATED ON
METAL-WALLED ABOVE-GROUND
SWIMMING POOLS FROM JAPAN
Assistant Secretary of the Treasury David R. Macdonald
announced today the initiation of an antidumping investigation
on imports of metal-walled above-ground swimming pools from
Japan.
Notice of this action will be published in the
Federal Register of April 21, 1976.
The Treasury Department's announcement followed a
summary investigation conducted by the U.S. Customs Service
after receipt of a petition alleging that dumping was
occurring in the United States. The information received
tends to indicate the prices of the merchandise exported
to the U.S. are less than the constructed value of such or
similar merchandise produced in Japan.
The imported merchandise usually consists of three
components sold together as a package: a wall, a frame
(composed of a seat and uprights), and a liner. The wall
and the frame are generally made of steel or aluminum, and
the liner is made of vinyl. The larger units are referred
to as "family pools11 and the smaller pools as "splashers."
Imports of the subject product are dutiable under a
basket provision of the Tariff Schedules of the United States.
Imports from Japan are believed to amount to at least
$4.5 million annually.
WS-791
JU
J-
JL
f\
r\
t\
WfU
REMARKS BY THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE THE
BETTER BUSINESS BUREAU LUNCHEON
ROCHESTER, NEW YORK
APRIL 21, 1976
Thank you Representative Conable, Congressman Horton,
members of the head table, ladies and gentlemen:
I am delighted to be with you today and to learn first
hand of some of the efforts your organization is making to
stimulate a climate of economic development in the Rochester
area. I'm fully aware that your town has earned the reputation of being an economic leader with a strong and diversified industrial base. Being here also affords me the pleasure
of seeing again my good friends, Representatives Barber
Conable and Frank Horton, both men of outstanding talent,
a credit to their constituencies, and valued friends of this
Administration.
As I look around this room, I realize that among you
are many whose businesses were hard-hit by the recent recessii. :
and simultaneous double-digit inflation. Perhaps I can cheer
you with some words of optimism. For, although I will be the
first to warn that we still have a way to go, we are now well
into a period of economic expansion.
— 1975 opened with inflation raging at 13 percent,
we have now cut that rate in half.
— During the spring of 1975, the unemployment rate
reached nine percent, today it has fallen to 7.5 percent.
— And earlier this week we learned that real GNP, that
is, total output after adjusting for inflation, increased at
an annual rate of 7-1/2 percent during the first quarter of 1976.
WS-792
— Other signs point to an economy that is gaining
increasing momentum: Personal income, industrial output,
housing starts, retail'sales, the stock market — all
are registering solid gains and this reflects rising public
confidence about the economy that contrasts sharply with
the deep pessimism reported by the polltakers the middle of
last year.
Thus we made considerable headway in 1975, and the outlook for 1976 remains encouraging. But that;' sr still nbt^good
enough, and this is certainly no time for complacency.
Unemployment is still intolerably high, and inflation is
by no means under complete control. In fact, it remains the
most dangerous enemy of real economic growth. The ruinous
inflation that crested in 1974 was the chief cause of the
recession of 1975. Let us learn from history so that it
will never be said that the pain and suffering of the 1974-75
recession were in vain — that the politicians in Washington
again ignored the national interest and refused to accept
economic reality.
Of course when I speak of economic reality, I mean to
emphasize the difference between performance and promise.
There is already a tendency on our national scene, which
shows every sign of intensifying as the elections draw closer,
to look with great alarm upon the current unemployment and
inflation figures. There is a seemingly endless stream of
political rhetoric about the insensitivity of this Administration for not spending massively enough and acting decisively
enough to solve all our problems. But for once, let us not
fall prey to those who tour the country, their bags brimming
with instant quack cures — self-proclaimed compassionate
people whose spending proposals promise everything, but deliver
us only one thing: more inflation.
Indeed I urge you, as intelligent and objective citizens
to ask yourself a few fundamental questions. How could the
most dynamic economic system in the world become infected with
the diseases of inflation and unemployment at the same time?
As a people where did we lose our way?
I believe it is imperative to decide how we got ourselves
into this mess if we're really sincere about getting out of it
permanently. Economists argue about this a good deal. Many
politicians are ignoring the question entirely, seeking instead
to capitalize on the effects of the problems. But to me there
is no real mystery about how we got there, nor what we must do.
To an objective observer, the first and most glaringly
obvious fact is that our economic problems do not stem from a
- 3 lack of compassion, concern or vision on the part of the Federal
government. Since President Eisenhower left office:
— The number of domestic spending programs has increased
tenfold.
— The American people have spent over one trillion dollars
on social programs for people and communities that needed help —
a commitment that now equals 73% of our entire budget.
— The staple of our national life has become politicians
with grand visions and even grander promises of what can be
accomplished if they can just spend more of our money and be
given greater authority over our lives.
So over the past 15 years, the government has tried many,
many solutions. Yet the problems persist and our people are
now more frustrated, disillusioned, and cynical. This doesn't
mean there are no answers. It means only, I would suggest,
that we have been taking fundamentally the wrong approach. We
suffer not from a lack of government action, but from an excess
of government action. The trouble with the Federal government
is that it is trying to do more than its resources permit, to
do many things that it cannot do very well, to do some things
that it should not do at all, and to do all these things at
the same time. Excesses in governmental action have been most
damaging to three critical areas affecting the economy:
— fiscal policy
— monetary policy
— regulatory policy
No one who has followed the pattern of Federal spending
in recert years can fail to be impressed by its explosive
growth.
— The Federal budget has quadrupled in 15 years;
— We have had 16 budget deficits in 17 years;
— And we have doubled the national debt in just 10 years
time. It took 75 years for our national debt to reach one
billion dollars. Today government spending is causing the
debt to grow by one billion dollars every week.
The Federal Government today is the nation's biggest
single employer, its biggest consumer, and its biggest borrower.
And if present trends continue until the end of the century,
4*f7
Government at all levels will account for almost 60% of our
gross national product. Once government achieves that degree
of dominance over your lives, much of the economic and political freedom you now take for granted will have been lost.
The alarming fact is that in every country in which this
percentage has increased there has been a tendency to move
toward instability, toward minority government and toward a
threat to a free society. The only outstanding exception that
I know of at the moment is Sweden, and I am somewhat mystified
why it is an exception. Britain is the outstanding current
demonstration with government spending equalling 60 percent
or more of the national income.
The issues involved are by no means narrowly economic.
They concern fundamental principles of equity and of social
stability. The problem of growing government spending is that
however good those intentions which underlie the growth, those
intentions are not achieved, that instead the growth in government spending makes low-income people worse off, undermines
social cohesion and threatens the very foundation of a free and
representative government.
Partly to accomodate the federal government's borrowing
needs in the private markets, there has been a significant
shift in monetary policies. From 1953 to 1965 the money
supply of the United States was growing at approximately 2-1/2%
and we enjoyed relative price stability. From 1965 to the
present, however, the average rate of growth o f the money
supply has more than doubled and it is no accident that during
this same period we have had spiraling inflation.
This past decade has also witnessed an excessive growth
in the regulatory responsibilities of the federal government.
This is an area of particular concern to you in Rochester, as
well it should be. Government agencies now directly regulate
over 10% of everything bought and sold in the United States
and indirectly regulate
almost every other industry of
the private economy. The power of the army of more than 100,000
government regulators has become incredibly strong. Just to
fill out the necessary forms, the American people must now
spend over 130 million work hours a year.
This regulatory process has become so burdensome, for all
business big and small, that it is threatening the continued
viability of free enterprise. General Motors for example,
recently estimated that it spent more than 1.3 billion dollars
in 1974 just to comply with existing government regulations
and get ready for new ones. That is more than it cost to run
- 5 the entire Federal government for all of the first 75 years of
our history. But, as bad as that is, at least GM can live to
fight another day. Smaller businesses have not been so lucky.
Consider the case history of one Ed Sohmers, a typical
American businessman, who honestly and conscientously tried
to comply with Federal rules and regulations.
Ed Sohmers was general manager of Marlin Toy Products,
Inc., a Wisconsin company that made a toy cited as unsafe in
November 1972 by the U.S. Food and Drug Administration. The
toy, a plastic ball containing colored pellets, was declared
unsafe, the FDA said, because if it broke open a child could
swallow the pellets. No matter that Marlin had been marketing
the toy since 1962 and had received no complaints.
Mr. Sohmers recalled the toy at a cost of $95,000, removed
the pellets and thought his problems were over.
But, as he and his 85 employees were preparing for the
1973 holiday season making the toy and other products, a new
Federal Agency — The Consumer Product Safety Commission —
took over the safety regulation of toys and other products. In
the process, some of the paperwork on the Marlin plastic toy
went astray. Shortly thereafter, the Commission published a
banned products list and sure enough, the Marlin plastic toy
was on the list.
Ed Sohmer's protest fell on deaf ears. The erroneous
list has been distributed to thousands of toy shops and the
Commission refused to recall its 250,000 copies "Just to take
one or two toys off the list," as they put it.
Predictably, the incorrect list caused order cancellations
from all over the country. Marlin found itself with a $1.3
million loss and had to lay off all but ten of its 85 workers,
many of whom were handicapped.
As Marlin's toy business plummeted, its paperwork problems
skyrocketed:
— Mr. Sohmers had to write more than 700 letters in an
effort to obtain enabling legislation that would permit him
to sue for damages.
*
— He spent two weeks and $15,000 gathering documents for
an appraisal company to prove the loss of business.
- 6 — Three employees had to work two seven-day weeks pouring
through documents that went back to the founding of the business
in a household kitchen in 1947, in order to answer government
inquiries.
— And while all this was going on, the Justice Department, pleading a heavy workload, was able to obtain delays on
the company's court action against the government.
Today, Marlin is out of the toy business.
Marlin1s Toys' difficulties are just one example of the
thousands of bureaucratic bungles that have taken their toll in
both human and financial terms. In this case, government regulatory overkill took a tragic economic toll on human beings.
Many of Marlin's discharged employees, especially the handicapped,
could not find other jobs.
It finally managed, through the intervention of the U.S.
Congress, to bring its case against the government to court.
I recently came under criticism from the Consumer Product
Safety Commission for having told Marlin's story as an example
of "bureaucratic bungling" to a group of small businessmen in
Dallas.
The Commission's chairman, Richard 0. Simpson, wrote me
and I quote: "Although your statements accurately reflect the
allegations Marlin Toy Products, Inc. have made, I believe it
inappropriate for you to publicize them when those very allegations are being contested in court."
The government's position, wrote Mr. Simpson, "is that
the principal cause of company's problems results from its
own mismanagement."
When I got that letter, naturally I did a little more
checking of the facts. I discovered by Mr. Simpson's own
admission in letters to Mr. Sohmers of Marlin in March 1974,
and to Senator Eastland in July 1974, that the Commission's
listing was indeed an error — an error committed by the Commission and not one that was the result of Marlin's mismanagement.
Was it inappropriate of me to speak of Marlin's plight in
a public forum in the first place? I submit that it was not.
Was it inappropriate to mention that the all-mighty U.S. Government made a mistake? I submit that it was not.
- 7 And I submit finally, that we need more,not less, public
discussion of regulatory and other matters that directly affect
businesses and individuals throughout the country.
Just recently I learned the Agriculture Department probably
spent several hundred thousand dollars of the taxpayers money and
employed four judges just to determine whether a man with a
trained dog and pony act could ply his trade without a 25 dollar
federal license. It turns out he cannot.
When you objectively add up all these facts of excessive
government spending, excessive expansion of the money supply and
excessive governmental regulation, one conclusion seems inescapable, our inflation and our resulting unemployment were made
in Washington, D.C. Here's just part of what the bill now adds
up to. Our current federal budget is equivalent to about $2,000
a head for every man, woman, and child in this country. Our
national debt equals almost $3,000 for every citizen. And
government regulation adds approximately $2,000 to the costs of
purchases made by each American family every year. How can
anyone make the case that the increase in government benefits
has in any way kept up with the increase in government costs?
The fact is that governmental excesses of the past 15 years
have become the strong underlying cause of inflation during the
1960's. They remain so today. The rise in spending has added
enormously to the aggregate demand for goods and services in
the economy, thus forcing up prices. And the government's
heavy borrowing needs require it to soak up 80% of all new
long-term loanable capital, leaving only 20% to the entire
private sector, which nevertheless must produce virtually all
our goods and services and employ 83% of our workforce.
This increasingly massive governmental presence has been
an important factor in the persistent rise in interest rates,
and the strains in the financial markets. Moreover, it is
clear that the cumbersome regulatory procedures of the government have too often only stifled competition and added billions
of dollars to the price of consumer goods.
Now I am not saying that governmental excesses are the
sole cause of our inflation and recession that followed in its
wake. The recent quadrupling of oil prices and rising food
prices have also played a significant part. But it is the
recklessly explosive growth in government that has reaped
the greatest destruction.
The evidence is in and it proves conclusively to me that
government, far from being our greatest source of prosperity
^ry
and material security as some people would have us believe,
has now become a direct threat to our survival as a free
society. And so that is why I must appeal to you this afternoon, not only for your support, but also for your direct participation in a massive effort to preserve the economic freedoms
that have given this country both the greatest prosperity and
the greatest freedom ever known to man. For what is at stake
now is not just the survival of this or that industry. What
really is hanging in the balance is the survival of our private
sector, and the individual liberties which have never long
survived the collapse of a society's economic freedoms.
The problem is a matter of both policy and perception.
Bad perception leads inevitably to bad policy/ and I am firmly
convinced that, taken together, misunderstanding and misdirection of the American economy have become the central underlying
problem of our times. Unfortunately the perception of what is
right or wrong is too often inaccurate, because it is described
inaccurately as a superficial division between those who "care"
and those who are "callous."
Many of today's youth view those who consistently advocate
bigger government as the savior of the modern world out to
rescue the persecuted underdog. On the other hand, those who
advocate less government and the strengthening of free enterprise are often dismissed out of hand as greedy exploiters out
to make a fast buck for themselves or their companies. And —
because image is so all important and bad news is big news —
those who supposedly "care" are often afforded greater media
exposure to expound about all our social ills and to claim they
cure them by just cranking out more currency and soaking up more
credit through massive deficit spending. In reality, of course,
this is no cure at all. It is this same destructive approach
that is at the very root of the problems we are struggling with
today. Big government isn't the solution; it's a large part of
the problem.
We who insist on the superiority of the free enterprise
system, emphasizing its competition, efficiency, and profitability
are nevertheless losing our argument. We tend to converse in
slogans and labels, while the proponents of big government speak
in more appealing, seemingly more humane terms. This is unfortunate, and to me it would be difficult to imagine any greater
irony. For even the most cursory glance at history shows us
that the American economy is the most successful the world has
ever known — precisely because it is an essentially humane
creation of the people, by the people, and for the people.
The performance of our economy proves this. In the
period since the early 1960s — a period during which one
abuse after another has been inflicted upon our private
sector, it has nevertheless managed to outperform all others.
— In the last 15 years, real purchasing power of Americans
has jumped by 40 percent, average family income has risen to
over $13,000 a year, 20 million new jobs have been created, and
we have cut in half the number of people below the poverty line.
— Our farmers harvest more than twice as much grain with
fewer workers compared to a generation ago.
— Medical science has added 10 years to our lives over
this period.
— And Americans today have more leisure time for study,
recreation and self-improvement than any society in recorded
history. We continue to spend about 90 percent of our personal
disposable income on ourselves.
No other country — no other system — has achieved so much
for its people. Yet these tremendous achievements are the product of the same free-market system that now finds itself under
attack.
Where does the Free Enterprise System stand today? For
all the talk about excessive profits, it's a system that, on
the average, offers a profit incentive of less than five cents
on the dollar, a small reward for all the effort and risk-taking
that goes into developing and operating a successful business.
Nevertheless, it remains the real productive source of our
nation's wealth, as well as that of each individual American.
Despite the growing influence of government over our lives,
the private sector produces the food we eat, the goods we use,
the clothes we wear, the homes we live in.
It is the source of five out of every six jobs in America,
and it provides directly and indirectly, almost all the pressure
for the rest of the jobs in our all-too-rapidly expanding public
sector.
It is the foundation for defense security for ourselves
and most of the Free World.
It is the productive base that pays for government spending
to aid the elderly, the jobless, the poor, the dependent and the
- 10 -
0J3
disabled. Indeed, far from being the anti-human caricature
painted by political demagogues, the American private sector is
in reality the mightiest engine for social progress and individual improvement ever created.
In a nutshell, all of the material and spiritual values
that make our country unique and make us so proud to be Americans
could not exist without the free enterprise system. Yet many
people still fail to understand the crucial link between our
economic and our political freedom. Destroy one, and the
other will soon disappear.
I can assure you that this administration is fighting to
ensure the survival of your economic freedoms. But to succeed,
we must have the active participation of business leaders like
yourselves in reopening the lines of communication to the
American people. It's been said that communication is the
web that holds civilization together, perpetuating its values
and traditions.
Never has that function been more important than today. We
must — all of us — communicate the great story of freedom.
— We must dispell the confusion that has made free enterprise a dirty word, and convince them that business, profits
and people are all mutually interrelated.
— We must let our lawmakers and leaders in government know
that they cannot continue to work at cross purposes with the very
system that generates our wealth, our strength and our freedom.
— We must make people aware that runaway spending and
unending deficits are sopping up much needed capital for productive jobs, and are only fueling inflation — a silent thief
that picks every American's pocket, undermines confidence, and
turns the desperate to government for still more illusory help.
But words are certainly not enough, the living example is
much more meaningful. That is why I urge each of you:
— To set a high moral and ethical standard by eliminating
any practices in your organizations and operations that may be
questionable.
— To square practices with principles by supporting deregulation across the board, not just selectively; by helping to
end government subsidies, quotas and handouts, bailouts or other
inducements that offer a superficial empty promise of security
in exchange for sacrifices of freedom and,
mmentofthetREASURY
„NGT0N,D.C. 20220
TELEPHONE 964-2041
^
ADDRESS BY THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
UNIVERSITY OF TULSA
TULSA, OKLAHOMA
APRIL 22, 1976
Thank you Senator Bartlett, Mayor LaFortune, President
Twyman, ladies and gentlemen:
It's wonderful to be in Oklahoma, and I'm especially
pleased to be here for a number of reasons:
-- To see first hand the remarkable progress underway
here in Tulsa, situated in your dynamic Southwest, the fastest
growing region in the country.
— To meet with the people whose hard work, self reliance,
and leadership are making this modern day success story
possible.
— To visit with the officials and students of this
university which is well known outside the state for its fine
school of petroleum engineering, and other energy research and
development courses.
— And finally of course, to have the chance to see
operate on their own home turf your talented Senators Dewey
Bartlett and Henry Bellmon.
I'm blessed with somewhat of a unique opportunity tonight in that this audience is so diverse, consisting of
students, faculty, business leaders and members of the
general community. I want to be sure to address my remarks
to all of you.
I also have a special sense of purpose tonight. With
the 1976 presidential race heating up I thought you deserved
to hear from at least one out-of-state speaker who wasn't
running for President.
I am not after your votes. But what I would like to
engage is your shared concern and thoughts about some of the
grave economic issues facing our country — issues that will
WS-793
-2-
//n
still be with us long after the dust of the 1976 campaign
trail has settled and issues that will help to shape the kind
of lives the students among you live long after you have left
your college days behind.
Here, then is a capsule review of where we have been
economically, where we stand today, and some of the crucial
decisions we still face.
Economists generally agree that the recession hit bottom
last April, that the recovery began sooner than expected, and
that it has been stronger than expected. Only six months
ago, we began to see light at the end of the tunnel. Today,
we are nearly out of the tunnel and on our way to recovering a
full head of steam. For example:
— 1975 opened with inflation raging at nearly 13 percent.
That rate has been cut in half at approximately 6 percent.
— Last spring, unemployment had reached nearly 9 percent.
It has now dropped to 7.5 percent and our forecasts indicate
a continuing downward trend.
— And earlier this week we learned that real GNP, that is,
total output after adjusting for inflation, increased at an
annual rate of 7-1/2 percent during the first quarter of 1976.
— Other signs point to an economy that is gaining increasing
momentum: Personal income, industrial output, housing starts,
retail sales, the stock market — all are registering solid
gains and this reflects a rising public confidence about the
economy that contrasts sharply with the deep pessimism reported
by polltakers the middle of last year.
But although we made considerable headway in 1975 and we
are making even more in 1976, this is no time for complacency.
Inflation is not yet under complete control and the jobless rate
is still too high.
That is why the Administration is urging Congress to
adhere to a broad-gauged plan to further nurture and stimulate
the natural forces of growth in our private enterprise economy.
An essential element of this plan is to put the brakes on the
dizzying momentum of Federal spending — to slow the rate of
increase to about 5 percent this fiscal year, contrasted with
40 percent the past two fiscal years. This will allow us to
continue to make additional tax cuts possible for businesses and
individuals and set the stage for a balanced budget within
three years.
Jj£(r
Further, the President has urged tax measures designed
to stimulate job creation generally, encourage the building
of sorely-needed electric power facilities, and increase construction of plant and equipment in areas where unemployment
has topped 7 percent.
Finally, the Administration has proposed elimination
of the unfair double taxation of dividends that retards
capital formation. This is the only major proposal I know
about that seeks to correct the imbalance between corporate
debt and equity. We must redress this imbalance to allow the
financial markets to channel society's savings more efficiently to the more promising investment opportunities. And,
as you also know, improving our lagging captial investment
picture is absolutely essential to meet our long-term goals of
more jobs, higher incomes, greater productivity, lower inflation
and sustained growth.
These steps and the balanced program we have pursued thus
far are designed to fight inflation and unemployment simultaneously and strengthen the private sector of our economy.
We firmly believe that this course is working, that it
is right for the nation, and that it is leading us back to
the position of robust growth and expanding opportunities.
And yet you will hear a mournful chorus of rhetoric
out of Washington, especially as the election campaign draws
closer, claiming that we aren't spending enough, aren't
pressing hard enough, aren't pushing enough panic buttons to
solve our problems. Despite our steady gains, many of these
critics assume there must be a basic flaw in the system and
they cast about for other remedies: governmental control over
economic planning — guaranteed jobs for everybody at government
expense — a new round of wage and price controls — and many
other encroachments on the market place.
Frankly, I believe that many of these critics suffer
from what Mark Twain called "loyalty to petrified opinions."
They fail to see that efforts to strengthen the public sector
at the expense of the private sector are a large part of
the problem, not part of the solution. They refuse to recognize that the same excessive government fiscal, monetary and
regulatory policies they call for today have led to abuse
of our economy and helped trigger, first, a storm of inflation
in the early 1970's and, second, the severe recession from which
we are now recovering. And they fail to comprehend a gathering
mood in this country against the further expansion of big government. They suffer from the economic variety of Potomac Fever --
- 4 the delusion that all economic cures must originate in
Washington with the Federal government. As President Eisenhower
once remarked, "There are a number of things wrong with
Washington, and one of them is that everybody has been too
long away from home."
However, public disenchantment with big government does
not mean that all Americans are necessarily immune from the
superficial appeal of quick-fix government programs whose
short-term benefits are well publicized but whose long-term
impact in terms of inflation and economic stagnation is
carefully masked from view.
It may seem strange, and it is certainly ironic, but
at a time when the vast majority of Americans are enjoying
such abundance and opportunity, too many of us have lost
sight of the principles and institutions that have made our
way of life possible.
This is certainly not true in many countries abroad.
I was reminded of this fact during my recent two-week trip
to the Middle East. Israel and the Arab states have sharp
differences, of course. But on one thing they are agreed.
They all have a profound admiration for the achievements and
performance of the American economy. The leaders of the
Middle East believe, as I do, that the United States has
developed the most dynamic and efficient economic system
ever devised.
Largely because of this, they see the United States as the
major source of strength and stability in today's unstable
world.
But here in the United States, somewhere along the line
there seems to have been a dangerous breakdown in communication. Secretary of Commerce Elliot Richardson put it
succinctly the other day when he said that producers and
consumers in this country tend to view each other as antagonists — despite the fact that neither can thrive without
the other.
Too many Americans — especially those born into an
affluent society which seemed to have no beginning or end,
no cause and no effect — have lost sight of, or have never
been taught, the actual dynamics of prosperity in a free
society.
Today, when nearly everybody takes the fruits of the
free enterprise system for granted — the abundance, the
- 5 -
¥0
opportunities, the freedom of choice, the chance for
learning, travel and general upward mobility — not everyone
understands the basic economic facts of life that have produced
these benefits.
Because of this, I believe that the time is ripe for
an economic heart-to-heart talk with the American people.
And I believe that the men and women who make up our free
enterprise economy — in business, in the professions, in
the factories — must do even more than they are now if such
a national dialogue is to succeed.
What is at stake is not simply the future of this or
that company, or even this or that industry. At stake is
the survival of the private sector, and, because of the interlocked nature of our freedoms, the survival of the individual
liberties which can never long endure after the collapse of
a society's free enterprise system.
This problem of communications exists, as I have had
ample opportunity to observe in my job as Secretary of the
Treasury, and it is getting worse, not better. It is a
question of both policy and perception, for a faulty view or
understanding of the economy makes faulty economic policymaking almost inevitable.
Part of the problem is a matter of image. Frequently,
those who support bigger government spending and more government domination of the private sector are perceived as concerned and socially progressive individuals who 'tare," who
are champions of the persecuted underdog.
On the other hand, people who warn that the government
should not and cannot effectively solve every new problem
that comes down the pike, and who advocate instead the
strengthening of the free enterprise system, are seen as
either outdated ideologues or a new generation of economic
exploiters — indifferent to human suffering and only out to
make a fast buck for themselves or their companies.
This stereotype wouldn't matter if it were not so
misleading — so blatantly phoney. My experience in Washington
has convinced me that almost every man and woman in a position
of high public trust cares deeply about the well-being
of our citizens, especially those who are impoverished or
face disadvantages because of artificial barriers of sex or
color or national origin.
The central question is not who cares the most — we all
care, it is rather the method we choose to broaden prosperity,
- 6 reduce human hardship and meet our other national goals without sacrificing our freedoms or destroying the most successful economic system that man has ever known.
We can talk about the free enterprise system until we
are blue in the face, but it still won't mean much to those
who do not understand what it really means and what makes it
work. It's like trying to discuss the birds and the bees
sensibly with somebody who is unshakeable in his belief that
babies are delivered by the stork.
People who have never seen what happens to countries
with state-controlled economies simply have no r standard for
comparison.
They have never witnessed the long lines of workers
and housewives who have to queue up for hours to buy a poor
selection of over-priced food and state-manufactured
clothing and merchandise.
They don't realize what a miracle of variety, economy
and productive competition an average shopping center found
anywhere in the U.S. would represent to most of the world's
people.
They have never asked themselves why a country like
the Soviet Union, with some of the richest grain land in
the world — but with an agricultural system owned and
operated by the government — cannot even feed its own
people without turning to American farmers who own their own
land, make their own decisions and feed not only their
fellow Americans but millions of others as well.
They have never lived in countries where the seemingly
idealistic dream of a society without private property or
profits has turned into a nightmare reality: where the
state and the state alone dictates what kind of education
you will receive, whether or not you will be allowed to
travel, what kind of job you can have, what you will be
paid, what you can buy with your own earnings, where you
will live and, ultimately, wheie you will be buried.
They have not seen the erosion of incentive and opportunity
— the general lowering of morale — in democracies that have
given themselves over to pursuit of the welfare state and
the controlled economy at all costs. For the personal rights
all Americans cherish — freedom of worship, freedom of
speech and freedom of association — have never long endured
once economic freedom has been destroyed. As Alexander
- 7 Hamilton warned so long ago, "Power over a man's substance
amounts to power over his will."
The truth is that regimented societies inflict upon
their citizens not only a political regime that reduces the
individual, in Churchill's phrase, to a mere fraction of the
state, they also inflict an economic regime that smothers
enterprise and breeds inefficiency. Let's face it: Without
the individual profit motive, people simply do not work as
hard, produce as much, or bother to come up with as many
fresh ideas and new improvements. Whether we like it or not,
this is an immutable law of human nature.
Unfortunately, like clean air, economic freedom is
something most people don't really appreciate until it
begins to run out — and then it is often too late.
So I submit to you tonight that if America continues
down the road toward greater governmental spending and
greater governmental control over our economy and over our
lives — a road that we have been traveling for several
decades — then all of us will be condemned to an economy
riddled by chronic inflation and incurable unemployment and
those who come after us will be robbed of their personal
and economic freedoms. That is really what is at issue
underneath the semantics and the misleading labels.
Let me be specific about how our private enterprise
economy has been undermined by excessive government policies.
Just before the New Deal, government spending at all
levels — Federal, state and local — was about 10 percent
of our total national output. Today, because budgets have
mushroomed, government accounts for almost 40 percent of
the GNP. And if recent trends prevail, the government's
share of the total economy will reach 6 0 percent before the
end of this century.
The alarming fact is that in every country in which this
percentage has increased there has been a tendency to move
toward instability, toward minority government and toward a
threat to a free society. The only outstanding exception that
I know of at the moment is Sweden, and I am somewhat mystified
why it is an exception. Britain is the outstanding current
example with government spending equaling 60 percent or more
of the national income.
The issues involved are by no means narrowly economic.
They concern fundamental principles of equity and of social
- 8 stability. The problem of growing government spending is
that however good the intentions which underlie the growth,
those intentions are not achieved, that instead, the growth
in government spending makes low-income people worse off,
undermines social cohesion and threatens the very foundation
of a free and representative government.
Let's put present spending in dollar signs. Today,
and every day during this fiscal year, the Federal government
will spend $1 billion. And this week and every week this
fiscal year it will go into debt an additional $1 billion.
Since 1962, when the Federal budget hit the $100 billion
mark, it has almost quadrupled, and has been in the red for
all but one of those years.
The interest on the Federal debt alone by the end
of fiscal 1976 will have climbed to $36 billion. The amount
in fiscal 1977 will reach $45 billion. That's more than we
spent in any one year on the war in Vietnam. It is almost
half of what we will be spending on total national defense
next year. And it is money, I'm sure you will agree,-that
could better be spent on improvements in health care, public
transportation, rebuilding our cities or any of a dozen
other national needs.
Anyone who has ever kept a checking account or managed
the smallest household budget knows that it spells disaster
to borrow and spend more than you take in. Heavy government borrowing has fueled inflation and driven up interest
rates so that strains have developed in money and capital
markets. Businessmen feel these strains when they try to
get loans to expand their businesses and create new jobs:
Consumers feel the pinch when they try to buy a new home without
paying an arm and leg in mortgage interest, (and some of you
have probably realized the problem when you have tried to
secure low interest student loans in a tight credit market).
Throughout the nation, we see signs that taxpayers,
who have so long borne the burden of heavy government
spending, are close to open rebellion. In the 1974 elections,
for example, voters across the country turned down more
than 75 percent of all bond issues on the ballot. And eight
state legislatures, fed up with rising national debt, have
now adopted resolutions calling for a constitutional
amendment requiring a balanced national budget. As one
state representative put it: "I don't want the government
spending my grandchildren into a poorhouse."
- 9 So our major concern as we work our way to a sound
and durable recovery is to avoid another dose of the
same poison which brought on the recession in the first
place: rampant inflation fed by runaway Federal spending.
But spending isn't the whole problem. As government
spending has grown by leaps and bounds, so too have
government controls, regulation and red tape.
Did you realize that government agencies, with an army
of 100,000 (on the payroll), exercise direct regulation over
10 percent of everything bought and sold in the United States
and indirectly regulate almost every other sector of the
private sector?
The avalanche of paperwork required by this regulatory
network is a tremendous burden on small and big businesses
alike. Business spends an incredible $20 billion a year
just to fill out government forms. General Motors recently
calculated that it spent more than $1.3 billion in 1974
just to comply with existing government regulations or get
ready for new ones. This is more than it cost to run the
entire Federal government for all of the first 75 years of
our history — and that includes the Louisiana Purchase.
Some of these regulations are, of course, necessary and
in the public interest. But many more of them are counterproductive, wasteful, and obsolete. And as President Ford
has repeatedly stated, those regulations and regulatory
bodies that no longer serve a useful purpose should be
abolished, before we strangle in our own red tape.
Consider the case of natural gas. Because of the
unwillingness of some politicians to deregulate natural gas,
many areas of the country will continue to experience gas
shortages that will cost them jobs, inflict individual
discomfort and inconvenience and slow the pace of economic
recovery. All this because a handful of politicians refuse
to deregulate natural gas and let the simple but crucial
free market principle of the profit motive come into play.
The economic fact of life is that products which people are
willing to pay for will be produced, and an adequate price
will insure an adequate return. Things for which people
are not willing to pay an adequate price — or which
government does not allow to be sold at an adequate price —
will not be produced. This is not only the essence, but the
genius of free enterprise.
- 10 So today, when so many of America's rich energy resources
remain untapped, and when the need for energy self-sufficiency
is greater than ever, much of our natural gas potential goes
undeveloped because politicians refuse to admit that you
cannot take away the incentive to produce and encourage
production at the same time.
We still have the choice of acting in our own best
energy interests instead of reacting to * decisions made by
foreign countries. We must start thinking of the energy
challenge in terms of American jobs, homes, food and
financial security.
Our economic well-being and national security depend
upon American control of the American economy. We cannot
jeopardize the future by avoiding the tough energy choices
today. But we must pay the price necessary to give us
command of our own economic destiny.
Let me give you another example of how big government,
if allowed to get out of control, threatens the best interests
not only of businesses but consumers. Today, many politicians
and pundits are calling for the massive dismantling of the
American petroleum industry through divestiture.
At a time when we should be encouraging domestic oil
production to make America less dependent on foreign imports,
they advocate a wholesale disruption of the complex and
highly productive free enterprise structure that still makes
it possible for Americans to drive their cars, heat their
homes and turn the mighty wheels of industry at a lower
cost than in any other major industrial nation.
It seems to me that those who urge divestiture have a
tremendous obligation to show us how — if at all — divestiture will benefit the consumer and the nation. So far, they
have utterly failed to do so, relying instead on anti-business
rhetoric and the vague promise that somehow, if they are
allowed to go after American oil corporations with a hatchet,
the price of gas will go down.
This is illogical and self-destructive. It makes about
as much sense as asserting that you can get better mileage
out of your car by chopping it up into tiny pieces. In fact,
you will probably get no mileage at all. And it will cost
you more -- not less — to get the mechanism repaired and
back in working order again. But, in an age when imagery is
often more persuasive than the facts, people sometimes lose
sight of the basic truths.
#6?
-nSpeaking in 1865, Lincoln said, "I have faith in the
people...the danger is in their being misled. Let them
know the truth and the country is safe." What I have
been trying to emphasize here today is the need to hammer
home the truth — the economic facts of life — to the
American people, especially the young Americans who must
lead us in the years ahead.
It is a story that cannot be vividly portrayed on
television like the war in Vietnam.or the urban riots of
the sixties. Yet it is the one thing that affects every
aspect of our lives.
And I am convinced that the American public — and
especially young Americans — have not irrevocably closed their
ears to this story. The polls tell us that businessmen themselves rank low in public confidence, and yet the principles
of private enterprise rank high. A majority of Americans
say they want more regulation of businesses* and yet business
is the most popular major field of study among college
students — above education, science and the humanities.
We can strike a responsive chord in telling this story to the
American people if we tell it in human, comprehensive
terms.
For when we talk about our free enterprise economy we
are talking about food on the table, goods on the shelves
and services at the counter. We are talkiig about medical
breakthroughs that have added 10 years to our lives in the
past generation. We are talking about labor-saving devices
that have freed millions of women for productive careers
and the pursuit of self-enlightenment. We are talking about
five out of every six jobs in America and wages and benefits
that stagger the imagination of the rest of the world. We
are talking about a productive base that pays for government
support of the elderly, the jobless, the poor, the dependent
and the disabled. And we are talking about basic freedoms;
to choose a career, to choose what and where we buy, to
choose wheieand how we live, and yes, to swim against the
tide
as did Fulton and Ford and Edison — things you could
never do living in the gray shadow of conformity under a
regimented society.
And this is the heart of what I am trying to express to
you
the vital human importance behind all those gray, boring
tacts and figures that litter the financial page each day.
. ^° man can be free and a slave at the same time. No
Y can sacrifice its economic freedoms and responsibilities
- 12 -
4tr
and still expect to preserve the individual economic rights
of its citizens. This is particularly important to those
of you who are just beginning your adult lives. Whatever
happens to me down the road, I have already had the opportunity
to live and prosper as a free man. It is an experience that
no one can take away from me, no matter what the future may
hold. So I am not very worried for my own sake.
But I do worry about what the future holds for my
children — some of who are the same age as you students
here in this audience. For as I have tried to show here
tonight, there are a number of alarming economic trends
already at work that are undermining your futures. They
aren't inevitable and they can be stopped. But they must
be recognized and understood before they can be mastered.
And until they are mastered, your future freedoms are in
jeopardy, along with the very essence of the independent
competitive spirit that has made America the richest,
freest country in the world.
In this Bicentennial year, if we keep alive the spirit
that infuses our national character — the spirit of personal
freedom and free enterprise — then we can be certain that
it will endure for another 200 years.
But, if we let free enterprise wither away, we may be
sure that our other freedoms and individual liberties will
expire as well. We must not, we will not, allow this to
happen.
Thank you.
0O0
(""TREASURY |
. D.C. 20220
,ux
TELEPHONE 964-2041
" *-
REMARKS BY THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE THE
WILL COUNTY BAR ASSOCIATION
JOLIET, ILLINOIS, APRIL 21, 1976
(Off the cuff) You know, I have heard our National Anthem
sung many times in the last few years, but I have never heard
that song rendered as beautifully and movingly as it was
tonight by Juliet King. I only hope I speak about America
half as well as she sings about it.
Congressman O'Brien, Mr. Garrison, Miss King, Father Niles,
Mr. Mahoney, ladies and gentlemen:
It gives me great pleasure to be here tonight to share
with you your 29th annual Law Day Dinner.
Our legal heritage has given us standards of democracy and
justice that are unequalled in the rest of the world. It is
our balanced system of law that keeps us from the brink of
chaos on the one hand and tyranny on the other. In short, our
system of law helps to guarantee us our liberty. Two
hundred years ago when our founding fathers framed the
original Constitution, they knew that a fair system of
national law would protect us from the excesses of both the
Right and the Left. As we honor that system of law here
tonight, with the theme of "Law and Liberty," I am reminded
of a poll taken several years ago. The polltakers read an
anonymous document to a number of citizens asking them their
opinion of it. A majority did not like it — said it was
too far out. What they did not know was that the document was
a paraphrase of the Bill of Rights.
By relating this story, I do not mean to imply that
many Americans disapprove of our guiding principles of
rreedom as written by the founding fathers. On the contrary,
re Americans are demonstrating their patriotism in this
faifh n i a l Y e a r t h a n e v e r b e f o r e ' an<* reaffirming their
WhiJ lh ~~ l f n 0 t t h e i r knowledge of — our legal system.
Y believe
h^,le
in our laws and our Constitution, many
nave
WS-794never read them.
4&7
-2For a time, law can survive — on the basis of tradition,
trust and sheer weight of habit. But ultimately, without a
proper knowledge of the law, people can be too easily led
astray. Knowledge and understanding are the only ultimate
guarantees for the survival of any system; legal, social or
economic.
I cite this particular case about the Constitution only
as one example. I could also point to examples of popular
ignorance about the free enterprise system, our legislative
process, government regulations, our tax laws, and a host of
others. Such misinformation breeds unfortunate misunderstandings
That is what I believe is happening in America today: Too
many people do not know the political, legislative and
economic laws that govern our country, and that ignorance
threatens the structural soundness of our nation. In my own
area of responsibility, this misunderstanding and ignorance
abound.
Now it may seem strange, and it is certainly ironic,
that at a time when Americans are enjoying such great
abundance and such great opportunity, too many of us have
lost sight of the principles and institutions that have made
our way of life possible.
Somewhere along the line,
there has been a dangerous breakdown in communications.
Too many Americans — especially those born into an
affluent society which seemed to have no beginning or end,
no cause and no effect — have lost sight of, or have never
been taught, the dynamics of prosperity in a free society.
Today, when nearly everyone takes the fruits of the
free enterprise system for granted — the abundance, the
opportunity for learning, travel, and general upward mobility —
not everyone understands the basic economic facts of life
that created all these benefits.
Small wonder then, that when economic difficulties like
the recent recession hit, millions of otherwise reasonable
people fall for the quack nostrums of politicians who are
more interested in promising than performing, and for quick
tix government spending programs that provide some short
term relief but only aggravate the long-term economic ills
or inflation and stagnation in the private sector.
46
-3Because of this, I believe that the time is ripe for an
economic heart-to-heart talk with the American people.
What is at stake is not just the future of this or that
industry. At stake is the survival of the private sector,
and the individual liberties which have never long survived
the collapse of a society's free enterprise system.
Unless we get the facts across today, the America of
tomorrow — our children and grandchildren — will be
doomed to a system of economic and political bondage that is
the very opposite of all that we hold dear.
The problem already exists, as I have had ample opportunity
to observe in my job as Secretary of the Treasury. And it
is getting worse, not better. It is a question of both
policy and perception, for faulty perception of the economy
makes faulty economic policy almost inevitable.
And I am firmly convinced that, taken together, misunderstanding and misdirection of the American economy have
become the central, underlying problem of our times.
Part of it is a matter of image. Frequently those who
support bigger government spending and more government
domination of the private sector are perceived as concerned,
socially progressive men and women who "care" — in a
nutshell, they are seen as the humane champions of the
persecuted underdog.
On the other hand, those who warn that the government
should not — and cannot -- effectively solve every new
problem that comes down the pike, and who advocate instead
the strengthening of the free enterprise system are seen as
either outdated theorists or a new generation of economic
exploiters indifferent to human suffering and only out to
make a fast buck for themselves and their companies.
To make matters worse, surface appearances often tend
to confirm this inaccurate impression. Advocates of big
government are able to wax eloquent for hours about the ills
they imagine they can cure by cranking out more currency and
soaking up more credit through massive deficit spending.
hey have as many arguments as there are social, economic
and political problems — even though the spending they
advocate, as we have seen with the Great Society's War on
overty, i s often part of the problem rather than part of
the solution.
-4Those of us who recognize the fallacy of the big
government approach have only one argument. It's the right
one, but, by dint of repetition, people are getting tired of
hearing about it. For we constantly invoke the free
enterprise system, too often without defining the freedoms
and the opportunities that it, and it alone, provides. We
chant a slogan, a label, without defining it in comprehensible, human terms.
We can talk about the free enterprise system until we
are blue in the face, but it still won't mean anything to
those who do not understand what it really is and what makes
it work. It's like trying to sensibly discuss the birds and
the bees with someone who is unshakable in their belief that
babies are delivered by the stork.
People who have never seen what happens to countries
with state-controlled economies simply have no standard for
comparison.
They have never witnessed the long lines of workers and
housewives who have to queue up for hours outside stateowned food and department stores in order to buy a poor
selection of overpriced food staples and state-manufactured
clothing and merchandise.
They don't realize what a miracle of variety, economy
and productive competition the average American shopping
center would represent to nine-tenths of the earth's people.
They have never asked themselves why a country like the
Soviet Union, with some of the largest, richest tracts of
grainland in the world, but with a government-owned and run
agricultural system, cannot even feed its people without
turning to American farmers who own their own land, make
their own decisions and feed not only our own people, but
millions of others as well.
Too often they have been taught to scoff at the very
profit and property motives which make our prosperity possible.
They have never lived in countries where the seemingly
idealistic dream of a non-profit, propertyless society has
turned into a nightmare reality — where the state and the
state alone dictates what kind of education you will receive;
whether or not you will be allowed to travel; what kind of
job you can have; what you will be paid; what merchandise
you can buy with your earnings; where you will live; where
you will receive medical treatment; and, ultimately, wht^e
^7#
-5you will be buried.
They have not seen the erosion of incentive and opportunity —
the general lowering of morale — in Democracies that have
given themselves over to pursuit of the welfare state and
the controlled economy at all costs. For the personal
rights all Americans cherish — freedom of worship, freedom
of speech and freedom of association — have never long
endured once economic freedom has been destroyed. As Alexander
Hamilton warned so long ago, "Power over a man's substance
amounts to power over his will."
Without the individual profit motive, people simply do
not work as hard, produce as much, or bother to come up with
as many new improvements. Whether we like it or not, it is
an immutable law of human nature.
Unfortunately, like clean air, economic freedom is
something most people don't really appreciate until it
begins to run out — and then it is often too late.
So we have reached the point where, although the free
enterprise system works, and works better than any other
economic system in effect anywhere in the world — and
although it feeds, clothes and houses more people more
affluently than any other while serving as the underpinning
of our free society — it is somehow losing the semantic war
to an alien philosophy of government control and economic
irresponsibility that has never worked but has somehow
managed to preserve an aura of idealism and altruism that
attracts many wishful thinkers.
I am simply saying that those of us who believe in the
free enterprise system have got to do a better job of getting
our story across.
All of these misconceptions would be unimportant if
they were not so misleading — so blatantly phony. My
experience in Washington has convinced me that almost every
man and woman in a position of high public trust cares
deeply about the well being of our people, especially those
who are impoverished or face disadvantages because of their
sex or the color of their skin.
The central question is not who cares the most, but
rather how we broaden prosperity and reduce human hardship
without sacrificing our freedom or destroying the most
successful economic system that man has ever known.
J/11
-6I submit to you today that if America continues down
the road toward greater governmental spending and greater
governmental control over our economy and our lives —
a road that we have been moving steadily down for several
decades — then our children will be robbed of their personal
and economic freedoms. And, in the meantime, all of us will
be condemned to an economy riddled by chronic inflation and
incurable unemployment.
Let's look at a few facts about government spending.
For most of our history, the Federal budget stayed somewhere
below the $100 billion mark — usually way below it.
Then, in 1962, we finally hit $100 billion — and that
was only the beginning. Seven years later, the budget broke
the $200 billion barrier and then, only four years after
that, we hit the $300 billion mark. And now, in our bicentennial
year, we have reached the point where the Federal Government
is spending $1 billion a day and going into debt another $1
billion each week.
As the budget grows, the government comes to occupy a
more and more dominant role within our society.
In 1930, government spending at all levels — Federal,
state and local — amounted to approximately 10 percent of the
Gross National Product. Today, because budgets have mushroomed,
government at all levels accounts for almost 4 0% of our entire
national output. And if recent trends prevail, the government's
share of the total economy could reach 60 percent before the
end of this century.
The alarming fact is that in every country in which this
percentage has increased there has been a tendency to move
toward instability, toward minority government and toward a
threat to a free society. The only outstanding exception that
I know of at the moment is Sweden, and I am somewhat mystified
w
hy it is an exception. Britain is the outstanding current
demonstration with government spending equalling 60 percent or
*iore of the national income.
The issues involved are by no means narrowly economic.
f K - C ? n C e r n f u n d a m e n t a I principles of equity and of social
stability. — t h e problem of growing government spending is
nat however good the intentions which underlie the growth,
nose intentions are not achieved, that instead the growth in
government spending makes low-income people worse off, undernes social cohesion and threatens the very foundation of a
**ee and representative government.
/ff*
-7For taxpayers, the burden of paying the Government's
bills has become so heavy that many are now in open rebellion.
In the 1974 general elections, for example, voters across
the country turned down some three quarters of all bond
issues on the ballot. But we in the Federal Government get
around this public opposition by voting more Federal spending
without increasing taxes.
The result has been a string of Federal budget deficits
that are unparalleled in our history. In 16 of the last 17
years, the budget has been in the red. And now, just when
a balanced, healthy economic recovery has begun the
advocates of big spending would have us launch another round
of reckless spending and runaway inflation.
It is up to us to stop them.
I wish that there was some way for television cameras
to portray this story as vividly as they did the war in
Vietnam or the race riots of earlier years. For while the
visual images are less dramatic, the problem is every bit as
pressing and important.
But, as the great 19th century historian Thomas Carlyle
once said, political economics is the "dismal science." On
the surface, it seems nothing more than a pile of charts and
a jumble of numbers so large as to be incomprehensible in
everyday terms. To put it mildly, economics seldom makes
"sexy" news stories. And yet the economy is the one thing
that affects every other aspect of American life — the food
we eat, the quality of our education, our mobility, our
freedom of choice in careers, services and merchandise, and
our material and personal sense of pride and independence.
The smallest shock to the economy is felt in every limb
of the body politic. And that is a big story, if only a
graphic, gripping way of telling it could be found.
Consider the case of the Federal debt and its impact.
As the debt climbs rapidly upwards, we have to pay higher
and higher interest costs on it. In fiscal year 1976 we
will have spent $36 billion in interest payments alone.
The amount in fiscal 1977 will reach $45 billion or $125
million per day.
That's more than we spent in any single year on the war
in Vietnam. It's more than a third of our national defense
budget. And it is money that could be better spent on needs
such as public transportation, health care or any of a dozen
worthy purposes.
0$
-8This heavy borrowing by the government has also aggravated
inflation and increased interest rates, creating strains in
money and capital markets. This, in turn, affects everyone
from the businessman interested in expanding his plant to
create new jobs to the young couple trying to buy their
first home without paying an arm and a leg in mortgage
interest.
Reckless government spending and credit policies are
the basic causes of inflation, and inflation was the underlying
cause of the worst recession our country has experienced in
a generation.
It was inflation that caused a loss in real income and
the confidence of consumers, prompting the sharpest drop in
consumer spending since World War II. And it was inflation
that helped dry up the flow of savings into our thrift
institutions, driving up interest rates and causing the
housing industry to collapse.
So one of our prime concerns as we proceed with the
economic recovery is to avoid another dose of the poison
that brought the recession on in the first place — rampant
inflation fed by runaway Federal spending.
But spending isn't the whole problem. There is also
the matter of government controls and regulation, for
as government spending has grown by leaps and bounds, so too
has Federal red tape.
Did you realize that government agencies now exercise
direct regulation over 10 percent of everything bought and
sold in the United States and indirectly regulates
almost every other sector of the private economy?
Did you know that it costs private industry — and
that means each one of us as consumers — an estimated $20
billion a year just to do the paper work demanded by Federal
bureaucrats?
Some of these regulations are, of course, necessary.
But many of them are counter-productive, wasteful or obsolete.
And as President Ford has repeatedly stated, those regulations
and regulatory bodies that no longer serve a useful purpose
should be abolished, before we strangle in our own red tape.
Hi*
-9As the Yale historian, Charles Reich, described the
nefarious end purpose of over-regulation:
"We cannot safely entrust our livelihoods and our
rights to the discretion of authorities, examiners, boards
of control, character committees, regents, or license
commissioners. We cannot permit any official or agency to
pretend to be the sole knowledge of the public good. We
cannot put the independence of any man... wholly in the
power of other men. "
As we celebrate "Two hundred years of liberty and the
law" here tonight, it is wise to remember that economic
independence goes hand in hand with individual political
freedoms. If we forfeit our economic freedom, all too soon
we may find ourselves bereft of our political liberties as
well.
In closing, I'd like to remind you of what President
Eisenhower said on the first U.S. Law Day: "The clearest
way to show what the role of law means to us in everyday
life is to recall what has happened when there is no rule of
law. The dreaded knock on the door in the middle of the
night."
If the Bar Association continues its struggle to uphold
the principles of liberty in this country of ours by preventing
the knock on the door in the middle of the night, then I can
do no less by pledging to struggle to prevent another symbol
of the end of economic freedom: the wheelbarrow full of
inflated, worthless money.
America can continue to be the citadel of freedom and
justice for all only if each of us does our share.
Thank you.
0O0
^Otpattmcnt of tne
INGTON, D.C. 20220
TREASURY
TELEPHONE 964-2041
HI?'
ADDRESS BY THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
JACKSONVILLE UNIVERSITY COMMENCEMENT
JACKSONVILLE, FLORIDA - APRIL 24, 1976
Dr. Spiro, Mr. Botts, Mr. Hadlow, members of the Bicentennial Graduating Class, Ladies and Gentlemen.
It is a particular pleasure for me to participate in
Jacksonville University's Graduation this year and to accept
this honorary degree. Not only has this University been
selected as a Bicentennial College, but it has the further
distinction of operating in the black -- no mean accomplishment
in these days. In fact, to someone like myself who must agonize
daily over our national debt, Jacksonville University is like
an oasis in the desert.
It is a melancholy truth that more commencement addresses
have been listened to more patiently, delivered more solemnly
and forgotten more promptly than any other form of human discourse. Although I try desperately, I am unable to recall what
was said at my graduation from Lafayette College in 1951.
The distinguished speaker doubtless oozed sage advice, but he
was merely looked upon by my classmates as the last remaining
roadblock separating us from our diplomas.
Today I would like to talk with you for a few moments about
a
challenge that faces us all: how to deal with a rapidly
changing way of life. An ancient philosopher once observed that
there is nothing permanent except change." This observation
has always been accurate, but it is particularly pertinent today.
Why even the failure to read one day's newspapers or watch the
evening news on television can literally leave you several Cabinet members behind.
In the four years that each of you has spent here at this
diversity, amazing social and scientific developments have
aken place around the globe. And they have come at a rate
^aranteed to cause what was popularly become known as "future
Ln°fh'" I t i s U p t o e a c h o f u s t o deal with this new reality
the best possible way. Some of you will choose an area of
'oi?rQfilization a n d m a k e t h a t your career. Others will dedicate
selves t o c r e a t i n g a strong family life. It is obvious
Lnf S ? e c t r u m u P o n which you can imprint your achievements is
^•7^"
- 2 Your academic studies have ranged from anatomy to zoology.
There is little that I can add to your studies except to make
this point: You will discover in every field of endeavor that
the world is very different now than what it was when you parents
were in school; indeed, it...is already very different from when
you entered college. Few people foresaw only a few years ago
that oil-producing nations of the Middle East would suddenly rise
to world power, that the United States would be engulfed in the
worst economic difficulties in a generation, or that a President
of the United States might resign from office. Rapid change has
come not only in the economic and political spheres but in others
as well, as environmentalists have begun to study possible limits
to industrial growth and scientists fathom more deeply the use
of the world's resources.
It is important that you learn and understand the contours
of these changes in our civilization, but it is perhaps even more
important that you learn a more fundamental lesson: How to cope
with change and become the master of it. Some of the leaders of
our society argue that because we are living in a new age, we
must adopt new values and new lifestyles. I would urge you
instead that before you make such a choice, you re-examine the
old values and the old lifestyles.
The progression of the Western life has not followed an
even, upward course — it has certainly had its zigs and zags —
but over the years certain values have endured and stand ready
to serve you now during an age of turmoil and confusion.
Beliefs in a higher being and in the dignity of man, the primacy
of the individual over the State, love of family and of mankind —
these are the foundation blocks of our civilization.
At this stage of your lives, you are not expected to have
all of the answers, but you are expected to ask many of the right
questions. Certainly one of the most important questions is one
of basic purpose. What do I really want to do with my life:
How can I — in some big or small way — make a contribution to
my country and the world I live in?
Each of us serves in some way. Our relations with our
family and friends inevitably cast us in the role of influencing
their lives. The question is whether we serve as a positive
force or a negative one. And the question also is whether we
are willing to stretch our horizons to the limit, learning to be
of service not only in the home and on the job also in the community and the Nation.
W9
- 3 Serving the country has become one of the great challenges
of our time. Many of our public leaders in Washington labor long
hours, and not one of them has ever received a dozen long-stemmed
roses with a card reading "Thanks, the United States of America."
We usually receive more complaints than compliments, because we
all know how hard it is to please all of the people all of the
time. But let me assure you: Just as the work may often be
thankless on a day-to-day basis, the rewards of knowing you are
helping your fellow countrymen are greater than the pleasures of
a handshake, a dozen roses, or a plaque on the wall. Patriotism
in times of peace is a quiet blessing without neon lights. Its
supporters usually remain nameless. As the late Adlai Stevenson
described it, "Patriotism...is not short, frenzied outbursts of
emotion, but the tranquil and steady dedication of a lifetime.
In recent years there has been an unfortunate groundswell
of people who shirk their responsibilities to come to the aid
of their country. People have lost much of their faith in
government at all levels, nationally as well as locally. Many
of our brightest young people have dropped out altogether.
There is a widespread feeling of frustration, of skepticism,
and even of despair. As a result the Nation suffers because
leadership at all levels finds it increasingly difficult to meet
the needs of our day.
Even more disheartening, the refusal of people to serve
others destroys the commitment to others which is a cornerstone
of America's greatness. Such withdrawal from public service
and the mood of cynical despair will not destroy the Nation
overnight, but the corrosive mood may eventually erode the strength
of our public institutions and our desire for social, economic,
political and spiritual progress.
Our history books show us that nations begin to fail when
their citizens lose their interest in the Nation's welfare.
The late historian Arnold J. Toynbee believed that the decline
of the great nations of the past can be directly attributed to
a lack of spiritual faith during changing times. The Roman
Empire lasted almost six hundred years. If you had been alive
then, would you have been able to imagine the end of the Roman
Empire? Never, because power breeds a mask of self-confidence
where the people in power and the citizens they represent shield
themselves from any savage truths pointing to the fissures in
the foundation of their power.
Mt
- 4 America is only two hundred years old, quite young when
compared to the longevity of ancient Rome. Yet in those two
centuries we have significantly changed the world through the
contributions of our scientists, our inventors, our artists,
our laborers, and all those who have dedicated their lives to
serving the public good. Can you imagine all that we can create
in another 400 years? Inventors say, close your eyes and imagine the world as it might be. I would add: open your hearts
and your minds and then go forth in the great pioneering spirit
of the past to create the new world as it should be.
I am deeply troubled today because I believe that many of
the difficulties we have in this country are of our own making —
and that not enough people have yet awakened to the dangers we
are continuing to create for ourselves.
Let us ask for a moment: What has made this a great Nation?
What has made people across the globe talk about the American Dream?
Has it been the land and our natural resources? To be sure,
we have been blessed with an abundance of resources, but in tht
Soviet Union we see a land mass that is much larger than our own/ is
equally well endowed, and yet the Soviet land yields a much
smaller harvest of goods to its people. Today the Soviets turn
to the United States for the grain they so badly need.
Does our secret lie in the talents of our people? To be sure,
we are blessed with one of the largest and most talented populations that the world has ever known, but in China today we see a
population that is four times as large as our own, whose civilization was developed far in advance of our own, and yet today
their standard of lifting is far below ours.
So our land and our people, while they have both been
essential parts of the American story, are not the whole story.
A third ingredient — the ingredient that is missing in the
Soviet Union and China, the ingredient that has always made us
different — has been our commitment to human liberty.
For two hundred years people have streamed to our shores in
search of freedom -- freedom of religion, freedom of speech,
freedom of the press, freedom of assembly, and freedom to seek
their fortunes without fear or favor of the Government. Each of
these freedoms was planted firmly in our Constitutional soil;
each grew and thrived in the climate of freedom. But each has
become such a familiar part of our landscape that I wonder whether
we now take them too much for granted.
01
- 5 There is nothing plastic or artificial about freedom, nor
is there any guarantee of its permanency. As Dwight Eisenhower
once said, "Freedom has its life in the hearts, the actions, and
the spirit of men, and so it must be daily earned and refreshed —
else like a flower cut from its life-giving roots, it will
wither and die."
Early in this century the idea began to take hold in the
United States that the problems of our society were growing so
large that individuals could no longer cope with them. Instead,
people began asking the Government to assume responsibility for
solving our problems -- and to do things for them that they once
did for themselves. Government gradually became a beneficent
protector against the evils of modern day life.
That trend sharply accelerated during the 1960's as we were
promised that through the powers of Government, we could fight
a land war in Asia, create a Great Society, achieve permanent
prosperity, abolish the business cycle, eradicate pollution, and
put a man on the moon — all at the same time. It just couldn't
be done, even by the most powerful nation on earth.
What the 1960's has left us is a residue of disillusionment
and distrust. The grand promises of the 60's have become the
broken promises of today. Young people like yourselves in particular have soured on politics and politicians — and I can't say
that I blame you.
In my work at the Treasury Department and in the energy
field, I have also found that the decade of the 1960's and on
into the 1970's has also left us with a very unhappy legacy of
economic problems — potentially ruinous inflation and extremely
high levels of unemployment.
There is no question in my mind that one of the chief villains
of our economic troubles has been the enormous growth of the
Federal government itself in recent years, growth that has witnessed:
— A quadrupling of the Federal budget in just 15 years;
— A string of 16 budget deficits in 17 years;
— And a doubling of the national debt in just 10 years time.
Of course, the energy crisis, food shortages, wage and price
•nd £°1S a n d t h e l i k e h a v e c o n t r i buted significantly to higher
1
« higher rates of inflation and unemployment. But the under|lng momentum has been built up by the excessive economic policies
he Federal Government for more than a decade.
- 6 The tragedy of such misguided policies is that they were
sold on the mistaken notion that they would help the poor, the
elderly, the sick and the disadvantaged. Yet when those policies
trigger inflation and unemployment, who gets hurt the most?
The same ones the politicians claimed they were trying to help —
the poor, the elderly, the sick and the disadvantaged.
Even more fundamentally, the decade of the 1960's accelerated
the trend toward Big Government and the diminishing of economic
and personal freedoms in the United States. The Federal Government has now become the most dominant force in our society: It
is the biggest single employer, the biggest consumer, and the
biggest borrower. Fifty years ago, Government at all levels spent
10 cents of every dollar spent in this country. Today is spends
almost 40 cents of every dollar, and if current trends prevail,
it will be spending as much as 60 cents of every dollar by the
year 2000 — when most of you will be in the prime of life. When
Government exercises such enormous authority in our economy, it
also exercises control over many of the economic decisions of its
citizens -- and when economic freedom disappears, you can be certain that your personal and political freedoms will not be far
behind.
The inextricable relationship between economic freedom and
personal freedom is sometimes overlooked by those who constantly
seek to expand the powers of government, but it is plain to see
in countries such as the Soviet Union and China today. It was
also plain to our forefathers. Let me read to you from letters
that Thomas Jefferson wrote to three of his friends:
— "I...place economy among the first and most important
of republican virtues, and public debt as the greatest of the
dangers to be feared."
-- "I am not among those who fear the people... To preserve
their independence, we must not let our rulers load us with perpetual debt. We must make our election between economy and
liberty, or profusion and servitude."
"If we can prevent the government from wasting the labors
of the people, under the pretense of taking care of them, they
must become happy."
Those were the thoughts of Jefferson, and they are as relevant now as they were then.
It distresses me today that America has wandered so far
from its original moorings. Our society is in the state of apparent drift and the direction is not encouraging
0
7 To me, looking at our economic problems, the answers are
relatively clear. We are now in the midst of a healthy economic
recovery, and we know what to do to make it lasting. It won't
be easy and it won't be fast; the sins of a decade cannot be
paid for by a year of penance. But we can do it if we have the
wisdom and the courage.
We must strive to reduce our chronic budget deficits in
Washington, to begin living within our means and to scale down
our mounting demands on the Government. Please do not misunderstand me: There are many good and noble goals that the government must continue to serve. It would be foolhardy to dismantle
many of the programs now in place. But the time has come to show
a greater sense of moderation and self-restraint, learning to
trust more to our own ingenuity and initiative and less to those
in positions of official power.
To accomplish these great goals of the future, I would
suggest, we urgently need a continuing infusion of fresh new
blood in our political and economic systems — young men and
women who understand both the glories as well as the mistakes
of the past, who have a sense of the enduring values of our
civilization, and who share an ardent desire to shape a better
world for themselve and their children.
We must drawn upon young people from every walk of life —
rich and poor, East and West, professionals and laborers. And
surely you are in the forefront of those who can serve this
Nation — young men and women who can master the changes in our
society because they are firmly anchored in a lasting set of
beliefs.
Some critics claim that the familiar institutions of
family, church, schools, and democratic political processes
are no longer pertinent in today's atmosphere of change. To
contrary, they are even more important than ever and represent
our only real hope of overcoming the confusion and cynicism that
pervades every layer of our society.
AS t le an
*
cient philospher Mencius stated 2,000 years before
Thomas Jefferson and John Adams, "The men of old, wanting to clarify
and diffuse throughout the empire that light which comes from
-Looking straight into the heart and then acting, first set up
good government in their own states; wanting good government in
neir own states they first established order in their families;
anting order in their families they first disciplined themselves;
siring discipline in themselves they first rectified their hearts."
- 8 We must become personally involved to preserve and strengthen
the virtues of our civilization. Families will not be strengthened
unless we care enough to make them better. Churches will not provide spiritual leadership unless they affect the lives of people
who are participating in their programs. Our schools will not
produce educated and committed graduates unless students and
teachers participate more effectively. Finally, our democratic
political institutions will not function effectively unless
there is increased personal involvement. In the Congressional
elections of 1974 only 37 percent of the Nation's eligible voters
participated. The media and pessimistic leaders constantly tell
us that respect for public leaders and institutions has fallen to
very low levels and that people feel that withdrawal is the only
proper response. This approach, of course, is the worst thing
that could happen. If the American people withdraw from public
affairs we will never be able to correct the mistakes of the past
or solve the problems of the future.
In years to come I do not want the last third of this century to be remembered as a time of lost opportunities and lackluster leadership in America. I want this time to be recalled
as the era when our energy was equal to the emergency and our
commitment equivalent to the challenge. And that is where you
come in.
Today marks the beginning of a new chapter in each of your
lives -- the beginning of a new voyage of discovery, adventure,
struggle and achievement. But in beginning this great personal
adventure of life, I urge you not to lose sight of the bigger
picture — of the people and the problems that make up the world
around you.
Twenty, thirty or even forty years from now, when you look
back on your lives and careers, you will find that the most satisfying things of all are not those you have accumulated for yourselves but those you have left behind for others — achievements,
inspirations and examples to your fellow men and women.
Good luck and God's blessings to each and every one of you —
not only for the individual lives you will lead in the years
ahead, but for the contributions that each of you can make to
building a better country and a better world.
Thank you.
oOo
4 £5
REMARKS BY THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE
THE OKLAHOMA CITY CHAMBER OF COMMERCE
OKLAHOMA CITY
APRIL 23, 1976
Thank you, Dean McGee, President Jim Harlow, Mr. Lyon,
Mr. Knotts, members of this distinguished organization, and
ladies and gentlemen:
I greatly appreciate your warm welcome and I am delighted
to be in one of the biggest, friendliest and most progressive
cities in the United States.
Having seen your rising skyline and other visible signs
of your growth and diversified economy, it's almost impossible
to believe that less than 90 years ago, there stood on this
spot only a railroad depot and a few modest homes. Oklahoma
City has been mushrooming ever since -- a city with a spirit
of self-reliance and promise that many older cities in the
nation would do well to copy.
It is small wonder that the Southwest is the fastest
growing region in the country. Everything out here points
ahead to tomorrow rather than back to yesterday. And it is
individuals like yourselves and organizations like the
Oklahoma City Chamber of Commerce that have kept this spirit
alive.
On this particular occasion, I have an added sense of
mission. I feel that, in this busy election year, the people
of Oklahoma deserve a little change of pace; you deserve to
hear from at least one out-of-state speaker who isn't running
for President.
So here I am, asking not for your votes, but for a few
minutes of shared thoughts on some of the basic facts and
Problems facing America — the sort of thing that sometimes
gets buried in the political rhetoric of an election year.
WS-796
w
Let me begin with a subject of enormous importance to
the country and, even more so, to your state — energy.
There's been an awful lot of talk about energy lately
and much of it dangerously misinformed. Particularly
misinformed have been some of the loud, politically motivated
cries for divestiture and further government controls in
the energy field.
These cries may yield a few short-term political returns
in an election year, but they are not in the best interests
of the country. Our whole economic system is based on the
simple market principle that products which people are
willing to pay for will be produced, and an adequate price
will insure an adequate return. Things for which people are
not willing to pay an adequate price will not be produced.
This is not only the essence, but the genius, of free enterprise. Arbitrary controls and politically motivated regulations that strangle the profit motive can only, in the long
run, make the consumer as well as the producer suffer.
That is why the Administration I serve feels so strongly
about deregulation in general and deregulation of natural gas
in particular. It is also why we continue to oppose those
who would inject more federal interference into the energy
field.
For the facts show that free enterprise is the strongest
force we have going for us in our efforts to meet the energy
challenge. Consider the record to date. Despite inflation
and the oil embargo, Americans still pay less to heat their
fuel their cars and keep the mighty wheels of industry turning
than any other major industrial power — thanks to our free
enterprise system of energy production.
Unfortunately, this hasn't stopped some people from
trying to make a scapegoat of the energy industry. Imagine,
this is the only sector of our economy that is still under
price controls. What a monumental con job on the part of
political demagogues who have convinced a naive public that
you can control prices and encourage production at the same
time — that you can take away the incentive to drill and
still expect efficient development of America's untapped
energy abudance.
Yet I'm sorry to say that the enemies of the free
enterprise system seem to be winning the propaganda war.
One recent result was the passage in Congress of energy
legislation that neither I nor President Ford felt completely
comfortable with. However, given the current political climate
and the composition of the Congress, the President had to
- 3 -
U&
choose between a compromise or no energy legislation at all.
This Administration fully recognizes the dangers posed
by excessive government controls. And we will continue to
do everything we can to eliminate these unnecessary controls
as fast as possible and prevent the establishment of new ones.
Speaking from personal experience, I know all too well
how an originally small, temporary bureaucracy can take on
a life of its own and spread its tentacles. During the
energy crisis I was called on to head the Federal government's
effort to cope with the problems raised by that national
emergency.
Little did I suspect that, in becoming the so-called
"Energy Czar" I would also be present at the creation of a
vast new federal energy empire. The temporary hysteria ended
and we weathered the storm. The crisis continued and I went on
to another job. But the Federal Energy Administration is still
with us. It has taken on a life of its own and is still a large
and growing part of the Washington scene -- a striking example
of the cancer of big government.
Another striking example of heedless government interference is the growing chorus of politicians and pundits
calling for divestiture of the oil industry.
It seems to me that those who urge the fractionalization
of this complex and curcial industry have a tremendous
obligation to show us how — if at all -- divestiture will
benefit the consumer and the nation. So far, they have
utterly failed to do so, relying instead on anti-business
slogans, political rhetoric, and the vague promise that
somehow, if we go after the oil companies with a hatchet,
the price of gas will go down.
This is illogical and self-destructive. It makes about
as much sense as asserting that you can get better mileage
out of your car if you chop it up into small pieces. In
fact, you may get no mileage at all. And it will cost you
more
not less — to get the delicate mechanism repaired
and back in working order once the damage has been done.
So I repeat to you my personal commitment to the
Principles of free competition and minimum government
interference in the energy field. But I also remind you
that neither I nor the Administration I serve can win this
b
attle alone.
- 4 We still have the choice of acting in our own best
energy interests instead of reacting to decisions made by
foreign countries. We must start thinking of the energy
crisis in terms of American jobs, homes, food and financial
security.
Our economic well-being and national security depend
upon American control of the American economy. We cannot
jeopardize the future by avoiding the tough energy choices
today. We must pay the price necessary to give us command
of our own economic destiny.
We need your help in getting our side of the story
across to the public. And I hope that each of you as
individuals and as businessmen and women with a strong
personal stake in the energy industry, will devote more of
your time and efforts to getting that story across.
If you don't do it, who will?
Energy, of course is an international as well as a
national matter. A few weeks ago I returned from a two-week
tour of the Middle East. That fascinating and turbulent
part of the world has many dangerous problems. However, I
came away from my trip with one positive impression. Today,
despite old animosities and conflicts, both the Arabs and
the Israelis, regardless of their political opinions,
realize that the United States had developed the most dynamic
and efficient economic system the world has ever known.
They see the United States as a major source of strength and
stability — economically as well as politically — in
an unstable world. As Secretary of the Treasury, I found
this encouraging because I am convinced that the way to a
peaceful world political order is through a strong stable
world economic order. For the Middle East, peace and
prosperity can and must, go hand in hand.
As I look around this room, I realize that there are
some among you whose businesses were hard-hit by the recent
recession and simultaneous double-digit inflation. Perhaps
you might think that the leaders of the Middle East have the
wrong impression in viewing the United States as being
super-strong economically. Perhaps you would think that, on
the contrary, our economy is in trouble and our economic
future uncertain.
I would agree certainly, our economy has undergone
some trials in the last few years that have made for some
unpleasant results both in unemployment and inflation. But,
- 5 -
W
despite this, our country remains the world's greatest
economic power — and, believe me, the world knows it. Even
today, we are proving our basic strength by the speed and
the security of our recovery from the recession as compared
with other industrial nations around the world.
We still have a long way to go, but we are on the road
to recovery and we can all take heart from the progress
that was made during 1975.
1975 opened with inflation raging at 13 percent; we
have cut that rate in half - - t o approximately six percent.
— During the spring of 19 75, the unemployment rate
reached nine percent; today it is down to 7.5 percent.
— Over the past year over 2 million people have found
work and the number of people employed today is at a record
high.
— And earlier this week we learned that real GNP,
that is, total output after adjusting for inflation, increased
at an annual rate of 7-1/2 percent during the first quarter
of 1976.
Thus we made considerable headway in 1975, and we will
make even more in 1976. But it's not good enough and this
is certainly no time for complacency. The unemployment rate
is still far higher than we can tolerate. And inflation is
by no means completely under control. In fact, it remains
the most dangerous enemy of real economic growth. And all
of us — especially those with a say in federal spending
must do everything we can to prevent another inflationary
spiral. The ruinous inflation that crested in 1974 was the
chief cause of the severe recession of 1975; if we embark
once again on excessive fiscal and monetary policies resulting
in double-digit inflation, I guarantee you we will have an
even worse recession than before. Let us hope that it
will never be said that the pain and suffering of the
1974-75 recession were in vain because the politicians in
Washington refused to face the economic facts of life.
But the problem is not confined to politicians alone.
It may seem strange, and it is certainly ironic, but at a
time when Americans are enjoying such great abundance and
such great opportunity, too many of us have lost sight of
the principles and institutions that have made our way of
life possible. Somewhere along the line, there has been a
dangerous breakdown in communications.
- 6 Too many Americans — especially those born into an
affluent society which seemed to have no beginning or end,
no cause and no effect — have lost sight of, or have never
been taught, the dynamics of prosperity in a free society.
Today, when nearly everyone takes the fruits of the
free enterprise system for granted — the abundance, the
opportunity, the freedom of choice, the unprecedented
opportunities for learning, travel, and general upward
mobility — not everyone understands the basic economic
facts of life that create all these benefits.
Small wonder then, that when economic difficulties like
the recession hit, millions of otherwise reasonable people
fall for the quack nostrums of politicians who are more
interested in promising than performing, and for quick-fix
government spending that provide some short-term relief but
only aggravate the long-term economic ills of inflation and
stagnation in the private sector.
Because of this, I believe that the time is ripe for an
economic heart-to-heart talk with the American people. And
I believe that organizations like the Chamber must to even
more than they are doing if such a national dialogue is
to succeed.
What is at stake is not just the future of this or that
industry. At stake is the survival of the private sector,
and the individual liberties which have never long survived
the collapse of a society's free enterprise system.
Unless we get the facts across today, the America of
tomorrow -- of our children and grandchildren — will be
doomed to a system of economic and political bondage that is
the very opposite of all that we hold dear.
The problem already exists, as I have had ample
opportunity to observe, and it is getting worse, not better.
It is a question of both policy and perception, for faulty
perception of the economy makes faulty economic policy
almost inevitable.
And I am firmly convinced that, taken together, misunderstandings and misdirection of the American economy have
become the central, underlying problem of our times.
Part of it is a matter of image. Frequently, and
especially to youthful idealists, those who support bigger
government spending and more government domination of the
private sector are perceived as concerned, socially pro-
4f?
- 7gressive men and wpmen*who "care." In a nutshell
they are seen as the humane champions of the persecuted
underdog.
On the other hand/ those who, warn that the government
should not — and cannot -- effectively solve every new
problem that comes down.*the pike, and who advocate instead
the strengthening of the free enterprise system are seen as
either outdated theorists or a «new generation of economic
exploiters, indifferent to human suffering and only out to
make a fast buck for themselves and their companies.
To make matters worse, surface appearances often tend
to confirm this inaccurate impression. Advocates of big
government are able to wax eloquent for hours about the ills
they imagine they can cure by cranking out more currency
and soaking up more credit through massive deficit spending.
They have as many arguments as there are social, economic
and political problems -r- even though the spending they
advocate, as we have, seen with the Great Society's War on
Poverty, is often part of the problem rather than part of
the solution.
Those of us who recognize the fallacy of the big
government approach have only one argument. It's the right
one, but, by dint of repetition, people are getting tired of
hearing about it. For we constantly invoke the free
enterprise system, too often without defining the freedoms
and the opportunities that;it, and it alone, provides,
we chant a slogan, a label, without defining it in comprehensible, human terms.
We can talk about the free enterprise system until we
are blue in the face, but it still won't mean anything to
those who do not understand what it really is and what
makes it work. It's like trying to sensibly discuss the
birds and the bees with someone who is unshakable in his
belief that babies are delivered by the stork.
People who have never seen what happens to countries
with state-controlled economies simply have no standard
for comparison.
They have never witnessed the long lines of workers
and housewives who have to queue up for hours outside stateowned food and department stores in order to buy a poor
selection of overpriced food staples and state-manufactured
clothing and merchandise.
- 8 They don't realize what a miracle of variety, economy
and productive competition the average American shopping
center would represent to nine-tenths of the earth's people.
They have never asked themselves why a country like
the Soviet Union, with some of the largest, richest tracts
of grainland in the world, but with a government-owned and
run agricultural system, cannot even feed its people without
turning to American farmers who own their own land, make
their own decisions and feed not only our own people, but
millions of others as well.
Too often they have been taught to scoff at the very
profit and property motives which make our prosperity
possible.
They have never lived in countries where the seemingly
idealistic dream of a non-profit, propertyless society has
turned into a nightmare reality -- where the state and the
state alone dictates what kind of education you will
receive; whether or not you will be allowed to travel;
what kind of job you can have; what you will be paid; what
merchandise you can buy with your earnings; where you will
live; where you will receive medical treatment; and,
ultimately, where you will be buried.
They have not seen the erosion of incentive and
opportunity — the general lowering of morale -- in
democracies that have given themselves over to pursuit of
the welfare state and the controlled economy at all costs.
For the personal rights all Americans cherish — freedom
of worship, freedom of speech and freedom of association -have never long endured once economic freedom has been
destroyed. As Alexander Hamilton warned so long ago, "Power
over a man's substance amounts to power over his will."
Without the individual profit motive, people simply do
not work as hard, produce as much, or bother to come up
with as many new improvements. Whether we like it or not,
it is an immutable law of human nature.
Unfortunately, like clean air, economic freedom is
something most people don't really appreciate until it
begins to run out — and then it is often too late.
So we have reached the point where, although the free
enterprise system works, and works better than any other
economic system in effect anywhere in the world — and
although it feeds, clothes and houses more people more
affluently than any other while serving as the underpinning
- 9 of our free society — it is somehow losing the war to an
alien philosophy of government control and economic
irresponsibility that has never worked but has somehow
managed to preserve an aura of idealism and altrusism that
attracts many young idealists.
All of these misconceptions would be unimportant if
they were not so misleading — so blatantly phoney. My
experience in Washington has convinced me that almost every
man and woman in a position of high public trust cares
deeply about the well being of our people, especially those
who are impoverished or face disadvantages because of their
sex or the color of their skin.
The central question is not who cares the most, but
rather how we broaden prosperity and reduce human hardship
without sacrificing our freedom or destroying the most
successful economic system <that man has ever known.
I submit to you today that if America continues down
the road toward greater governmental spending and greater
governmental control over our economy and our lives — a
road that we have been moving steadily down for several
decades — then our children will be robbed of their personal
and economic freedoms. And, in the meantime, all of us will
be condemned to an economy riddled by chronic inflation
and incurable unemployment.
That is really what is at issue underneath the semantics
and the misleading labels, and of course young Americans
have an even greater stake in the outcome than the rest of
us.
Let's look at a few facts about government spending.
tor most of our history, the Federal Budget stayed somewhere
Deiow the $100 billion mark — usually way below it.
Then, in 1962, we finally hit $100 billion -- and that
was only the beginning. Seven years later, the budget
oroke the $200 billion barrier and then, only four years
arter that, we hit the $300 billion mark. And now, in our
bicentennial year, we have reached the point where the
eaeral Government is spending $1 billion a day.
The very size of such numbers makes them almost
^aningless to the average American. But there are ways
g t h e mess
on th
a g e across. For example: suppose that
daY Christ was bor
on lh
n , a man had been given $1 billion
tne condition that he or his heirs spent $1,000 every day,
seven days a week. How long would that $1 billion last?
Adding it up, I think you'll find that today, almost 2000
years later, the grandchildren would still not have spent
the full billion dollars. In fact, the money would not run
out until 2716, 740 years from now.
Yet our Federal government is spending $1 billion every
single day, and, more importantly, going into debt another
$1 billion every week.
And as the budget grows, the government comes to occupy
a more and more dominant role within our society.
In 19 30, government spending at all levels — Federal,
state and local -- amounted to about 10 percent of the Gross
National Product. Today, because budgets have mushroomed,
government accounts for nearly 40% of our entire national
output, and if recent trends prevail, the government's share
of the total economy could reach 60% before the end of
this century.
The alarming fact is that in every country in which
this percentage has increased there has been a tendency
to move toward instability, toward minority government and
toward a threat to a free society. The only outstanding
exception that I know of at the moment is Sweden, and I am
somewhat mystified why it is an exception. Britain is the
outstanding current demonstration with government spending
equalling 60 percent or more of the national income.
The issues involved are by no means narrowly economic.
They concern fundamental principles of equity and of social
stability. The problem of growing government spending is
that however good the intentions which underlie the growth,
those intentions are not achieved, that instead the growth
in government spending makes low-income people worse off,
undermines social cohesion and threatens the very foundation
of a free and representative government.
For taxpayers, the burden of paying the government's
bills has become so heavy that many are now in open rebellion.
In the 19 74 general elections, for example, voters across
the country turned down some three quarters of all bond
issues on the ballot. But the Federal Government gets
around this public opposition by voting more federal spending
without increasing taxes.
The result has been a string of Federal Budget deficits
that are unparalleled in our history. In 16 of the last 17
years, the budget has been in the red. And now, just when
a balanced, healthy economic recovery has begun, the advocates
- 11 of big spending would have us launch another round of
reckless spending ahdrirunaw£y inflation.
It is up to us to' stdp them.
I wish that there was some way for television cameras
to portray this story as vividly as they did the war in
Vietnam or the race riots of earlier years. For, while the
visual images are less dramatic, the problem is every bit
as pressing and important.'* l
But, as the great 19th century historian Thomas Carlyle
once said, political economics is the "dismal science."
On the surface, it seems ^nothing more than *a pile of charts
and a jumble of numbers so"large as to be incomprehensible
in everyday terms.' To put it mildly, economics seldom
makes "sexy" news stories. And yet the economy is the one
thing that affects every other aspect of American life —
the food we eat, the qualityvof our education, our mobility,
our freedom of choice in careers, services and merchandise,
and our material and personal sense of pride and independence
The smallest shock to the economy is felt in every
limb of the body politic. And that is a big story, if only
a graphic gripping way of telling it could be found.
Consider the case of the Federal debt and its impact.
As the debt climbs rapidly upwards, we have to pay higher
and higher interest costs on it.' By the end of fiscal year
1976 we will have spent $36 billion in interest payments
alone. In fiscal 1977 it will come to approximately $45
billion, or $125 million a day.
That's more than we spent in any single year on the war
in Vietnam. It's more than a third of our national defense
budget. And it is money'"that could be better spent on
needs such as public transportation, health care or any of
a dozen worthy purposes.
This heavy borrowing by the government has also
aggravated inflation and increased interest rates, creating
strains in money and capital markets. This, in turn,
affects everyone from the businessman interested in expanding
his plant to create new jobs, to the young couple trying to
buy their first home without paying an arm and a leg in
mortgage interest.
- 12 Reckless government spending is the basic cause of
inflation, and inflation was the underlying cause of the
worst recession our country has experienced in a generation —
a recession we are only now beginning to recover from.
It was inflation that caused a loss of real income and
the confidence of consumers, prompting the sharpest drop in
consumer spending since World War II. And it was inflation
that helped dry up the flow of savings into our thrift
institutions, driving up interest rates and causing the
housing industry to collapse.
So one of our prime concerns as we proceed with the
economic recovery is to avoid another dose of the poison
that brought the recession on in the first place — rampant
inflation fed by runaway federal spending.
But spending isn't the whole problem. There is also
the matter of government control and regulation, for as
government spending has grown by leaps and bounds, so too
has federal red tape.
Did you realize that government agencies now exercise
direct regulation over 10 percent of everything bought and
sold in the United States and indirect regulation over
almost every other sector of the private economy?
Did you know that it costs private industry — and that
means each one of us as consumers — approximately $20
billion a year just to do the paper work demanded by Federal
bureaucrats?
Some of these regulations are, of course, necessary.
But many of them are counter-productive, wasteful, or
obsolete. And as President Ford has repeatedly stated,
those regulations and regulatory bodies that no longer
serve a useful purpose should be abolished, before we
strangle in our own red tape.
Let me conclude with these few observations:
As we enter our third century as a nation, I believe
the time has come not to reappraise our dedication to a
better life for all — that dedication is clear — but to
reappraise what we can pay for and how we can do it.
The current plight of New York City, the disease that afflicts
the British economy, and the overwhelming size of our own
Federal deficits are all grave warnings to us. We can
yfy
- 13 pay for what we now have and provide for the future only if
our great capitalist economy does its job — produces
goods in a free market and makes a sufficient profit.
I am sick and tired of apologizing for the free
enterprise system. It has given this country the highest
standard of living and the greatest prosperity ever known,
and of most importance, has helped to give us the greatest
freedom ever known to man. And it will continue to do that
unless it is crushed by the juggernaut of big Government.
What we need are not fewer but more capitalists in the
United States — more people with a real and direct stake
in the profits generated by a productive economy. We cannot
continue to have more and more of our citizens involved
only in receiving benefits from the government and fewer
and fewer people responsible for paying the benefits.
We must broaden the base of those who work and narrow the
base of those who are able but don't want to work.
President Ford urged that we strike a "new balance" in
our national life:
— A balance that favors greater freedom and vitality
for our private enterprise system.
— A balance that lf^vors greater honesty and realism
in dealing with the challenges of our time.
These are great goals — goals worthy of the greatest
nation on earth. We should not begin our Bicentennial year
by retreating into the past, but by going forward into the
future with a combination of patience, realistic hope,
courage and common sense.
If we work together with common purpose and conviction •
with pride in ourselves and our nation — the goals we share
today can become the first achievements of our third century
together.
President Ford has set a course which points us in the
right direction and will permit us to get a grip on these
problems, but it will take several years, not months, to
bring this about. Unfortunately, the election is only
seven months away. There will be calls from the opposition
for "sweeping changes" and "broad new initiatives" which
will really mean bigger spending, bigger deficits and
ultimately bigger governmental control of the economy. We
- 14 must persuade the American people that this course is
wrong and that the other approach is much sounder in the
long run.
The real choice is between greater government control
or greater individual freedom. That is the decision before
us.
Thank you.
0O0
497
REMARKS BY THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE THE
NATIONAL ASSOCIATION OF BUSINESS ECONOMISTS
TULSA, OKLAHOMA, APRIL 22, 1976
Senator Bartlett, Ladies and Gentlemen:
It is always a pleasure to come to the Southwest and to
Tulsa in particular. This town and this region blend the best
qualities of two frontiers. There is a venturesome and confident attitude here that reflects the spirit of the old frontier.
The virtues of hard work, self-reliance and individual enterprise are still happily in evidence here in Tulsa and the Southwest. And today you stand on a new technological frontier as
an advanced computer center and an integral part of the domestic
energy complex which means so much to the future of the American
economy.
Other speakers on your program this morning will be dealing
with the hard details of the energy situation and some aspects
of the capital availability problem in the economy generally.
My own remarks will center on the role of government in our recent
economic past and the potential threat this poses for a secure
economic future.
As I look around this room, I realize that among you are
many whose businesses were hard-hit by the recent recession and
simultaneous double digit inflation. Perhaps I can cheer you
with some words of optimism. For, although I,will be the first
to warn that we still have a way to go, we are now well into a
period of economic expansion.
— 1975 opened with inflation raging at 13 percent, we have
now cut that rate in half.
— During the spring of 1975, the unemployment rate reached
nine percent, today it has fallen to 7.5 percent.
— and earlier this week we learned that real GNP, that is,
total output after adjusting for inflation, increased at an annual
rate of 7-1/2 percent during the first quarter of 1976.
WS-797
4?f
— Other signs point to an economy that is gaining increasing
momentum: Personal income, industrial output, housing starts,
retail sales, the stock market — all are registering solid gains
and this reflects rising public confidence about the economy
that contrasts sharply with the deep pessimism reported by the
polltakers the middle of last year.
Thus we made considerable headway in 1975, and the outlook
for 1976 remains encouraging. But that's still not good enough,
and this is certainly no time for complacency. Unemployment is
still intolerably high, and inflation is by no means under complete control. In fact, it remains the most dangerous enemy of
real economic growth. The ruinous inflation that crested in 1974
was the chief cause of the recession of 1975. Let us learn from
history so that it will never be said that the pain and suffering
of the 1974-75 recession were in vain — that the politicians in
Washington again ignored the national interest and refused to
accept economic reality.
Of course when I speak of economic reality, I mean to emphasize the difference between performance and promise. There is
already a tendency on our national scene, which shows every sign
of intensifying as the elections draw closer, to look with great
alarm upon the current unemployment and inflation figures. There
is a seemingly endless stream of political rhetoric about the
insensitivity of this Administration for not spending massively
enough and acting decisively enough to solve all our problems.
But for once, let us not fall prey to those who tour the country,
their bags brimming with instant quack cures — the self-proclaimed
compassionate people whose spending proposals promise everything,
but deliver us only one thing: more inflation.
Indeed I urge you, as intelligent and objective citizens to
ask yourselves a few fundamental questions. How could the most
dynamic economic system in the world become infected with the
diseases of inflation and unemployment at the same time? As a
people where did we lose our way?
I believe it is imperative to decide how we got ourselves
into this mess if we're really sincere about getting out of it
permanently. Economists argue about this a good deal. Many politicians are ignoring the question entirely, seeking
instead to
capitalize on the effects of the problems. But to me there is no
real mystery about how we got here, nor what we must do.
To an objective observer, the first and most glaringly
obvious fact is that our economic problems do not stem from a
lack of compassion, concern or vision on the part of the Federal
government. Since President Eisenhower left office:
49?
- 3— The number of domestic spending programs has increased
tenfold.
— The American people have spent over one trillion dollars
on social programs for people and communities that needed help —
a commitment that now equals 73 percent of our entire budget.
— The staple of our national life has become politicians
with grand visions and even grander promises of what can be accomplished if they can just spend more of our money and be given
greater authority over our lives.
So over the past 15 years, the government has tried many,
many solutions. Yet the problems persist and our people are now
more frustrated, disillusioned, and cynical. This doesn't mean
there are no answers. It means only, I would suggest, that we
have been taking fundamentally the wrong approach. We suffer
not from a lack of government action, but from an excess of government action. The trouble with the Federal government is that it
is trying to do more than its resources permit, to do many things
that it cannot do very well, to do some things that it should
not do at all, and to do all these things at the same time.
Excesses in governmental action have been most damaging in three
critical areas affecting the economy:
— fiscal policy
— monetary policy
— regulatory policy
No one who has followed the pattern of Federal spending in
recent years can fail to be impressed by its explosive growth.
— The Federal budget has quadrupled in 15 years;
— We have had 16 budget deficits in 17 years;
— And we have doubled the national debt in just 10 years
time. It took 75 years for our national debt to reach one billion
dollars. Today government spending is causing the debt to grow
by one billion dollars every week.
The Federal Government today is the nation's biggest single
employer, its biggest consumer, and its biggest borrower. And if
present trends continue until the end of the century, Government
at all levels will account for almost 60 percent of our gross
national product. Once government achieves that degree of dominance over your lives, much of the economic and political freedom you now take for granted will have been lost.
- 4 -
J^
The alarming fact is that in every country in which this
percentage has increased there has been a tendency to move toward
instability, toward minority government and toward a threat to a
free society. The issues involved are by no means narrowly
economic. They concern fundamental principles of equity and of
social stability. The problem of growing government spending
is that however good the intentions which underlie the growth,
those intentions are not achieved, that instead, the growth in
government spending makes low-income people worse off, undermines social cohesion and threatens the very foundation of a
free and representative government.
Partly to accomodate the federal government's borrowing
leeds in the private markets, there has been a significant shift
In monetary policies. From 1953 to 1965 the money supply of the
Jnited States was growing at approximately 2-1/2 percent and we
mjoyed relative price stability. From 1965 to the present,
iowever, the average rate of growth of the money supply has more
:han doubled and it is no accident that during this same period
'e have had spiraling inflation.
This past decade has also witnessed an excessive growth in
he regulatory responsibilities of the federal government. Governent agencies now directly regulate over 10 percent of everything
ought and sold in the United States and indirectly regulate almost
very other industry of the private economy. The power of the
rmy of more than 100,000 government regulators has become
ncredibly strong. Just to fill out the necessary forms, the
merican people must now spend over 130 million work hours a year.
- 5Consider the case history of one Ed Sohmers, a typical
American businessman, who honestly and conscientiously tried to
comply with Federal rules and regulations.
Ed Sohmers was general manager of Marlin Toy Products, Inc.,
a Wisconsin company that made a toy cited as unsafe in November
1972 by the U. S. Food and Drug Administration. The toy, a plastic ball containing colored pellets, was declared unsafe, the
FDA said, because if it broke open a child could swallow the
pellets. No matter what Marlin had been marketing the toy since
1962 and had received no complaints.
Mr. Sohmers recalled the toy at a cost of $95,000, removed
the pellets and thought his problems were over.
But, as he and his 85 employees were preparing for the 1973
holiday season making the toy and other products, a new Federal
Agency — The Consumer Product Safety Commission — took over the
safety regulation of toys and other products. In the process,
some of the paperwork on the Marlin plastic toy went astray.
Shortly thereafter, the Commission published a banned products
list and sure enough, the Marlin plastic toy was on the list.
Ed Sohmer's protest fell on deaf ears. The erroneous list
has been distributed to thousands of toy shops and the Commission
refused to recall its 250,000 copies "Just to take one or two
toys off the list," as they put it.
Predictably, the incorrect list caused order cancellations
from all over the country. Marlin found itself with a $1.2 million
loss and had to lay off all but ten of its 85 workers, many of
whom were handicapped.
As Marlin's toy business plummeted, its paperwork problems
skyrocketed:
— Mr. Sohmers had to write more than 700 letters in an
effort to obtain enabling legislation that would permit him to
sue for damages.
— He spent two weeks and $15,000 gathering documents for
an appraisal company to prove the loss of business.
— Three employees had to work two seven-day weeks pouring
through documents that went back to the founding of the business
in a household kitchen in 1947, in order to answer government
inquiries.
And while all this was going on, the Justice Department,
Pleading a heavy workload, was able to obtain delays on the company's court action against the government.
Today, Marlin is out of the toy business.
£23- 6 Marlin Toys' difficulties are just one example of the
thousands of bureacratic bungles that have taken their toll
in both human and financial terms. In this case, government
regulatory overkill took a tragic economic toll on human beings.
Many of Marlin's discharged employees, especially the handicapped,
could not find other jobs.
It finally managed, through the intervention of the U.S.
Congress, to bring its case against the government to court.
I recently came under criticism from the Consumer Product
Safety Commission for having told Marlin's story as an example
of "bureacratic bungling" to a group of small businessmen in
Dallas.
The Commission's chairman, Richard 0. Simpson, wrote me and
I quote: "Although your statements accurately reflect the allegations Marlin Toy Products, Inc. have made, I believe it inappropriate for you to publicize them when those very allegations are
being contested in court."
The government's position, wrote Mr. Simpson, "is that the
principal cause of the company's problems results from its own
mismanagement."
When I got that letter, naturally I did a little more
checking of the facts. I discovered by Mr. Simpson's own admission in letters to Mr. Sohmers of Marlin in March 1974, and to
Senator Eastland in July 1974, that the Commission's listing
was indeed in error -- and error committed by the Commission and
not one that was the result of Marlin's mismanagement.
Was it inappropriate of me to speak of Marlin's plight in a
public forum in the first place? I submit that it was not.
Was it inappropriate to mention that the all-mighty U. S. Government made a mistake? I submit that it was nc?t.
And I submit finally, that we need more, not less public
discussion of regulatory and other matters that directly affect
businesses and individuals throughout the country.
Just recently I learned the Agriculture Department probably
spent several hundred thousand dollars of the taxpayers' money
and employed four judges, just to determine whether a man with a
trained dog and pony act could ply his trade without a 25 dollar
federal license. It turns out he cannot.
- 7 When you objectively add up all these facts of excessive
government spending,excessive expansion of the money supply,
and excessive governmental regulation, one conclusion seems inescapable. Our inflation and our resulting unemployment were made
in Washington, D. C. There's just part of what the bill now adds
up to. Our current federal budget is equivalent to about $2,000
a head for every man, woman and child in this country. Our
national debt equals almost $3,000 for every citizen. And government regulation adds approximately $2,000 to the costs of purchases
made by each American family every year. How can anyone make the
case that the increase in government benefits has in any way kept
up with the increase in government costs?
The fact is that governmental excesses of the past 15 years
have become the strong underlying cause of inflation during the
1960's. They remain so today. The rise in spending has added
enormously to the aggregate demand for goods and services in the
economy, thus forcing up prices. And the government's heavy
borrowing needs require it to soak up 80 percent of all new longterm loanable capital, leaving only 20 percent to the entire private sector, which nevertheless must produce virtually all our
goods and services and employ 83 percent of our workforce.
This increasingly massive governmental presence has been an
important factor in the persistent rise in interest rates, and the
strains in the financial markets. Moreover, it is clear that the
cumbersome regulatory procedures of the government have too often
only stifled competition and added billions of dollars to the
price of consumer goods.
Now I am not saying that government excesses are the sole
cause of our inflation and recession that followed in its wake.
The recent quadrupling of oil prices and rising food prices have
also played a significant part. But it is the recklessly explosive growth in government that has reaped the greatest destruction.
The evidence is in and it proves conclusively to me that
government, far from being our greatest source of prosperity and
material security as some people would have us believe, has now
become a direct threat to our survival as a free society. And so
that is why I must appeal to you this afternoon, not only for your
support, but also for your direct participation in a massive effort
to preserve the economic freedoms that have given this country
hoth the greatest prosperity and the greatest freedom ever known
to man. For what is at stake is not just the survival of this or
that industry. What really is hanging in the balance is the survival of our private sector, and the individual liberties which
nave never long survived the collapse of a society's economic
freedoms.
- 8 The problem is a matter of both policy and perception. Bad
perception leads inevitably to bad policy, and I am firmly convinced that, taken together, misunderstanding and misdirection of
the American economy have become the central underlying problem
of our times. Unfortunately the perception of what is right or
wrong is too often inaccurate, because it is described inaccurately as a superficial division between those who "care" and
those who are "callous".
Many of today's youth view those who consistently advocate
bigger government as the saviors of the modern world out to rescue
the persecuted underdog. On the other hand, those who advocate
less government and the strengthening of free enterprise are often
dismissed out of hand as greedy exploiters out to make a fast buck
for themselves or their companies. And — because image is so
all important and bad news is big news — those who supposedly
"care" are often afforded greater media exposure to expound about
all our social ills and to claim they can cure them by just cranking out more currency and soaking up more credit through massive
deficit spending. In reality, of course, this is no cure at all.
It is this same destructive approach that is at the very root of
the problems we are struggling with today. Big government isn't
the solution; it's a large part of the problem.
We who insist on the superiority of the free enterprise
system, emphasizing its competition, efficiency, and profitability
are nevertheless losing our argument. We tend to converse in
slogans and labels, while the proponents of big government speak
in more appealing, seemingly more humane terms. This is unfortunate, and to me it would be difficult to imagine
any greater
irony. For even the most cursory glance at history shows us that
the American economy is the most successful the world has ever
known — precisely because it is an essentially humane creation
of the people, by the people, and for the people.
The performance of our economy proves this. In the period
since the early 1960s — a period during which one abuse after
another has been inflicted upon our private sector, it has nevertheless managed to outperform all others.
— In the last 15 years, real purchasing power of Americans
has jumped by 40 percent, average family income has risen to over
$13,000 a year, 20 million new jobs have been created, and we
have cut the number of people below the poverty line in half.
— Our farmers harvest more than twice as much grain with
fewer workers compared to a generation ago.
— Medical science has added 10 years to our lives over
this period.
— And
Americans
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history.
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and
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- 9 No other country — no other system — has achieved so much
for its people. Yet these tremendous achievements are the product of the same free-market system that now finds itself under
attack.
Where does the free enterprise system stand today? For all
the talk about excessive profits, it's a system that, on the
average, offers a profit incentive of less than five cents on the
dollar, a small reward for all the effort and risk-taking that
goes into developing and operating a successful business.
Nevertheless, it remains the real productive source of our
nation's wealth, as well as that of each individual American.
Despite the growing influence of government over our lives,
the private sector produces the food we eat, the goods we use,
the clothes we wear, the homes we live in.
It is the source of five out of every six jobs in America,
and it provides directly and indirectly, almost all the pressure
for the rest of the jobs in our all-too-rapidly expanding public
sector.
It is the foundation for defense security for ourselves and
most of the Free World.
It is the productive base that pays for government spending
to aid the elderly, the jobless, the poor, the dependent and the
disabled. Indeed, far from being the anti-human caricature painted
by political demagogues, the American private sector is in reality
the mightiest engine for social progress and individual improvement ever created.
In a nutshell, all of the material and spiritual values that
make our country unique and make us so proud to be Americans
could not exist without the free enterprise system. Yet many
people still fail to understand the crucial link between our economic and our political freedom. Destroy one, and the other will
soon disappear.
I can assure you that this Administration is fighting to
ensure the survival of your economic freedoms. But to succeed,
we must have the active participation of business leaders like
yourselves in reopening the lines of communication to the American people. It's been said that communication is the web that
holds civilization together, perpetuating its values and traditions
- 10 Never has that function been more important than today.
We must — all of us — communicate the great story of freedom.
— We must dispell the confusion that has made free enterprise a dirty word, and convince them that business, profits and
people are all mutually interrelated.
— We must let our lawmakers and leaders in government know
that they cannot continue to work at cross purposes with the very
system that generates our wealth, our strength and our freedom.
— We must make people aware that runaway spending and
unending deficits are sopping up much needed capital for productive jobs, and are only fueling inflation — a silent thief that
picks every American's pocket, undermines confidence and turns
the desperate to government for still more illusory help.
But words are certainly not enough, the living example is
much more meaningful. That is why I urge each of you:
— To set a high moral and ethical standard by eliminating
any practices in your organizations and operations that may be
questionable.
— To square practices with principles by supporting deregulation across the board, not just selectively; by helping to
end government subsidies, quotas and handouts, bailouts or other
inducements that offer a superficial empty promise of security
in exchange for sacrifices of freedom and,
— To initiate and in some cases intensify our efforts to
inform and educate the public about the benefits and realities
of private enterprise.
This, ladies and gentlemen, is the crucial theme that must
be communicated broadly and deeply into the national consciousness: The American production and distribution system is the
very wellspring of our nation's strength — the source of present
abundance and the basis for our hopes of a better future. America
can solve its pressing problems if it preseryes and continues to
improve this immensely productive system. And in this process,
we'll also be preserving the freedoms that made it all possible.
Let us make that our common resolve.
Thank you.
0O0
£V7
REMARKS BY THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE THE
CARBONDALE CHAMBER OF COMMERCE
CARBONDALE, ILLINOIS
APRIL 29, 1976
Thank you, .
Congressman Simon , Mayor Eckert,
President Brandt, Mr. Emerson, distinguished guests,
Ladies and Gentlemen:
It's a pleasure to join you in this well-deserved
tribute to Senator John Gilbert and a very special pleasure to be among so many good friends here in Carbondale.
When Paul Simon, your able Congressman, and my good
friend, invited me to join you here tonight I responded
most enthusiastically for two reasons. First, I want to
get in on record once and for all that the Simon who is
spearheading the Draft Hubert Humphrey movement and the
Simon who is Secretary of the Treasury are not related.
And second, I always enjoy coming to Illinois, a great
state of great sons who have given much to our nation.
Abe Lincoln, Everett Dirksen, Adlai Stevenson, Charles
Percy and others too numerous to mention all have in common a unique spirit. It is a spirit that stems directly
from this heartland of America -- a spirit of vitality,
self-reliance, individuality and dignity.
And it is a spirit that is too rare these days in
Washington -- the city that subscribes to Ben Franklin's
dictum that "three may keep a secret if two of them are
dead."
After more than three years in Washington, one other
thing is also apparent to me. Washington is full of politicians -- present company excepted, of course -- who tend
to be obsessed with our immediate problems and with creating instant formulas and overnight panaceas to solve them.
It is almost a cardinal sin in that city to look beyond
November in an election year.
WS-798
As a non-politician, I am going to commit that sin
tonight and I ask your indulgence as we take a longerterm view of where we have been and where we are going
as we confront our economic problems.
There is a strong irony in the fact that when the need
for long-term vision about our economy has never been greater,
we are being deluged with a series of suggestions of quick
fixes for our economic ills0 Those who call for these magic
cures claim that we aren't spending enough, aren't pressing
hard enough, aren't pushing enough panic buttons to solve our
problems.
Despite our steady economic gains many of these critics
say there is some basic flaw in our system and they bombard
us with countless sleight-of-hand remedies: governmental
control over economic planning -- guaranteed jobs for all
at government expense - - a new round of wage and price controls -- and other so-called solutions.
Frankly, I believe that many of these critics suffer
from what Mark Twain called "loyalty to petrified opinions."
They fail to see that efforts to strengthen the public
sector at the expense of the private sector are a large
part of the problem, not part of the solution. They refuse
to recognize that the same excessive government fiscal,
monetary and regulatory policies they call for today have
led to abuse of our economy and helped trigger, first, a
storm of inflation in the early 1970s and, second, the
severe recession from which we are now recovering. And
they fail to comprehend a gathering mood in this country
against the further expansion of big government. They
suffer from the economic variety of Potomac Fever -- the
delusion that all economic cures must originate in Washington with the Federal government. As President Eisenhower
once remarked, "there are a number of things wrong with
Washington, and one of them is that everybody has been too
long away from home."
But before we look at where we are going, I'd like
to take a moment to look at where we have been in the
recent past -- and to itemize our recovery from the worst
recession in more than a generation and the worst inflation
in our peacetime history.
As we work our way out of one of the most:; severe economic slowdowns of the entire post-war experience, I believe
that the decisions we have had to make, and are making,
will serve as an instructive guide to the future.
S»7
Many of you in this room who are small businessmen
and women may still be feeling the effects of the recent
double-digit inflation and severe recession. Perhaps
some of you fear that our immediate economic future is
uncertain and that you may wake up tomorrow to face a new
round of inflation, tighter credit and more unemployment.
Let me put things into perspective. We have had
extensive and impressive evidence that our national economy
is on the road to a healthy recovery. Economists generally
agree that the economy began to recover a year ago, that the
recovery began sooner than expected, and that it has been
stronger than expected. This is not to say that everything is fine. But for 12 months the U.S. economy has
been expanding rapidly, and the benefits of a reviving
private sector have already accomplished much in unwinding
the severe inflation and unemployment caused by the stop-go
policies of the past decade.
-- 1975 opened with inflation raging at nearly 13
percent. That rate has been sharply reduced to approximately 6 percent. In fact, over the last three months
for which we have statistics, December through February,
consumer prices have only risen at an annual rate of 4.4
percent. Over the last five months, wholesale prices have
actually declined. We do not expect those experiences
to continue. But we have made significant progress already
and more can be expected if responsible policies are followed.
-- Last spring, unemployment had reached nearly 9 percent. It has now dropped to 7.5 percent and our forecasts
indicate a continuing downward trend toward 7 percent by
the end of the year.
-- And last week we learned that real GNP, that is,
total output after adjusting for inflation, increased at
an annual rate of 7-1/2 percent during the first quarter
of 1976.
-- Other signs point to an economy that is gaining
increasing momentum: personal income, industrial output,
housing starts, retail sales, the stock market -- all are
registering solid gains and this reflects a rising public
confidence about the economy that contrasts sharply with
the deep pessimism reported by polltakers the middle of
last year.
- 4 -
0
But although we made considerable headway in 1975
and we are making even more in 1976, this is no time for
complacency. Inflation is not under complete control and
the jobless rate is still too high. Right here in Jadkson
County, unemployment is running above the national average -and this translates into hardship and suffering for many
families. And per capita family income in this area and
in many other areas of the Nation is still too low. Let
me assure you that we will not be content until the rising
vigor of the economy nationally is reflected in communities
that have been hardest hit by recent economic conditions.
But there is another basic consideration we must not
lose sight of. Inflation remains the most dangerous enemy
of future economic growth, and we must do nothing to unleash
another inflationary spiral. Ruinous inflation was the
chief cause of our recent recession. Inflation hits everyone,
rich, poor and middle class alike, the small business
owner, the college professor, the college student and
Caterpillar Tractor. It erodes the value of our dollars,
stifles profits and real earnings, drives up interest rates
and puts the pinch on investment and expansion. In short,
it drains the life-blood and vitality from our society.
We can indeed take comfort from the fact that the
symptoms of inflation are receding for now; but the root
cause of the disease remains. I refer to the excessive
governmental fiscal, monetary and regulatory policies that
we have pursued over part of the past 40 years, particularly
over the last decade. These policies, the legacy of the
Great Depression of the 1930's, could lead to even worse
recessions and more ruinous inflation in the future if
we do not learn from history and act now, before it is
too late.
Let us just look at a few economic trends and facts :
In 1930, government spending at all levels amounted
to approximately 10 percent of the GNP. Today government
accounts for almost 40 percent"of our entire national out
put, and if this trend continues, the government's share
of the economy will reach 60 percent within 2 5 years.
-- In just 15 years time the Federal budget has quadrupled.
6
§"
-- We have failed to balance the budget for 16 of the
past 17 years.
-- And in just ten years time, we have doubled the
national debt. It took 75 years for our national debt
to reach one billion dollars. This year, government
spending is causing the debt to grow by one billion dollars
every week.
-- And the average American bears a tax burden of
over 30 percent of his earnings -- that means working
for the government instead of yourself from January to May.
The Federal Government today is the nation's biggest
single employer, its biggest consumer, and its biggest
borrower. Partly to accommodate the Federal Government's
borrowing needs in the private markets, there has been a
less noticed but equally significant shift in monetary
policies. From 1955 to 1965, the money supply of the
United States was growing at approximately 2-1/2 percent
a year. During that period we enjoyed relative price
stability. But from 1965 to the present, the average
rate of growth in the money supply has more than doubled.
It is no accident that during this same period we have also
had spiraling inflation.
The alarming .fact is that in every country that has
given way to these trends, there has been a tendency :to
move toward instability, toward minority government and
toward a threat to a free society. The important point
here is that the issues involved are by no means narrowly
economic. They concern fundamental principles of equity
and of social stability. The problem of growing government
spending is that, however good the intentions which underlie the growth, those intentions are not achieved; that,
instead, the growth in government spending makes low-income
people worse off, undermines social cohesion and threatens
the very foundation of a free and representative government.
This past decade has also s.een tremendous growth in the
regulatory apparatus of the government. Government agencies
now exercise direct regulation over 10 percent of everything
bought and sold in the United States and indirectly regulate
almost every other sector of the private economy. Just to fill
out the necessary Federal forms, the American people now spend
over 130 million work hours a year. Indeed
-6-
iuui_u ui J-ICC cui-crpri^v *•• • - -
—i---
-
. -
«
ing costs involved. Last year, business spent an estimated
$20 billion just to do the paper work demanded by Federal
bureaucrats. Of course, it is you and I and every otner
consumer who pay for this in the form of higher prices
and higher taxes.
This is not to say that some government regulations
are not necessary and even desirable. We must control the
quality of the air we breathe, the food we eat and water
we drink. These are all desirable regulatory objectives.
But do we really need government telling businessmen what
the height of their office washrooms should be?
It is the case history of one Ed Sohmers, a typical
American businessman, who honestly and conscientiously
tried to comply with Federal rules and regulations.
Ed Sohmers was general manager of Marlin Toy Products,
Inc., a Wisconsin company that made a toy cited as unsafe
in November 1972 by the U.S. Food and Drug Administration.
The toy, a plastic ball containing colored pellets, was
declared unsafe, the FDA said, because if it broke open
a child could swallow the pellets. No matter that Marlin
had been marketing the toy since 1962 and had received no
complaints.
Mr. Sohmers recalled the toy at a cost of $95,000,
removed the pellets and thought his problems were over.
But as he and his 85 employees were preparing for
the 19 73 holiday season making the toy, a new Federal
Agency -- the Consumer Product Safety Commission -- took
over the safety regulation of toys and other products.
In the process, some of the paperwork on the Marlin plastic
toy went astray. Shortly thereafter, the Commission published a banned product list and, sure enough, the Marlin
plastic toy was mistakenly included on the list.
Ed Sohmer's protest fell on deaf ears. The erroneous
list had been distributed to thousands of toy shops and
the Commission refused to recall its 250,000 copies "just
to take one or two toys off the list," as they put it.
Predictably, the incorrect list caused order cancellations from all over the country. Marlin found itself
with a $1.2 million loss and had to lay off all but ten
of its 85 workers, many of whom were handicapped.
As Marlin1s toy business plummeted, its paperwork
problems skyrocketed.
-- Mr. Sohmers had to write more than 700 letters in
an effort to obtain enabling legislation that would permit
him to sue for damages.
-7-- He spent two weeks and $15,000 gathering documents
for an appraisal company to prove the loss of business.
-- Three employees had to work two seven-day weeks
pouring through documents that went back to the founding
of the business in a household kitchen in 1947, in order
to answer government inquiries.
-- And while all this was going on, the Justice Department, pleading a heavy workload, was able to obtain delays
on the company's court action against the government.
Today, Marlin is out of the toy business.
Marlin Toys' difficulties are just one example of
the waste and suffering caused by over-regulation and
bureaucratic bungling. In this case, over-zealous government regulation took a tragic economic toll on human beings.
I recently came under criticism from the Consumer
Product Safety Commission for having told Marlin's story
as an example of "bureaucratic bungling" to a group of
small businessmen in Dallas.
The Commission's Chairman, Richard 0. Simpson, wrote
me and I quote: "Although your statements accurately
reflect the allegations Marlin Toy Products, Inc. have
made, I believe it inappropriate for you to publicize them
when those very allegations are being contested in court."
The government's position, wrote Mr. Simpson, "is
that the principal cause of the company's problems results
from its own mismanagement."
When I got that letter, naturally I did a little more
checking of the facts. I discovered by Mr. Simpson's own
admission in letters to Mr. Sohmers of Marlin in March,
1974, and to Senator Eastland in July, 1974, that the
Commission's listing was indeed an error -- an error committed by the Commission and not one that was the result
of Marlin's mismanagement.
Was it inappropriate of me to speak of Marlin's plight
in a public forum in the first plaee? I submit that it
was not. Was it inappropriate to mention that the allmighty U.S. Government made a mistake? I submit that it
was not.
And I submit finally, that we need more, not less
Public discussion of regulatory and other matters that
directly affect businesses and individuals throughout the
country.
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it is not just Mr. Sohmers and other victims of overregulation that suffer the consequences of big government.
We all .pay the bill, and^ ,itfs^gettinq bigger every year.Look at the figures.
. _
'"'"
Our current Federal budget is equivalent to about $2,000 for every man, woman and child in
America. Our national debt equals almost another $3,000
for every citizen. And government regulation adds about
$2,000 to the costs of purchases made by each American
family every year. How can anyone make the case that
government benefits have in any way kept up with government costs?
Indeed, is it any wonder that if present trends continue, government at all levels could account, as I pointed
out earlier, for almost 60 percent of our GNP by the end
of the century?
If we ever let government become such a dominant
part of our society, I have no doubt that most of our
economic freedoms will disappear. And when that happens
the precious individual freedoms we enjoy will soon erode
after them.
Thomas Jefferson understood this close link between
individual and economic freedom. To preserve our independence, he once wrote, "We must not let our rulers load
us with perpetual debt. We must make our choice between
economy and liberty, or profusion and servitude."
When you add up all these facts of excessive government spending, excessive expansion of the money supply
and excessive governmental regulation, one conclusion seems
inescapable. If there is such a thing as truth in packaging, both our inflation and our resulting unemployment
should bear the label "Made in Washington, D.C."
The fact is that governmental excesses of the past
15 years were the strong, underlying cause of inflation
during the 1960s. They remain so today. The rise in
government spending has added enormously to the aggregate
demand for goods and services in the economy, thus forcing
up prices. And the government's heavy borrowing requirements
means that this year it will soak up 80 percent of the
capital in the capital markets, leaving only 20 percent to
the entire private sector, which nevertheless must produce
virtually all our goods and services and employ 83 percent
of our work force.
-9-
This increasingly massive governmental presence has
been an important factor in the persistent rise in interest rates and the strains we have seen in the financial
markets. Moreover, it is clear that the cumbersome regulatory procedures of the government have too often stifled
competition which has inevitably added billions of dollars
to the price of consumer goods.
The evidence is in and it proves conclusively to me
that government, far from being our greatest source of
prosperity and material security as some people would have
us believe, has now become a direct threat to our survival
as a free society.
As we enter our third century as a nation, I believe
the time has come not to reappraise our dedication to a
better life for all -- that dedication is clear -- but to
reappraise what we can afford to pay for this goal and
how we can best achieve it. The current plight of New
York, the malaise affecting many other state-controlled
economies and the overwhelming size of our Federal deficits
are all grave warnings to us. We can pay for what we now
have and provide for the future only if our great free
enterprise economy is allowed to do its job -- to produce
goods and jobs in a free market at a fair price.
I am sick and tired to apologizing for free enterprise. It's our profit system that has given this country
a prosperity that is now the envy of the entire world. If
we were to listen to some of our critics and run our businesses the way they would run the government, there would
be no profits to tax, no revenues to collect, and thus no
programs to fund.
This great country of our* has the human resources,
the economic resources, and a productive and creative
economic system to keep going and growing if we will only
look at the facts as they are. At the height of the energy
crisis, the doom peddlers pounded away at an inventory
of disasters -- dollar gas, dollar bread, dollar sugar,
and even dollar toilet paper. The disasters never came.
511
During the debate of New York City's fiscal problems,
many of the same voices joined together in a chorus of
doom promising that, unless President Ford wrote New York
a blank check, there would be a collapse of the international
finance system. It never happened.
If each of us will just act responsibly and consider
the facts calmly in deciding the political and economic
issues of the day, we have every reason to be optimistic
about our country's future. The free enterprise ideals
and principles that have guided this nation for 200 years
will be true to us as long as we are true to them.
That is why the Administration is urging Congress to
adhere to a broad-gauged plan to further nurture and stimulate the natural forces of growth in our private enterprise
economy. An essential element of the plan is to put the
brakes on the dizzying momentum of Federal spending --to
slow the rate of increase to about 5 percent this fiscal
year, contrasted with a jump of 40 percent from Fiscal
Year 1974 to Fiscal Year 1976. This will allow us to continue to make progress on inflation and, at the same time,
will make additional tax cuts possible for businesses and
individuals and set the stage for a balanced budget within
three years.
Further, the President has urged tax measures designed
to stimulate job creation generally, encourage the building of sorely needed electric power facilities, and increase
plant and equipment construction in areas where unemployment has topped 7 percent, which includes virtually every
major job market in Illinois and many other parts of the
Mid-West.
Finally, the Administration has proposed elimination
of the unfair double taxation of dividends that retards
capital formation. This is the only major proposal I know
about that seeks to correct the imbalance between corporate
debt and equity. As you well know, we must redress this
imbalance to allow the financial markets to channel society's
savings more efficiently into promising investment opportunities. And, as you also know, improving our lagging
capital investment picture is absolutely essential to meet
our long-term goals of more jobs, higher incomes, greater
productivity, lower inflation and sustained growth.
-11-
These steps and the balanced program we have pursued
so far are designed to fight inflation and unemployment
simultaneously and strengthen the private sector of our
economy.
We firmly believe that this course is working, that
it is right for the Nation, and that it is leading us forward towards robust growth and expanding opportunities.
One hundred and one years ago, Lincoln said, "I have
faith in the people. . .The danger is in their being mislead. Let them know the truth and the country is safe."
The truth is what I have tried to emphasize here
tonight. As business and professional people, each of
you benefits from our great free enterprise system. Each
of you knows first-hand -- sees every day -- the strengths
of a free economy.
And each of you knows, as I do, that while the free
enterprise system is not perfect, it has provided us with
the highest standard of living ever known to man, unparalleled national wealth, and individual freedoms that are
the envy of the world.
For when we talk about our free enterprise economy, we
are talking about food on the table, goods on the shelves
and services at the counter. We are talking about medical
break-throughs that have added 10 years to our lives in
the past generation. We are talking about labor-saving
devices that have freed millions of women for productive
careers and the pursuit of self-enlightenment. We are talk1ing about five out of every six jobs in America and wages
and benefits that stagger the imagination of the rest of
the world. We are talking about a productive base that pays
for government support of the elderly, the jobless, the
poor, the dependent and the disabled. And we are talking
about basic freedoms, freedom to choose a career, to choose
what and where we buy, to choose where and how we live,
and yes, to swim against the tide -- as did Fulton and
Ford and Edison -- things you could never do living in
the gray shadow of conformity under a regimented society.
And so I would like to ask each and every one of you
here tonight to help preserve that system. If we work
together, with pride in ourselves and in our past, the goals
we share for the future can become the first great achievements of America's third century.
^
&f
These steps and the balanced program we have pursued
so far are designed to fight inflation and unemployment
simultaneously and strengthen the private sector of our
economy.
We firmly believe that this course is working, that
it is right for the Nation, and that it is leading us forward towards robust growth and expanding opportunities.
One hundred and one years ago, Lincoln said, "I have
faith in the people. . .The danger is in their being mislead. Let them know the truth and the country is safe."
The truth is what I have tried to emphasize here
tonight. As business and professional people, each of
you benefits from our great free enterprise system. Each
of you knows first-hand -- sees every day -- the strengths
of a free economy.
And each of you knows, as I do, that while the free
enterprise system is not perfect, it has provided'us with
the highest standard of living ever known to man, 'unparalleled national wealth, and individual freedoms that are
the envy of the world.
For when we talk about our free enterprise economy, we
are talking about food on the table, goods on the shelves
and services at the counter. We are talking about medical
break-throughs that have added 10 years to our lives in
the past generation. We are talking about labor-saving
devices that have freed millions of women for productive
careers and the pursuit of self-enlightenment. We are talking about five out of every six jobs in America and wages
and benefits that stagger the imagination of the rest of
the world. We are talking about a productive base that pays
for government support of the elderly, the jobless, the
poor, the dependent and the disabled. And we are talking
about basic freedoms, freedom to choose a 'career, to choose
what and where we buy, to choose where and how we live,
and yes, to swim against the tide --as did Fulton and
Ford and Edison -- things you could never do living in
the gray shadow of conformity under a regimented society.
And so I would like to ask each and every one of you
here tonight to help preserve that system. If we work
together, with pride in ourselves and in our past, the goals
we share for the future can become the first great achievements of America's third century.
£'?
But if we allow those who call for "sweeping changes
and broad new government initiatives" to prevail (and their
cries are louder in this election year), it will mean
higher spending, higher deficits, higher taxes and greater
control by the government over our lives.
As Daniel Webster once said, "God grants liberty
only to those who love it, and are always ready to guard
and defend it." For more than two centuries, Americans
have met that challenge. If we keep alive the spirit that
infuses our national character -- the spirit of free enterprise that each of you personifies -- then we can be certain
that it will endure for many centuries to come.
Thank you.
0O0
REASURY
,D.C. 20220
«
TELEPHONE 964-2041
FOR RELEASE AT 4:00 P.M. April 20, 1976
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites tenders for
two series of Treasury bills to the aggregate amount of $6,100,000,000 , or
thereabouts, to be issued April 29, 1976,
as follows:
91-day bills (to maturity date) in the amount of $2,600,000,000, or
thereabouts, representing an additional amount of bills dated January 29, 1976,
and to mature July 29, 1976
(CUSIP No. 912793 A2 2 ) , originally issued in
the amount of $3,501,865,000, the additional and original bills to be freely
interchangeable.
182-day bills, for $3,500,000,000, or thereabouts, to be dated April 29, 1976,
and to mature October 28, 1976
(CUSIP No. 912793 B7 0 ) .
The bills will be issued for cash and in exchange for Treasury bills maturing
April 29, 1976,
outstanding in the amount of $6,305,065,000, of which
Government accounts and Federal Reserve Banks, for themselves and as agents of
foreign and international monetary authorities, presently hold $2,616,620,000.
These accounts may exchange bills they hold for the bills now being offered at
the average prices of accepted tenders.
The bills will be issued on a discount basis under competitive and noncompetitive bidding, and at maturity their face amount will be payable without
interest.
They will be issued in bearer form in denominations of $10,000,
$15,000, $50,000, $100,000, $500,000 and $1,000,000 (maturity value), and in
book-entry form to designated bidders.
Tenders will be received at Federal Reserve Banks and Branches up to
one-thirty p.m., Eastern Daylight Saving time, Monday, April 26, 1976.
Tenders will not be received at the Department of the Treasury, Washington.
Each tender must be for a minimum of $10,000.
multiples of $5,000.
Tenders over $10,000 must be in
In the case of competitive tenders the price offered must
be expressed on the basis of 100, with not more than three decimals, e.g., 99.925.
Fractions may not be used.
Banking institutions and dealers who make primary markets in Government
WS-799
(OVER)
&
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\
securities and report daily to the Federal Reserve Bank of New York their positions
with respect to Government securities and borrowings thereon may submit tenders
for account of customers provided the names of the customers are set forth in
such tenders.
own account.
Others will not be permitted to submit tenders except for their
Tenders will be received without deposit from incorporated banks
and trust companies and from responsible and recognized dealers in investment
securities.
Tenders from others must be accompanied by payment of 2 percent of
the face amount of bills applied for, unless the tenders are accompanied by an
express guaranty of payment by an incorporated bank or trust company.
Public announcement will be made by the Department of the Treasury of the
amount and price range of accepted bids.
Those submitting competitive tenders
will be advised of the acceptance or rejection thereof.
The Secretary of the
Treasury expressly reserves the right to accept or reject any or all tenders,
in whole or in part, and his action in any such respect shall be final. Subject
to these reservations, noncompetitive tenders for each issue for $500,000 or less
without stated price from any one bidder will be accepted in full at the average
price (in three decimals) of accepted competitive bids for the respective issues.
Settlement for accepted tenders in accordance with the bids must be made or
completed at the Federal Reserve Bank or Branch on April 29, 1976,
in cash or
other immediately available funds or in a like face amount of Treasury bills
maturing April 29, 1976.
ment.
Cash and exchange tenders will receive equal treat-
Cash adjustments will be made for differences between the par value of
maturing bills accepted in exchange and the issue price of the new bills.
Under Sections 454(b) and 1221(5) of the Internal Revenue Code of 1954 the
amount of discount at which bills issued hereunder are sold is considered to
accrue when the bills are sold, redeemed or otherwise disposed of, and the bills
are excluded from consideration as capital assets.
Accordingly, the owner of
bills (other than life insurance companies) issued hereunder must include in his
Federal income tax
return, as ordinary gain or loss, the difference between
the price paid for the bills, whether on original issue or on subsequent purchase,
and the amount actually received either upon sale or redemption at maturity
during the taxable year for which the return is made.
Department of the Treasury Circular No. 418 (current revision) and this notice,
prescribe the terms of the Treasury bills and govern the conditions of their
issue.
Copies of the circular may be obtained from any Federal Reserve Bank or
Branch.
oOo
f2Z
Contact: J.C. Davenport
Extension 8585
April 22, 1976
FOR IMMEDIATE RELEASE
WITHHOLDING OF APPRAISEMENT ON
TANTALUM ELECTROLYTIC FIXED CAPACITORS
FROM JAPAN
Assistant Secretary of the Treasury David R. Macdonald
announced today a withholding of appraisement on tantalum
electrolytic fixed capacitors from Japan pending a determination as to whether they are being sold at less than fair
value within the meaning of the Antidumping Act of 1921, as
amended.
This decision will appear in the Federal Register of
April 23, 1976.
Under the Antidumping Act, the Secretary of the Treasury
is required to withhold appraisement whenever he has reasonable
cause to believe or suspect that sales at less than fair value
may be taking place.
A final Treasury decision in this investigation will be
made within three months. Appraisement will be withheld for
a period not to exceed six months from the date of publication
of the "Withholding of Appraisement Notice" in the Federal
Register.
Under the Antidumping Act, a determination of sales in the
United States at less than fair value requires that the case
be referred to the U.S. International Trade Commission which
would consider whether a United States industry is being or
is likely to be injured, or is prevented from being established, by reason of such sales. Both sales at less than
fair value and injury must be found before a finding of dumping can be issued. Upon a finding of dumping, the applicable
merchandise is then subject to the assessment of special duties.
Imports of the subject merchandise from Japan amounted to
$1.3 million during January-October 1975. Tantalum electrolytic
fixed capacitors are dutiable under item 685.80 of the Tariff
Schedules of the United States.
WS-800
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cT-23
Contact: Richard Self
Extension 2951
April 22, 1976
FOR IMMEDIATE RELEASE
TREASURY ANNOUNCES FINAL COUNTERVAILING DUTY
DETERMINATION ON
BEEF IMPORTS FROM THE EC
Assistant Secretary of the Treasury David R. Macdonald
announced today a final determination under the Countervailing
Duty Law that bounties or grants are being paid on imported
frozen boneless beef from European Community Countries.
Notice to this effect will be issued in the FEDERAL REGISTER
of April 23, 1976.
A notice of initiation of investigation coupled with a
preliminary countervailing duty determination was published
in the April 1, 1976, FEDERAL REGISTER. Information before
the Treasury indicates that exports of frozen boneless beef
to the U.S. receive export restitution payments under the
European Community's Common Agricultural Policy.
During 1975 imports of frozen boneless beef from European
Community Countries were approximately $3.6 million.
*
WS-801
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Department of the'fREASURY
TELEPHONE 964-2041
STATEMENT BY THE HONORABLE JAMES J. FEATHERSTONE
DEPUTY ASSISTANT SECRETARY (ENFORCEMENT) OF THE TREASURY
before the
PRIVACY PROTECTION STUDY COMMISSION
April 22, 19 76
j&y
2:00 P.M.
Mr. Chairman and Members of the Commission:
The Treasury Department appreciates this opportunity
to comment upon its role and responsibilities with respect
to Titles I and II of Public Law 91-50 8, commonly referred
to as the Bank Secrecy Act. We are grateful to the
Commission for having scheduled hearings at this time
to enable us to develop the underlying history and purposes
of the law and the implementing regulations, and to clear
up some misunderstandings about government access to bank
records.
The Treasury Department firmly supports the purpose
of the Act now just as it did when Chairman Patman introduced the initial legislation. The bank recordkeeping
requirements and the reporting provisions contained in
the regulations issued to implement the Act have assured
the public that the basic financial records essential to
the proper investigation of white collar crime, corruption,
and tax evasion will generally be available when the
appropriate government authorities need them. Furthermore, we believe that we have been able to accomplish
this primary objective without sacrificing our interest
in observing the Constitutional prohibition against
unreasonable searches and seizures and in avoiding
unnecessary incursions into the privacy of individuals.
Our desire to attain these goals is well documented in the
legislative history of the Act.
WS- 802
-2LEGISLATIVE HISTORY
Foreign bank secrecy and bank recordkeeping legislation was introduced in the House of Representatives
on December 3, 1969 (H.R. 15073) by Congressman Wright
Patman. It was aimed at the prevention of the use of
secret foreign financial facilities for illegal purposes
by persons subject to U.S. laws. Hearings were held
before the House Banking and Currency Committee on
December 4, 6 and 9 of 1969, and February 10, March 2
and 9, 1970. Testimony by representatives of the
Department of Justice, Department of the Treasury, and
the Securities and Exchange Commission revealed the
growing use of secret foreign bank accounts for a wide
variety of illegal purposes by U.S. citizens and
residents.
Thus, this legislation grew initially out of concern
over the use by criminal elements and others of secret
foreign bank accounts to evade income taxes and hide the
fruits of their illegal activities. However, the bill
also reflected Congressional concern over the availability
of records maintained by domestic financial institutions
relating to those engaged in organized and "white collar"
crime. As introduced, the House bill required U.S. banks
to copy checks and certain other instruments, maintain
certain records, and permit the Secretary to have access
to such records; it required U.S. financial institutions
and those dealing with them to report certain U.S.
currency transactions to the Treasury; and it required
citizens, residents, and persons doing business in
this country to report certain transactions with foreign
banks.
When the House Subcommittee on Financial Institutions
held hearings on this bill a Treasury spokesman testified
that we supported the objectives of preventing the use
of foreign bank accounts for illegal purposes, but that
we felt that the proposed bill went too far, that additional work was required to determine the best way to
achieve its objective without hampering commerce,
injuring the status of the dollar, creating undue
administrative burdens, and infringing upon the traditional
freedoms of American life. We were particularly critical
&
of the provisions of H.R. 150 73 which would have given
the Internal Revenue Service unlimited access to private
bank records. We opposed any such broad "survey" power.
We also were critical of the provisions of the bill
which made mandatory the photocopying of all checks. A
Treasury task force was studying the international banking
transactions area and had developed certain proposals for
legislative action similar to those in the House bill.
In the domestic area, however, we observed that the bill
as drafted provided the Secretary with little or no
flexibility with respect to the implementation of its
requirements.
As a result of our efforts, the provision giving
Treasury broad access to bank records was deleted from
the bill. However, the House Committee disagreed with
us that the domestic recordkeeping area required further
study. The bill reported out by the Committee contained
the following Congressional findings and statement of
purpose:
"Sec. 21. (a) (1) The Congress finds that
adequate records maintained by insured banks
have a high degree of usefulness in criminal,
tax, and regulatory investigations and proceedings.
The Congress further finds that photocopies made
by banks of checks, as well as records kept by
banks of the identity of persons maintaining or
authorized to act with respect to accounts therein,
have been of particular value in this respect.
"(2) It is the purpose of this section to
require the maintenance of appropriate types of
records by insured banks where such records may
have a high degree of usefulness in criminal,
tax, or regulatory investigations or proceedings.
The House Report justified these positions as follows:
"In recent years a few sizeable banks have
abolished or limited the practice of photocopying
checks, drafts and similar instruments drawn on
p7
them and presented to them for payment. This
failure to maintain photocopies of checks
has frustrated law enforcement personnel in
securing evidence necessary to criminal, tax,
and regulatory investigations and proceedings.
Many cases have either been dropped or their
conclusion has been long delayed because of
the difficulty or impossibility of obtaining
photocopies or records of essential checks,
drafts or similar instruments." (p. 11)
* * *
"The importance of photocopies of checks
to effective law enforcement, especially where
white collar crimes are concerned, simply cannot be overestimated. The recipient of a
direct or indirect bribe, for example, will
make no record of his receipt of the money,
and the person who wrote the check will take
pains to see that it is totally destroyed after
cancellation. In many instances, payments by
check which are not necessarily illegal in and
of themselves may constitute the only way that
the prosecution can establish the existence of
a relationship or pattern of conduct which may
be essential to making its case.
Finally, the maintenance of check photocopy
records by banks raises no constitutional issues
and poses no threat to individual liberty. As
has been pointed out, banks have wide experience
with maintaining these records, and the banking
industry has a creditable record of maintaining
their confidentiality. There is nothing in this
bill which would make such records any more
accessible to law enforcement officers, much
less anyone else, than they now are." (p. 16)
The House Report also commented:
"Read in conjunction with the findings set
forth in section 21(a) and the requirement in
section 21(b) that the Secretary 'shall prescribe
regulations to carry out the purposes of this
section, •' the statement of purpose leaves the
-5-
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Secretary little choice but to request upon
the effective date of the legislation, that
banks photocopy all checks except for those
exempt under subsection (i) , discussed below." (p. 16)
Subsection (i) provided that "this section shall
not apply to domestic financial transactions
involving less than $500."
Senate Action
Thereafter, Senator Proxmire introduced S. 36 78.
Title I of that bill contained the same findings, purpose
clause, and photocopying requirements as H.R. 150 73,
with the exception of the exclusion for checks under $500.
When this bill was being considered by this Subcommittee,
Treasury made the following comments concerning governmental access to bank records:
"We decided against seeking specific statutory
authority extending the rights of the Internal
Revenue Service to survey the records of international transactions in banks and other financial
institutions. In deciding this, we considered
the constitutional prohibition against unreasonable
searches and seizures and the need to avoid
unnecessary incursions against the right of
privacy. While it is clear that obtaining records
by established discovery procedures from the banks
and other institutions in connection with the
examination of a particular taxpayer would not
violate these rights, provision for a survey of
such records raises a much more serious question.
We are also concerned that surveys or information
returns could have an adverse effect on legitimate
foreign investment in the United States. It has
been the tradition overseas to place great emphasis
on the privacy of financial transactions and a
breach of this tradition could adversely affect
the flow of foreign funds to the United States."
We also indicated our concern that the Senate bill
could be interpreted as requiring the Secretary of the
Treasury to issue regulations providing that all banks
photocopy all checks drawn on them, or under the House
bill, all checks of less than $500 used in domestic
S4?
financial transactions. The Senate Committee Report
makes no mention of this issue but simply discusses
the domestic recordkeeping requirements as follows:
"Many of these records are already kept
by financial institutions and it is not the
committee's intent to encumber these institutions
with a substantial volume of additional paperwork.
The committee has, however, received testimony
from law enforcement officials on the high degree
of importance of having access to copies of checks
drawn on commercial banks. Mr. Will Wilson,
Assistant Attorney General, has testified that
copies of bank checks are 'very important' to
law enforcement activities and 'very helpful' in
the collection of income taxes. The U.S. Attorney
for the southern district of New York has said
that the availability of copies of bank checks
is 'an indispensable tool of law enforcement.'
A former IRS agent testified that the microfilming
of checks 'is really a vital tool'.
"According to Assistant Attorney General Wilson,
microfilm copies of checks are important because
they are frequently the direct evidence of a
financial transaction which would otherwise be
difficult to prove. Copies of checks are valuable
in investigating domestic crimes as well as those
involving secret foreign bank accounts. For example,
a single microfilmed check in the amount of $5.20
helped in the conviction of Frank Costello"While most commercial banks maintain copies
of checks as a normal business practice, some of
the larger banks have stopped microfilming in recen
years. This has placed a burden on law enforcement
officials and has made it more difficult to obtain
evidence of financial transactions. The cost of
microfilming has been estimated to range between
one-half of a mill and 1 1/2 mills per check, a
cost that does not appear to be unduly onerous
compared to the normal service charge of 10 cents
per check." (p. 5)
S^/
Conference Committee Action
The Conference Committee report notes that the
House passed bill required the microfilming of checks,
and that the Senate bill amended this congressional
purpose by requiring the maintenance of such records
only where the Secretary determined their usefulness
in the various proceedings.
This difference in views was resolved in conference
by preserving the House purpose clause (new sec. 21(a)(2)
of the Federal Deposit Insurance Act) and relegating the
Secretary's authority to a subordinate clause (new sec.
21(b)). The Conference Committee also deleted the $500
exclusion from the recordkeeping requirements in the
House bill and amended sec 21(c) to require that any
exemptions granted by the Secretary from the recordkeeping
requirement must be "consistent with the purpose of this
section." This Conference Committee bill was approved
by both Houses and enacted into law.
- 8 FINANCIAL RECORDKEEPING AND REPORTING REGULATIONS
In March, 1972, the Treasury Department issued
regulations as Part 103 of Title 31 of the Code of
Federal Regulations to implement Titles I and II of
Public Law 91-508 effective July 1, 1972. The provisions
can be classified into the following categories:
(1)
Those pertaining to the recordkeeping
practices of banks and other financial
institutions.
(2) Those requiring reports of currency
transactions, foreign financial accounts,
and the international transportation of
monetary instruments.
(3) Those requiring financial institutions
to identify their customers.
(4) Those requiring persons having foreign
financial accounts to report them and
to maintain records of them.
Banks, savings and loans, securities brokers,
dealers in foreign exchange, agents of foreign banks,
and certain other financial institutions are required
to retain the original or a copy of the following
records:
(1)
Each extension of credit in excess of
$5,000 except for those secured by real
estate.
(2) Records of instructions given or received
concerning the transmission of more than
$10,000 in credit, funds, currency or
other monetary instruments, checks, or
securities out of the United States.
- 9-
°
Bank and bank-type institutions, such as savings
and loans, credit unions, and agents of foreign banks
must also retain a copy of the following records:
(1) Documents granting signature authority
over each deposit or share account.
(2) Statements of account.
(3) Checks and other charges in excess of
$100 that are posted to accounts. (Checks
drawn on certain high volume accounts are
exempt.)
(4) Each check or other item in excess of
$10,000 transmitted outside the United States.
*
(5) Each check or draft in excess of $10,000
drawn on or issued by a foreign bank which
is paid by the domestic bank.
(6) Each check in excess of $10,000 received
directly from a foreign financial
institution.
(7) Records of each receipt of currency,
other monetary instrument, securities,
checks, or credit received from a foreign
financial institution.
(8) Records necessary to reconstruct a checking
account and to furnish an audit trail for
each transaction over $100.
Securities brokers within the jurisdiction of the
SEC have been subject to recordkeeping regulations for
many years, even before Treasury issued 31 CFR 103. The
Treasury regulations, however, added the requirement
that brokers obtain a signature card of similar document
establishing trading authority over an account and that
- 10 -
r
they make a reasonable effort to obtain a Social
Security number for each account.
The reporting requirements are a mixture of the
old and the new.
There is a requirement that financial institutions
file a report with the IRS concerning any unusual,
domestic transaction involving more than $10,000 in
currency. This is only a modification of a similar
provision that was in effect for more than 25 years
before it was repealed by the current regulations.
The previous regulations required banks to report any
unusual customer transaction involving more than
$2,500. The major differences are that there has been
no attempt to conceal the current reporting requirement
from the public and that penalties have been provided
for the willful failure to file the reports.
One of the new reporting requirements calls for
reports of the international transportation of currency
and certain monetary instruments in excess of $5,000.
A traveller carrying a reportable amount must file a
report with the Customs Service at the time he enters
or leaves the United States. If the monetary instruments
are transported in some other manner, the report must
be filed with Customs before the shipment enters or
leaves this country. A United States resident who
receives a shipment from overseas is required to file
a report with Customs within 30 days after the shipment
is received in the United States.
There is a third reporting requirement that
actually went into effect before the regulations were
issued. The IRS included a question concerning the
ownership or control of foreign financial accounts
on the Federal income tax returns for 1970. Persons with
a financial account were also required to file an
additional report furnishing additional information
about the account. Under the regulations, they are,
in addition, required to retain certain records pertaining
to the account.
- 11 The regulations reinforce the precept "know your
customer" which is widely accepted in financial
circles. A financial institution is required to verify
and record the identity of any person for whom it
handles a transaction that is required to be reported.
Verification of the identity of a non-depositer may
be made by examination of a drivers license, passport,
or other document normally accepted as a means of
identification. There is also a requirement that
financial institutions make a reasonable effort to
obtain a Social Security or other taxpayer
identification number for each deposit account. These
provisions establish a minimum identification requirement.
Financial institutions have a vital interest in
knowing their customers. Each year banks and brokers
routinely guarantee the authenticity of the endorsements
on checks .and stock certificates worth billions of dollars.
While the risk resulting from this service is occasionally
dramatized by an incident similar to the Clifford
Irving-H. Hughes affair, most of us are unaware of the
tens of thousands of attempted forgeries that occur
each year. The Secret Service alone investigated more
PENALTIES
than 75,000 check cases last year.
The Act and the regulations provide a variety of
penalties and enforcement measures that include seizure
and forfeiture, cease-and-desist orders, fines, and
imprisonment. For example, currency or other
monetary instruments that are imported or exported
without being properly reported are subject to seizure
and forfeiture. In lieu of the forfeiture, a civil
penalty up to the amount of the currency or monetary
instruments involved may be assessed.
The usual civil and criminal penalties available
for willful violations of the regulations are limited
to a $1,000 fine and, in addition for criminal
violations, 1 year in prison. However, a criminal
violation of any of the provisions authorized by
- 12 Title I of the Act that is committed in furtherance
of the commission of a violation of Federal law
punishable by imprisonment for more than 1 year
may result in a fine of as much as $10,000 and
imprisonment up to 5 years. Furthermore, anyone
who willfully violates a reporting requirement in
furtherance of another violation of Federal law may
be fined $500,000 and imprisoned for 5 years. This
penalty would be applicable to the failure to report
an interest in a foreign financial account, if,
for example, that failure were related to a tax fraud
scheme. We believe that, as these penalties become
more widely known, they will become a powerful deterrent
to persons using secret foreign bank accounts to violate
our laws. OF RESPONSIBILITY FOR SECURING COMPLIANCE
DELEGATION
Responsibility for assuring compliance with the
requirements of the regulations is delegated as follows
(1) To the Comptroller of the Currency, with
respect to national banks and banks in
the District of Columbia;
(2) To the Board of Governors of the Federal
Reserve System, with respect to State bank
members of the Federal Reserve System;
(3) To the Federal Home Loan Bank Board, with
respect to insured building and loan
associations, and insured institutions
as defined in section 401 of the National
Housing Act;
(4) To the Administrator of the National Credit
Union Administration, with respect to
Federal credit unions;
(5) To the Federal Deposit Insurance Corporation,
with respect to all other banks except
- 13 agents of foreign banks which agents
are not supervised by State or Federal
bank supervisory authorities;
(6) To the Securities and Exchange Commission,
with respect to brokers and dealers in
securities;
(7) To the Commissioner of Customs with respect
to reports of transportation of currency
or monetary instruments and forfeiture of
currency or monetary instruments;
(8) To the Commissioner of Internal Revenue
except as otherwise specified in this
section.
Overall responsibility for coordinating the procedure
and efforts of the agencies listed herein and assuring
compliance with this part, is delegated to the Assistant
Secretary (Enforcement, Operations, and Tariff Affairs).
USEFULNESS OF THE REQUIRED RECORDS AND REPORTS
We think of the regulations as providing a system
for detecting and documenting the overwhelming majority
of the crimes committed for economic gain. Of course,
the records banks are required to keep are the heart of
the system. Most sizeable payments are made by check
today. Although charge cards are gaining in popularity
they are ultimately reflected in a charge to a bank
account. Except for cash transactions and the physical
movement of currency abroad, most substantial transactions
by U.S. persons will be reflected in some way in domestic
bank accounts. The currency transactions reports and the
reports of the international transportation of currency
were intended to fill the recording gap resulting from
the use of cash.
In addition, the reports are designed to alert law
enforcement officials to unusual transactions that might
warrant investigation. In the U.S. today, the use of
- 14 -
3~*7
cash for sizeable transactions is very limited. The
Federal Reserve banks no longer circulate bills in
denominations over $100, and the bankers have been
talking about not only a cashless, but a checkless
society. More and more payments are being handled
through credit cards and computers. Our experience
has shown that large cash payments have a relatively
high probability of being connected with some tax
evasion, or drug trafficking.
It is apparent that most organized crime, white
collar crime and tax evasion is undertaken for economic
gain. Law enforcement agents who are required to document
such gain must rely on the records of financial
institutions in many instances. Without the record
retention requirements established under the Bank
Secrecy Act there would be no assurance that the
necessary records would be maintained by the banks
and other institutions.
In the majority of criminal tax cases, the
suspect does not make his books and records available
to the IRS special agent. The agent must reconstruct
the suspect's financial transactions to determine
his taxable income. A large percentage of IRS
recommendations for prosecution are based on two indirect
methods of proof that depend heavily on records of the
subject's bank account. One, the net worth and
expenditures method requires an analysis of all checks
issued for personal living expenses, entertainment, travel,
etc. The other procedure requires deposit slips to
establish the subject's income and checks to reconstruct
his allowable expenses and deductions.
The following summaries illustrate the importance
(1) The St. Louis District is presently
of bank records and reports in IRS cases:
conducting an investigation that was
assisted in part by the fact that the
provisions of 31 CFR 103 were adhered to.
During the course of the investigation
the special agent came into possession of
a Form 4789, Foreign Currency Transaction
- 15 Report, which indicated that the taxpayer
had negotiated approximately $100,000 in
cash. This discovery led the agent to
additional sources of income, unknown
bank accounts and new leads. The Form 4789
was required under 31 CFR 103.
A prominent Midwest druggist was sentenced
to three years in prison for a tax evasion
scheme involving extensive use of cashier's
checks. He purchased stock in his name
using cashier's checks in the name of
professional athletes. Various sports
figures testified that the taxpayer
induced each of them to buy cashier's
checks and to open safe deposit boxes.
The taxpayer then gave them large amounts
of currency to buy cashier's checks payable
to stock brokers on behalf of the taxpayer.
The scheme was discovered when an athlete's
name was used as the payee, rather than the
stockbroker. Additional taxes and penalties
were in excess of $550,000. The availability
of bank records of cashier's checks and
safe deposit box rental accounts was
essential to the successful conclusion
of this case.
On December 9, 1974, a corporate president
was fined $4,000 after a plea of Nolo
Contendere to filing a false income tax
return in violation of Section 7206(1).
Since the taxpayer had refused to turn over
any of his personal records it was necessary
to reconstruct financial transactions
through extensive use of bank records.
The bank furnished microfilm records of
his transactions which made possible
the discovery of unreported sources of
income. The taxpayer made regular use
of cashier's checks. The bank records
made it possible to identify these checks
and, thereby, uncover hidden assets and
savings accounts. Bank records also were
valuable in refuting the taxpayer's defense
that the funds were being held for his
children. The defense was negated by the
reconstruction of the children's income and
expenses through bank records and tax returns
which proved that the children did not have
funds available to give their father.
Unreported income was in excess of $150,000.
On May 20, 19 75, Hawaii's crime syndicate
boss was sentenced to 24 years in prison
for violations of Sections 7201 and 7206(1),
IRC. During the trial the Government proved
that the syndicate collected nearly a million
dollars of extortion money during three years.
The money was invested through front men
into legitimate businesses. Bank records
were used extensively to trace the flow of
money from one corporation to another. This
analysis enabled those persons involved to
be identified and to testify as Government
witnesses. Personal expenditures of approximate
$400,000 were uncovered through this method.
A former IRS revenue agent and his business
partner were sentenced to prison terms of
four years and one year, respectively, for
tax evasion. The case was worked using the
bank deposit method of proof. The taxpayers'
records were destroyed making it necessary
to rely heavily on bank records for reconstruction of income. All unreported receipts of
the business were converted to cash. Extensive
use was made of money orders and cashier's
checks. Checks which had been cashed rather
than deposited, were traced by examining
bank microfilm of the checks and tracing
funds to the purchase of money orders and
cashier's checks, many times in fictitious
names. The bank documents placed the funds
in the hands of the partner and led to testimony
which revealed the ex-revenue agent's involvement.
-17-
SVo
In drug enforcement cases involving large scale,
international conspiracies, the use of bank records is
constantly increasing. Many of the large payments and
the sizeable profits associated with an organized
narcotics smuggling and distribution ring must be
reflected in the bank records in some way.
In one case currently under investigation, at least
15 banks, located in the U.S. and seven other countries,
were used by members of the ring. The records of the
domestic banks involved will play an important role
in establishing the nature of the alleged violations
and information gained from the domestic banks may
facilitate access to the foreign bank accounts.
The IRS Form 46 83, U.S. Information Return on
Foreign Bank, Securities, and Other Financaal Accounts,
was initially designed to provide the IRS audit personnel
with additional information concerning a foreign
financial account that a taxpayer disclosed on his
income tax return. When a return reporting a foreign
bank account is considered for audit, the information
on the Form 46 83 is taken into consideration with other
available data in making a decision concerning its
disposition. If the return is assigned to a revenue
agent for examination, the revenue agent is alerted to
the location and the nature of the account.
Since the 19 75 tax returns no longer carry a
question concerning foreign financial accounts, the
Forms 46 83 provide the primary indication that a taxpayer
has an interest in or control over a foreign bank account.
The domestic currency transaction reports that are
required to be filed with the Internal Revenue Service
on Forms 4789 are matched with tax related allegations
and open cases. Those that are not immediately selected
to be used in a criminal investigation are made available
to the Audit and Collection Divisions for possible use
in a tax examination or a delinquency investigation.
One of the principal benefits from this reporting
requirement is that it presents an additional obstacle
to drug traffickers. The illegal traffic in drugs generates
enormous quantities of currency. The industry, which is
largely cash and carry, is generally estimated to amount
to billions of dollars annually. At some point, this
currency must enter the banking system and be recirculated.
The requirement that large and unusual currency transactions be reported presents a problem to the criminal
and makes his crimes more difficult to conceal.
The IRS Form 4790, which is used to report the
international transportation of currency and monetary
instruments to the Customs Service, was intended to
discourage illegal schemes involving the international
transportation of large amounts of currency or negotiable
instruments in bearer form. Just as sophisticated tax
evasion, large scale drug trafficking, and political
or commercial corruption frequently entail large
domestic currency transactions they are also the types
of violations that are likely to entail international
movement of monetary instruments. At the time the law
was enacted, Treasury officials did not fully anticipate
its potential in the fight against drug traffickers.
This reporting provision was seen principally as a
measure to discourage the skimming of untaxed income
from gambling casinos and similar sources. Today, we
believe that this requirement can be used very effectively
against drug smuggling activities.
Although the need for some of the provisions of
31 CFR 103 pertaining to security brokers is questionable
in view of their similarity to many of the SEC regulations,
it is still essential that brokers be subject to certain
provisions of the regulations. One reason is that SEC
regulations do not require brokers to secure signature
cards or similar account authorities from their customers.
In addition, since the securities industry is often used
as a channel for the investment of funds from questionable sources, brokers should be required to file the
reports concerning currency and securities that are
specified by the regulations.
EXPERIENCES IN IMPLEMENTING THE ACT
The implementation of the regulations by those
Federal agencies having the responsibility for ensuring
compliance with their provisions appears to have been
quite effective.
We have received only a small number of reports
concerning apparent violations from law enforcement
agencies, and the bank examiners have reported relatively
few violations of the major recordkeeping provisions. A
surprising number of smaller banks, however, have failed
to inquire concerning the purpose of loans in excess of
$5,000 as required by the regulations.
The IRS has received over 40,000 Forms 4789 reporting
unusual currency transactions since the regulations went
into effect in July 19 72. In addition the IRS has detected
a number of apparent criminal violations of the requirement to file Forms 4789.
In one metropolitan area, employees of a bank were
alleged to have assisted drug traffickers by accepting
bills of smaller denominations in exchange for $50
and $100 bills. Millions of dollars were involved.
The bank employees received a commission for agreeing
not to file the required Forms 4789. This investigation
has also resulted in 11 income tax investigations.
More than 43,000 Forms 4790, the reports of the
international transportation of currency and monetary
instruments, have been filed with the Customs Service
since the regulations went into effect. Through January 31,
19 76, 360 seizures were made, 11.8 persons were arrested,
and 2 3 convictions were obtained. More than 50 cases
are pending. The following is a representative sample
of some of the cases that Customs has initiated:
(1) The subject was a courier between
various cities in the U.S., Canada,
and the Bahamas. In 19 73 he flew a
private airplane into Florida from
the Bahamas and executed a Form 4790
for $66,000. Verification disclosed
that he was carrying $100,000. He
was tried in U.S. District Court for
criminal violations of 31 CFR 10 3 and
18 USC 1001. He was found not guilty
-20on all charges. The issues raised
during the trial were without precedent
and contributed to the apathy of the
jury. The subject, however, paid a
substantial administrative penalty to
the District Director of Customs.
In 19 73, the subject drove a private
automobile into the U.S. at Detroit
and gave a negative Customs declaration.
He denied possession of currency which
would require reporting. Secondary
search of the vehicle disclosed $17,850
in a package concealed behind the instrument panel. Subject was charged with
currency violations and subsequently was
tried and found guilty by jury in U.S.
District Court. He fled while on bail
and is at present a fugitive.
In December 1973, the subject drove a
private vehicle into the U.S. at Champlain,
N.Y. and when stopped by a Customs inspector,
denied possession of currency which would
require reporting. Subsequent search of
the vehicle disclosed 32 cloth bags
containing Canadian silver coins valued
at $27,500. Subject subsequently entered
a plea of guilty to violation of 18 USC
545 and was sentenced to a fine of $500
and one year probation.
In 19 74, the subject arrived at JFK
International Airport and was accorded
a continued Customs examination. A
personal search revealed $80,000 in
one-hundred dollar bills concealed in
his socks. He admitted that the currency
was the result of an illegal ticket
discounting operation involving an airline and a travel agency. The subject was
arrested.
-21-
f0/
In 1974, the subjects arrived by
commercial air at Atlanta from Mexico
City. Routine examination of luggage
disclosed one of them to be in possession
of negotiable common stock certificates
valued at $530,000. He denied ownership
of the certificates and accused his
companion, who also denied ownership.
They subsequently admitted that the
certificates were stolen in the U.S.
The subjects had unsuccessfully tried
to dispose of them in Mexico. At the
time they were apprehended, the subjects
were returning to the U.S. with the
certificates. They were arrested for
currency violations and conspiracy
and, after a hearing before the U.S.
Magistrate, were bound over for grand
jury action.
In 1974, the subject arrived at Anchorage
International Airport from Japan and
responded negatively to the currency
question on his baggage declaration.
During a continued examination, an envelope
containing $9,000 was found in his coat
pocket, and after questioning he produced
four additional envelopes containing a
total of $35,000. The subject, a U.S.
resident and self-employed importer,
was arrested and charged with a currency
violation and 18 USC 1001.
In 1974, the subject drove a private
automobile into the U.S. In response to
direct questioning, he stated that he had
less than $5,000 in currency on his person,
yet a search of the vehicle disclosed $34,000
in U.S. and Canadian currency concealed
under the floor carpet. Subject claimed to
be a money speculator; however, subsequent
investigation disclosed him to be an
associate of known major narcotics suspects
in Canada.
-22He was charged with currency violations
and admitted to $50,000 bail pending
disposition of the case.
(8) In 1974, the subject, travelling alone,
arrived by commercial air from Europe
and was accorded a continued examination
by Customs patrol officers who discovered
$80,000 in U.S. and foreign currency and
bearer instruments concealed on her
person, in the lining of her purse, and
in her luggage. The money was seized.
She was a U.S. citizen, married to an
alien, and had been residing in Europe.
She claimed the currency and instruments
were jointly owned with her husband and
represented earnings from their business
in Europe. The subject was subsequently
charged with violation of 18 USC 1001,
but she has fled the United States and
is at present a fugitive.
According to information developed in
Rome the subject's husband was an associate
of "Lucky" Luciano, and he had been
ordered to travel to the U.S., marry a
U.S. citizen, and remain available.
Subsequent to his original entry into
the U.S., the husband was granted a
voluntary deportation. Later his application for reentry was denied under a
provision relating to suspected narcotic
traffic, and he opened a business in
Europe.
-23-
5
The California Bankers Case
In June of 19 72, complaints were filed in the U.S.
District Court of San Francisco against the Secretary
of the Treasury by Fortney H. Stark, Jr., and others,
and by the California Bankers Association challenging
the constitutionality of the Bank Secrecy Act, and as
a preliminary action the court on June 30, 19 72,
issued a temporary restraining order preventing the
Treasury Department from implementing the reporting
provisions of the regulations which were due to become
effective on the following day.
On September 11, 19 72, a three-judge Federal Court
by a two-to-one decision granted a preliminary injunction
against enforcement by the Treasury Department of the
provisions of the Act requiring reports of domestic
financial transactions involving the payment, receipt
or transfer of United States currency or monetary
instruments. The Court, however, unanimously upheld
the sections of the Act requiring reports of foreign
financial transactions and the sections imposing recordkeeping requirements on financial institutions.
The portions of the Act struck down by the District
Court related to the Secretary of the Treasury's authority
to require financial institutions and individuals to
report on domestic financial transactions whenever he
finds that such reports would have a high degree of
usefulness in criminal, tax, or regulatory investigations
or proceedings. The court stated that the mere general
possibility that these reports would help in such
investigations was insufficient to justify the invasion
of one's rights to privacy in his financial affairs.
The District Court concluded that these provisions of
the Act violated the Fourth Amendment of the Federal
Constitution, which protects the people against unreasonable searches and seizures. The other provisions of the
Act were upheld.
Without expressly saying so, the District Court
appeared to hold that, (1) bank customers have a reasonable expectation of privacy in their financial transactions; (2) that it is reasonable for the drawer of
-24a check to regard himself as the real owner of checks
on his account with the bank; (3) information shown
on his checks may not be transferred to government
agencies without at least some notice, summons, subpoena
or warrant in connection with a legitimate pending
inquiry; and (4) the Fourth Amendment protects the
bank customer's right of privacy in his financial
affairs.
On appeal to the Supreme Court of the United
States, the plaintiffs conceded that the Fourth and
Fifth Amendments do not prevent Congress from requiring
businesses to maintain adequate records. They also
concede that privacy rights of third parties under
the Fourth and Fifth Amendments are not violated
when businesses produce such records for governmental
use pursuant to lawful subpoena or summons, but they
argued that such recordkeeping requirements are
limited to situations in which the records are necessary
to determine tax liability or to ensure proper regulation
of an industry. They pointed out that the Act requires
banks to maintain records needed to ensure compliance
by others with provisions of federal law. Yet neither
the Fourth nor the Fifth Amendment contains any such
limitations on the authority of Congress to require
maintenance of records. Numerous provisions of the
Internal Revenue Code and the Treasury regulations
thereunder require financial institutions and other
third parties to maintain records of the financial
transactions of their customers, employees, and others
with whom they deal.
Moreover, the recordkeeping provisions of the Act
raise far less serious Fourth and Fifth Amendment
questions than those in Couch v. United States, 409
U.S. 322 (19 73), where the Supreme Court upheld the
right of the Internal Revenue Service to require
production of a taxpayer's own financial records in
the possession of his accountant. Indeed, unlike
such taxpayer records, which remain the property of
the taxpayer, title to the financial records here
resides in the financial institutions themselves.
Bank records have traditionally been subject to summons
or subpoena by governmental officials. Therefore, it
cannot be said that bank customers have a reasonable
J V?
svr
expectation of privacy which would call forth any
Fourth or Fifth Amendment protection for the records.
Couch v. United States, supra; United States v.
Cleveland Trust Co., 474 f.2d 1232 (6 Cir. 1973).
Nothing in the cases or in logic would indicate
that a different rule should apply in the case of
records needed for regulatory or criminal law enforcement purposes. It is no less important to achieve
effective enforcement of the norms of conduct set
forth in the regulatory and criminal laws than in
those relating to revenue. It has long been established
that records maintained for tax purposes may be utilized
in the investigation and prosecution of other laws,
including the criminal laws. Indeed, virtually all
records maintained pursuant to one statute may be used
in the enforcement of other statutory schemes.
United States v. Silverman, 449 F.2d 1341 (2d Cir. 1972).
The Supreme Court held that the Bank Secrecy Act
was a valid attempt to detect illegal use of secret
foreign bank accounts and the "heavy utilization of
our domestic banking system by the minions of organized
crime." In upholding the recordkeeping requirements,
the Supreme Court held them to be a proper exercise
of congressional power to deal with crime in interstate
and foreign commerce. The court also said that the
requirement for reporting foreign transactions was
within Congress' authority to regulate foreign commerce.
- 26 Mr. Chairman, since the enactment of the Bank
Secrecy Act we have been confronted with various
legislative proposals to amend substantively not only
P.L. 91-508 but also the entire body of Federal law
regarding law enforcement access to records. Our
foremost concerns have been the possible legislative
creation of a probable cause standard where it has
never before existed and the establishing of a
business customer's standing to receive notice of
requests for access to records and to intervene in the
criminal investigative process which seeks such records.
The creation of a probable cause standard for
access to the financial records of a banking institution
would have a very detrimental impact upon law enforcement,
interfering with quite ordinary investigative techniques,
and leaving investigators with a scarcity of preliminary
informational resources. What is involved in the
investigative process was described succinctly by the
Department of Justice in tesitmony concerning H.R. 214,
the Bill of Rights Procedures Act, before the House
Judiciary Committee's Subcommittee on Courts Civil
Liberties and the Administration of Justice:
"A criminal investigation must begin somewhere.
Many, if not most, criminal investigations are
instituted upon the basis of allegations and
suspicions. Federal agents do not usually start
out with probable cause to believe that a certain
person committed a certain offense, and that
certain items of real evidence, or the fruits
of crime, or contraband can likely be found
at a certain location. Investigations ordinarily
proceed by inquiring of a large number of people
in the hope of developing evidence amounting to
probable cause. When investigators go to written
records, they are not doing anything essentially
different from when they ask questions of the
persons who made or were involved in making the
records, except that the records preserve memories
that may be lost."
f)
- 27 The financial records maintained by banks regarding
their account holders are often reviewed as an essential
preliminary step in criminal investigations and are
likely to be of particular significance in investigations
of organized crime figures, narcotics traffickers,
corrupt public officials, and other white collar
criminals. A probable cause standard for examination
of bank records would be a shield for criminals with
large movements of money and complex financial maneuvers
but would constitute a crucial impediment to the
public's right to protection from criminal enterprises
flourishing through predations concealed in our
financial system.
Basic to the legislative initiatives for a probable
cause standard for access to financial records is the
presumption that a customer of financial institution has
a Fourth Amendment right, enforceable by him, in records
of his financial transactions with others, when those
records are the property of another party to the
transaction. Yet nearly every Federal court to consider
this issue has declined to recognize any proprietary
interest by a customer in such records and has ruled
that a bank customer has no standing to challenge
reasonable access by Federal investigators to such
records. Harris v. United States, 413 F2d 316 (9th
Cir. 1969); Dosek v. United States, 405 F2d 405 (8th Cir.
1968); Galbraith v. United States, 387 F2d 617 (loth Cir.
1968); DeMasters v. Arend, 313 F2d 79 (9th Cir. 1963);
and Foster v. United States, 265 F2d 183 (2d Cir. 1959).
Again, Mr. Chairman, I direct the Commission's
attention to the Justice Department's testimony on
H.R. 214:
"The Fourth Amendment protection to which a person
is entitled ought not to be extended solely because
the person wishes something to be private. As the
Supreme Court said in Katz v. United States, 389 U.S.
347, 351-52 (1967), the Fourth Amendment:
. . . protects people, not places. What a
person knowingly exposes to the public, even
in his own home or office, is not a subject
of Fourth Amendment protection. iCitations
omitted,J But what he seeks to preserve as
privater even in an area accessible to the
public, may be constitutionally protected,
- 28 The Katz case then raised the matter of the person's
reasonable expectation of privacy. Many of the
kinds of transactions that would be covered under
[such legislative proposals] are indeed "private"
transactions, in that they are not displayed
for general public consumption. But they are
hardly "private" transactions in any other sense.
Records kept of these transactions, especially
when owned and maintained and used by the other
parties to the transactions, are records that
are commonly inspected by or at least exposed
to a number of people. For instance one expects
that when a check is written, records of its
progress through the clearinghouses and eventually
on the books of the drawee bank will be seen by
many people. No expectation of privacy in such
records, at least as the phrase is used in Katz,
would appear to exist.
It is our view that a warrantless search is
not unreasonable unless the Government, without
probable cause or exigent circumstances, intrudes
into an area in which the "proprietor" has a
reasonable expectation of privacy. See Katz v.
United States 389 U.S. 347 (1967). Those things
which an individual exposes to public scrutiny,
things which he does not himself safeguard from
third parties, are not protected by the Fourth
Amendment. It follows that records of transactions
of an individual which, in the normal course of
events, can be viewed or obtained by persons whom
that individual evidences no desire to select or
restrict are not items in which the individual
has an expectation of privacy."
Those legislative proposals which envision notification
of and standing to oppose requests by law enforcement
officials for access to financial records are clearly
in conflict with the cases and would make records
sacrosanct far beyond what is now the law. We cannot
find a reasonable justification for granting such
privileges to account holders.
SSI
Certainly, before creation through legislation of
rights which may adversely impact on the alleged
beneficiaries of such rights is undertaken, the proponents of such "rights" should present clear and
convincing examples of actual abuses of the access
process. Equally essential would be proof that the
demonstrated wrongs are of such volume and impact that
the public interest in a remedy will clearly outweigh
the advantages to the public which already inhere in
the present system of access. We are confident that
the advocates of such changes cannot sustain their
burden of proof.
We are unaware of any record of measurable abuse by
law enforcement officials resulting from their undisclosed
access to financial records even though such access has been
employed routinely over many years. However, we believe
it is abundantly clear that the American public will suffer
substantially from these unnecessary hindrances to criminal
investigations. Clearly, notice to an account holder that
law enforcement officials wish to review bank records
concerning him will frequently sabotage the ongoing
investigation. Since access to financial records is
commonly an initial element in developing a criminal
case, exposure of the Government's interest in those records
will allow a suspect to alter his operations, to falsify
or destroy evidence (including witnesses), or to flee
the jurisdiction even before an indictable case can be
developed or an arrest made.
Even if an investigation survived notice to the
account holder, it would be equally vulnerable from the
delay caused by the account holder's "right" to contest
the disclosure. Delay would be much more than a timeconsuming burden upon and an additional physical hazard
for a Federal agent; it would be another opportunity
for a criminal suspect to alter his operations or take
other evasive and escape actions as described above.
- 30 _
The Duty to Give Evidence
This brief exposition of the case law has shown
that bank' customers have no proprietary interest within
the scope of the Fourth Amendment in records maintained
and owned by financial institutions simply because information about the customers is physically embodied
in them. The records are the property of the financial
institutions maintaining them, and the Fourth and Fifth
Amendments do not bar reasonable inspections of those
records by law enforcement officials. Federal cases
also hold that whatever duty, if any, a financial
institution has to keep customers' account records confidential, it is outweighed by the greater duty to give
evidence.
This obligation to give evidence is deeply rooted
in the common law as imperative to the administration
of justice, and it underlies the rejection of a "right
of privacy" for customers regarding the records of
financial institutions. Professor Wigmore has cogently
stated the rule, thus: "For more than three centuries
it has now been recognized as a fundamental maxim that
the public (in the words sanctioned by Lord Hardwicke)
has a right to every man's evidence." And while claims
are made for exemption from this duty, those few which
are recognized "are distinctly exceptional, being so
many derogations from a positive general rule."
The duty to give evidence flows from fundamental
requirements of justice in a society of ordered liberty.
The administration of justice must be a search for truth
regarding which men can, hopefully, exercise wisdom. From
Hellenic antecedents, through the history of the English
common law, to our own Constitution, men have recognized
that civilized society must be more than an amalgam of
free individuals but, on the other hand, it is not merely
an ordered community. Justice has, thus, been made an
institution of our society requiring that the knowledge
of all men be made available to its instruments with
allowance for only the most clearly drawn and strongly
reasoned exceptions. Without the imposition of such an
obligation, truth cannot be sought and justice cannot
be done.
£S3
-31That special interests in some states have managed
to achieve some legislative immunity from the duty to
give evidence does not diminish the wisdom of the common
law obligation or its recognition by the courts. Nor has
its concomitant, that privileges^ are "derogations from
a positive general rule .. /and/ therefore, to be discountenanced" lost its standing before the courts. Rather,
the principles of the testimonial duty and the rejection
of insufficiently based privileges have received recent
reinforcement by two history-making decisions of the
Supreme Cout, Branzburg v. Hayes, 40 8 U.S. 665 (19 72)
and United States v. Nixon, 418 U.S. 683 (1974).
Branzburg dealt with a group of appeals from different
journalists who had been subpoenaed by grand juries to
provide information regarding criminals and extremist groups
with whom the reporters had met, in one manner or another,
in gathering material for exclusive stories. Various claims
were made by the appellants including First Amendment
assertions that a privilege necessarily attached to
communication between newsmen and their "confidential
news sources." In addressing the case of one petitioner
who had asserted a claim of a "newsman's" privilege,
the Court cited with approval Professor Wigmorefs
description and analysis of the duty to give evidence
and the strong argument against exemptions (4 08 U.S.
at 690) . In flatly rejecting the concept of a First
Amendment reporter's privilege, the Court stated:
"Until now the only testimonial privilege for
unofficial witnesses that is rooted in the Federal
Constitution is the Fifth Amendment privilege
against compelled self-incrimination. We are
asked to create another by interpreting the First
Amendment to grant newsmen a testimonial privilege
that other citizens do not enjoy. This we
decline to do. Fair and effective law enforcement
aimed at providing security for the person and
property of the individual is a fundamental
function of government and . . . we perceive no
- 32 basis for holding that the public interest
in law enforcement and in ensuring effective grand
jury proceedings is insufficient to override the
consequential, but uncertain, burden on news
gathering that is said to result from insisting
that reporters, like other citizens, respond to
relevant questions . . . of a valid grand jury
investigation or criminal trial." (408 U.S. at 689)..
More recent, of course, is the Supreme Court's
discussion in United States v. Nixon of the presumptive
privilege of the President described therein as having
"all the values to which we accord deference for the
privacy of all citizens [as well as] the necessity for
protection of the public interest in candid, objective,
and even blunt or harsh opinions in Presidential
decision-making." (418 U.S. at 682). Stated succinctly,
the Presidential privilege is "fundamental to the
operation of government and inextricably rooted in
the separation of powers under the Constituion."
Yet despite the impelling bases for the Presidential
privilege, the Supreme Court balanced it against "our
historic commitment to the rule of law," and found that
the "very integrity of the judicial system and public
confidence in the system depend on full disclosure of
all the facts . . ." (418 U.S. at 683). In reciting
for comparison some of the other "weighty and legitimate
competing interests" protected by privileges — Fifth
Amendment self-incrimination protection, attorney-client
and priest-penitent communications — the Court restated
the rule that "exceptions to the demand for every man's
evidence are not lightly created nor expansively construed,
for they are in derogation of the search for truth."
(418 U.S. at 710). Following this principle, the Court
then found that, in the absence of military, diplomatic
or national security secrets, even the extraordinary
presumptive privilege of the President was outweighed by
the need for information in the fair administration
of justice.
These two landmark cases have again emphasized the
compelling claim to "every man's evidence" which inheres
in our constitution and the precepts of justice. Strong
arguments were made in Branzburg that the First Amendment
guarantee of a free press demands the recognition of a
"reporter's privilege" and in Nixon that the separation
of powers
high level
doctrine
communications
and the need
establish
for confidentiality
privileges
- 33 transcending the needs of our criminal justice system.
In each instance the Court recognized the historically
preferred status of the asserted privilege; and in
each case the Court rejected the incursion on the criminal
justice system. Should we, in the face of such decisions,
now accept a claim of privilege for records of a business
relationship which, is at best, tenuously associated with
another person's expectation of privacy? Let us examine
this further.
If a privilege were to be recognized for protecting
the banker-customer association against examination of
transactional records, it would have to meet the four
fundamental conditions described by Wigmore as the
recognized prerequisites to establishment of a communications privilege:
" (1) The communications must originate in a
confidence that they will not be disclosed.
" (2) This element of confidentiality must
be essential to the full and satisfactory maintenance of the relations between the parties.
"(3) The relation must be one which in the opinion
of the community ought to be sedulously fostered.
"(4) The injury that would inure to the relation
by the disclosure of the communication must
be greater than the benefit thereby gained for
the correct disposal of litigation." (emphasis
in original).
Test Number One is certainly debatable since neither
American case law nor Public Law 91-508 can reasonably
serve as a predicate for banks to offer customers any
assurance of confidentiality from authorized law enforcement officials. Furthermore, the movement of financial
papers through ordinary channels of commerce necessarily
involves the imposition of others into the association
between customer and financial institution. An expectation
^s
- 34 of non-disclosure would be less than reasonable in the
circumstances of today's business practices.
Test Number Two clearly cannot be met by the relationship of financial institution-to-customer. Confidentiality
is patently not essential to the full and satisfactory
maintenance of such a relationship. This is demonstrated
by the practice of the financial community itself which,
as a business convenience and precaution, exchanges
information from records of customers seeking sejTVicas
from different institutions. Today's booming credit
industry also involves intrusion by credit bureaus and
other businesses upon bank information about customers.
Yet no diminution in the public's use of checking accounts
and credit arrangements has resulted.
Number Three is controverted by the line of court
decisions holding against the assignment to financial
records of a confidential status from Federal law
enforcement officials. In addition, our credit-oriented
society has continuously fostered more expeditious and accurate
mechanisms for financial transactions rather than the confidentiality of information concerning the bank-customer
relationship.
Test Number Four cannot be met because the public
suffers no measurable injury from law enforcement access
to records of financial institutions while it benefits
greatly in the administration of justice. As I hope this
testimony and the record of previous hearings on bank
secrecy have made clear, society gains significantly from
the availability to law enforcement authorities of
relevant financial records but forfeits no rights.
Of course, many other associational relations have
been claimed to have such a privilege and in some cases,
privilege has been granted in whole or in part by legislative
enactment. But the fundamental requirements which have
historically limited the privilege to a few highly
justified relationships have been left unexplored by
legislatures confronted with strong advocacy from
5
- 35 special interests who seek advantage over other members
of society iwthout meeting the hard tests described by
Wigmore and looked to by the courts.
We submit, Mr. Chairman, that the impetus for
establishing a privilege for the records of financial
institutions is the result both of supposed benefits
to the financial community and also of attributing the
status of a "right" to circumstances for which there is
no reasonable expectation of privacy, thus capturing
new adherents despite the lack of demonstrable abuses.
Who, after all, wants to advocate the violation of
peoples' privacy?
What we do advocate is the continuation of the
non-privileged status of financial records and the
applicability of Public Law 91-508 to financial
transactions. We are not seeking expansion of powers
regarding official access to records of financial
institutions. Yet in merely asking that the law not
be changed, the Government is too often characterized
as seeking to violate a right which does not even exist.
In the "privacy rights" campaign we are constantly
met by the example of foreign bank secrecy laws. One
recent article claims that Americans are "much more
subject to government investigation and intimidation"
than foreign nationals who are protected "through the
use of many national referendums and banking privacy."
Interestingly, that article notes in passing, but
makes no further comment upon, the strong differences
between the civil law systems with their placing of
the burden of proof upon the accused and our common
law legal system and the presumption of innocence.
But these differences bear greatly upon the need, or
lack thereof, for access to financial records.
In the United States, an arrest warrant cannot be
issued without a finding of probable cause to believe a
crime has been committed and that the defendant has
committed it. A search warrant also may issue only upon
a finding of probable cause. In our system the accused
is presumed to be innocent, and the Government bears the
burden of proof to the contrary beyond a reasonable doubt.
-36Thus, limited in the manner in which the Government
can bring a suspected criminal to account, we must rely
upon each citizen for evidence and must be able to
examine bits and pieces of information which are not
constitutionally imbued under the Fourth and Fifth
Amendments with confidentiality. Only by this process
of sifting and examining information which often proves
to be irrelevant can we develop cases against criminals
involved in complex illegal schemes.
Furthermore, under our Fifth Amendment a citizen
is secure against compulsion to appear before police
authorities and account for himself. We must develop
our case from witnesses and physical evidence. But
the civil law system will demand a personal explanation
of charges even if the result is self-incriminatory.
For civil law countries therefore, the investigatoryaccusatory process is simpler. An individual under
suspicion bears the burden of proof to justify his
actions and, thus, to prove himself innocent. Under
such circumstances, the liberty of "bank secrecy" need
not be breached to achieve the government's end, a'
prosecutable case against a criminal, since the suspect
himself is bound to produce his own refutation of
accusations against him.
The point here is that the recurring calls for
"bank secrecy" like that of some civil law countries,
ignore the crucial distinctions between our common
law traditions of criminal justice and the civil law
systems of most of Europe.
I am certain that none of us wish to exchange our
form of criminal justice for the possible enhancement of
a privacy interest in records of financial institutions.
Yet if financial records were to be accorded a confidential
privilege regarding law enforcement officials, it would
encourage a system like that of the civil law nations in
order to continue to enforce the criminal laws against
major organized crime figures, narcotic traffickers, and
white collar criminals engaging in sophisticated and
complex illegal financial maneuvers.
-37CONCLUSION
Mr. Chairman, under current case law and Public
Law 91-50 8, we have the means in our free society for
the reasonable examination of records of financial
institutions without undue burdening of the institutions
possessing such records or unfair intrusions upon the
persons to whom such records may relate. The availability
of such information is a logical companion to our country's
goal of achieving justice for all. Were we now to
create a "right of privacy" where it has never existed,
which strongly conflicts with society's right to evidence,
and which has not been demonstrated to be needed, we
will have taken a significant step toward inducing
atrophy in the criminal investigative process. If
expanded to other related business contexts, such as
hotel records or gasoline stations receipts, effective
law enforcement would cease.
We urge the Commission to balance the strong need
for law enforcement officials to gain evidence from
financial institutions against the manufactured right
of privacy in such information which the courts have
rejected. Having done so, we are confident that you
will join us in strong support of the Financial Transactions and Currency Reporting Act.
Mr. Chairman, that concludes my statement. I
will be happy to answer any questions you may have.
0O0
lepartmentoj
REASURY
TELEPHONE 964-2041
IGTON, O.C. 20220
<6 & I
FOR RELEASE AT 4:00 P.M.
April 22, 1976
TREASURY'S 52-WEEK BILL OFFERING
The Department of the Treasury, by this public notice, invites tenders
for $3,185 million, or thereabouts, of 364-day Treasury bills to be dated
May 4, 1976, and to mature May 3, 1977 (CUSIP No. 912793 D4 5 ) . The bills
will be issued for cash and in exchange for Treasury bills maturing May 4, 1976.
This issue will provide $750 million of new money for the Treasury as the
maturing issue is outstanding in the amount of $2,435 million, of which $1,092
million is held by the public and $1,343 million is held by Government accounts
and the Federal Reserve Banks for themselves and as agents of foreign and international monetary authorities.
Additional amounts of the bills may be issued to
Federal Reserve Banks as agents of foreign and international monetary authorities.
Tenders from Government accounts and the Federal Reserve Banks for themselves
and as agents of foreign and international monetary authorities will be accepted
at the average price of accepted tenders.
The bills will be issued on a discount basis under competitive and noncompetitive bidding, and at maturity their face amount will be payable without
interest.
They will be issued in bearer form in denominations of $10,000,
$15,000, $50,000, $100,000, $500,000 and $1,000,000 (maturity value) and in bookentry form to designated bidders.
Tenders will be received at Federal Reserve Banks and Branches up to one-thirty
P-m., Eastern Daylight Saving time, Wednesday, April 28, 1976.
be received at the Department of the Treasury, Washington.
for a minimum of $10,000.
Tenders will not
Each tender must be
Tenders over $10,000 must be in multiples of $5,000.
In the case of competitive tenders the price offered must be expressed on the
basis of 100, with not more than three decimals, e.g., 99.925.
Fractions may
not be used.
Banking institutions and dealers who make primary markets in Government
securities and report daily to the Federal Reserve Bank of New York their
Positions with respect to Government securities and borrowings thereon may
submit tenders for account of customers provided the names of the customers
are s e t
tenders
*-«»
forth in such tenders.
Others will not be permitted to submit
except for their own account.
Tenders will be received without
(OVER)
S~d£
-2deposit from incorporated banks and trust companies and from responsible
and recognized dealers in investment securities.
Tenders from others must
be accompanied by payment of 2 percent of the face amount of bills applied
for, unless the tenders are accompanied by an express guaranty of payment
by an incorporated bank or trust company.
Public announcement will be made by the Department of the Treasury of
the amount and price range of accepted bids.
Those submitting competitive
tenders will be advised of the acceptance or rejection thereof.
The Secretary
of the Treasury expressly reserves the right to accept or reject any or all
tenders, in whole or in part, and his action in any such respect shall be
final.
Subject to these reservations, noncompetitive tenders for $500,000
or less without stated price from any one bidder will be accepted in full at
the average price (in three decimals) of accepted competitive bids. Settlement for accepted tenders in accordance with the bids must be made or
completed at the Federal Reserve Bank or Branch on May 4, 1976,
in
cash or other immediately available funds or in a like face amount of Treasury
bills maturing May 4, 1976.
equal treatment.
Cash and exchange tenders will receive
Cash adjustments will be made for differences between the
par value of maturing bills accepted in exchange and the issue price of the
new bills/
Under Sections 454(b) and 1221(5) of the Internal Revenue Code of 1954
the amount of discount at which bills issued hereunder are sold is considered
to accrue when the bills are sold, redeemed or otherwise disposed of, and the
bills are excluded from consideration as capital assets.
Accordingly, the
owner of bills (other than life insurance companies) issued hereunder must
include in his Federal income tax return, as ordinary gain or loss, the
difference between the price paid for the bills, whether on original issue
or on subsequent purchase, and the amount actually received either upon sale
or redemption at maturity during the taxable year for which the return is
made.
Department of the Treasury Circular No. 418 (current revision) and this
notice, prescribe the terms of the Treasury bills and govern the conditions
of their issue.
Copies of the circular may be obtained from any Federal
Reserve Bank or Branch.
oOOo
3~4>3
FOR IMMEDIATE RELEASE
April 23, 1976
RALPH M. FORBES LEAVES TREASURY POST
Secretary of the Treasury William E. Simon today announced
the resignation of Ralph M. Forbes as Special Assistant to the
Secretary for Debt Management effective May 8, 1976.
Mr. Forbes was appointed by Secretary Simon on April 2, 1975.
Since that time Mr. Forbes has had primary responsibility for the
formulation of public debt financing policy. Additionally, Mr.
Forbes served as Vice President of the Federal Financing Bank.
"Ralph Forbes joined the Treasury a year ago," Secretary
Simon said, "at what was a particularly difficult time in the
history of public debt management. The Treasury this past year
borrowed more than at any time since World War II. To borrow on
the average almost $2 billion a week in new money and to refinance
the hundreds of billions in maturing securities without totally
disrupting the capital markets has been one of the great challenges
Treasury has faced in recent years. Ralph Forbes1 expertise and
dedication in this area have been essential in meeting this
challenge. "
oOo
WS-804
£&9
FOR IMMEDIATE RELEASE
April 23, 19 76
CORRECTION OF TREASURY'S 52-WEEK BILL ANNOUNCEMENT
The auction date in yesterday's offering announcement of 52-week bills was incorrectly stated as Wednesday,
April 28.
The auction will be Thursday, April 29.
OoO
WS-805
S 6J~
FOR RELEASE
9:00 P.M. EST, APRIL 22, 1976
STATEMENT OF JOHN A. BUSHNELL
DEPUTY ASSISTANT SECRETARY OF THE TREASURY
BEFORE THE NINTH ANNUAL MEETING OF THE
ASIAN DEVELOPMENT BANK BOARD OF GOVERNORS
JAKARTA, INDONESIA - APRIL 23, 1976
Mr. Chairman, Fellow Delegates, and Distinguished Guests.
On behalf of President Ford and Secretary Simon my
delegation wants to stress our continuing deep concern with
accelerating development in Asia. We also want to repeat
our wholehearted support for the Asian Development Bank —
the key regional development finance institution. As a nation
of the Pacific as well as the Atlantic, the United States
has a vital interest in continued development and improved
living standards for all the people of Asia. In our increasingly interdependent world increased peaceful cooperation
among nations enhances the welfare of all.
International Economic Situation
At the Eighth Annual Meeting of the Bank last year
Secretary Simon identified three central economic issues facing
the world in 1975:
First, to restore economic growth and price
stability around the world.
Second, to adapt to the energy shock in ways
that will provide more secure sources of energy
and will support a pattern for orderly growth; and
— Third, to adjust our financial policies to accommodate
massive shifts in international flows of funds.
Fortunately, today we can already see substantial
progress on each of these economic problems. The pace of
economic activity is already picking up rapidly in a number
°f countries. In the United States our economy has now been
growing for nearly a year and we are already seeing the effects
°f this growth on. the demand for the imports of the regional
WS-806
3d&
- 2 -
members of the ADB. With the completion of the downward
adjustment of inventories in the United States along with
similar favorable indications from other countries, we expect
the faster growth in the developed countries will have a
much more apparent effect on demand for the exports of developing
countr ies.
Most countries have also made substantial progress in
reducing price inflation. Some regional members of the ADB
have set an example for all of us in bringing price inflation
under control. However, for many countries, including the
United States, inflation rates are still higher than we would
expect during a period when productive capacity is not strained.
Clearly continuing progress in reducing inflation rates is
one of the greatest challenges we face over the next year as
productive capacity is more fully utilized throughout the
world.
Considerable progress has been made in many countries
in adapting to the energy shock. In the United States we
still have much to do to supply our energy needs more fully
from domestic sources. As our oil consumption rises and
production falls, we expect the increase in our oil import
bill in 1976 to be almost as large as our current account
surplus in 1975, assuming no change in oil prices.
We welcome the greatly increased emphasis the ADB has
given to helping member countries develop indigneous energy
sources as a major contribution to their own development
and to a better energy balance in the world. Over 20 percent
of ADB lending was in the enermy field last year and most
of this was for domestic energy sources such as the power
project in Thailand based on lignite and the Garung Hydroelectric
project here in Indonesia. Just last month the Bank approved
a project to expand Korean coal production. This ADB emphasis
should continue.
Finally, private financial markets have done an outstanding
job of moving funds from surplus to deficit countries. We
expect that the private markets will continue to play this
critical role. We tend to look only at the net borrowing
or lending of countries. Thus we overlook the fact that many
countries have both large inflows and large outflows of
long-term capital. Many of the countries which provide
support for the Asian Development Bank have been large net
borrowers in recent years even while they have been providing
capital to the Bank. This year the United States will be in
a similar position as it is unlikely that our current account
surplus will be nearly as large as our capital outflows to
£6 7
- 3 support development in the poorer countries. It should be
recognized that this situation makes it harder to build
popular support for development assistance. In most cases
the interest and other terms on the borrowing of donors are
far harder than the terms of our support to the ADB and other
development programs.
Despite the many strains of the past year I believe we
can all take pride in the fact that most countries have maintained their commitment to open trading arrangements and a
relatively free international flow of funds. I am particularly
impressed by the fact that developing countries have relied
heavily on aggregate monetary, fiscal and exchange policies
in adjusting to recent difficulties. They have also made
excellent efforts to maintain relatively open markets for
imports. These policies suggest that most developing countries
are increasingly understanding the advantages to their development
of more intensive participation in an interdependent world
connected by increasing links of trade and financial flows.
Moreover, we have made substantial progress in improving
the international system to deal with the sort of problems
faced in the past couple of years as well as to assist with
longer term development problems.
The IMF has agreed on amendments to provide for
improved longer term stability in international
trade and payments and for a substantial increase
in quotas, particularly for developing countries.
— The Compensatory Financing Facility of the IMF has
been enlarged to assist in financing shortfalls
in export earnings for reasons beyond a country's
control.
— A trust fund is being established in the IMF
that will use profits from the sale of a portion
of the IMF's gold to provide concessional assistance
to overcome temporary balance-of-payments problems.
— Agreement appears to be near on the creation of
the International Fund for Agricultural Development
to help increase food production in developing countries.
— My own country has initiated a system of generalized
tariff preferences as part of our efforts to liberalize
imports from developing countries.
£6?
- 4 —
Negotiations are virtually completed for a World
Bank capital increase and discussions have started
on the fifth replenishment of the International
Development Association. We expect agreement within
the next few days on a fivefold increase in the
capitalization of the International Finance Corporation.
This general increase — the first since IFC was
founded in 1956 — will permit substantial additional
capital assistance to private firms in Asia. With an
increase in capital, the IFC can play an even more
important role than in the past in helping to build
a strong private sector which is essential to economic
growth in developing countries.
The Role of the International Development Banks
The international development banks remain the primary
multilateral source of capital for long-term economic growth.
These banks last year made new commitments of $8.5 billion for
nearly 400 projects in over 80 countries. However, economic
development is not primarily a matter of money. While money
is needed, the key factors determining the success of development efforts are the policies and priorities followed by each
country. The development banks make important contributions in
precisely such areas, and in institution building. In recent
years the banks have accelerated the process of spreading
development benefits to the poorer people by placing greater
emphasis on agriculture, the family farm, and cooperatives —
an emphasis we encourage and support. The regional banks in
particular have an important role to play, because they reflect
the desires and needs of their regional members and have an
expertise and understanding of local conditions and problems.
Role of ADB
The role of the ADB is to bring its special expertise
and local knowledge to the development problems of Asia.
The Bank has done this well, due in large part to the leadership of President Inoue. I would like to take this occasion
to express my country's appreciation for his dedicated service
to the Bank.
The Bank's growing impact on Asian economic progress
is reflected in its activities last year:
Lending for agriculture and agro-industry was
over 37% of total ADB/ADF lending in 1975 compared
with 24.5% in 1974; we believe the 1975 proportion
is about the right emphasis on agriculture.
- 5 The Bank has given greater emphasis to the use
of intermediate technology in Bank-financed projects.
Recognizing that traditional capital-intensive
projects are often neither the most cost effective
nor the most appropriate, the Bank has focused
attention on the basic use of labor, combined with
less capital intensive technology, by supplying labor
with appropriate tools — be it a wheelbarrow, a 4
or 5 horsepower hand tiller, or a hand operated water
pump. In this way the Bank is able to make use of
idle manpower in its developing member countries and
at the same time, spread its limited resources such
that it reaches many more people. We hope the Bank
will greatly expand its use of appropriate intermediate
technology in the future.
The Bank also deserves credit for its efforts to
mobilize co-financing for development projects. The
Bank's cooperation with OPEC nations in financing
fertilizer projects is well known. Co-financing in
cooperation with private banks and other private
financial institutions has the potential to be a
major source of development finance. Such arrangements increase private sector involvement in the
development process and stretch the Bank's scarce
resources. We congratulate the Bank on opening a
a new horizon through the recent water supply loan
to Singapore in which the ADB arranged co-financing
with a private financial institution. We hope there
will soon be many such loans involving co-financing.
Such arrangements also help to introduce developing
countries to the international capital market and
thereby initiate the process of establishing on-going
financial relations for further access to private
financial markets. Through the mechanism of cofinancing, smaller banks and other financial institutions may also begin to lend to developing nations
by benefiting from the project appraisals carried
out by the development banks.
In order to maximize the development impact of ADB
operations, we. continue to believe that it should
reduce its financing of cost overruns. The Bank
should use its financial and human resources
to develop new projects, instead of allocating
additional scarce resources to projects already
underway.
^70
- 6 With the rapid growth in lending from $254 million in
1971 to $660 million in 1975 it would be prudent in the
period immediately ahead for the Bank to concentrate on
improving the quality of new loans and on continuing to
seek more effective implementation of loans underway. To
further this effort, the Bank must work toward a system of
more intensive project supervision. As the Bank becomes
stronger it should also become more active in the difficult
sectors where innovative lending is needed — such as in
rural development and other projects to reach lower income
groups.
Another area to consider should be equity investments
by the Bank in productive, employment-creating enterprises.
Such investments could encourage policies and institutions
which would further promote and broaden participation in
the development process. The Articles of Agreement of the
Bank authorize the Bank to make equity investments. I would
urge that the Bank actively study how it might make equity
investments and that the Board of Directors consider the
matter in the near future.
To finance its rapidly rising disbursements on loans
the Bank borrowed more in 1975 than in all previous years
combined. In 1976 it has already borrowed more than in
all of 1975. However, much of the Bank's borrowing is still
relatively short-term in comparison with the maturities of
its lending. Greater effort may be needed to increase the
average maturity of the Bank's borrowing. The confidence
the markets are now showing in Bank obligations suggests
that longer terms are becoming feasible.
During the past year there appear to have been more
interruptions in meeting financial obligations to the ADB and
the proportion of Asian Development Fund resources tied up in
inactive loans has increased.
My government feels that the
Bank should exercise its normal responsibility by taking
action to collect amounts due and to assure that funds which
are not being used are reprogrammed where appropriate so that
the 1976 ADF program can be implemented to the maximum extent
possible.
U.S. Support for the ADB
Speaking for my Government, I want to emphasize that
the Administration will continue its strong support for
the ADB. Subject to final Congressional action we will
soon subscribe our second installment of $120.6 million
6 7/
- 7 to the first replenishment of the Bank's ordinary capital
and make a further contribution of $25 million to the initial
resource mobilization of the ADF. I hope we will complete
this financing commitment to ADF and also subscribe to the
remainder of our share of the capital increase by October
or November after approval of our FY-77 budget.
The United States supports the replenishment of the ADF.
I would hope shortly to be able to announce a U.S. contribution
target for the replenishment which will be higher than our
previous contr ibution.
The United States also supports a replenishment of
the Bank's ordinary capital.
We believe that in laying
out the criteria for replenishment it is appropriate for
the Bank to review its lending, borrowing and financial
policies. The ADB is entering a stage of rapidly increasing
loan disbursement and borrowing requirements. It is a period
when the ADB must move from financing its loans from paid-in
capital to relying primarily on private capital markets.
The increased reliance of the Bank on private capital
markets, in turn, makes it all the more important for the Bank
to maintain a solid financial position. An improvement in
its financial indicators and its general creditworthiness
will reduce the cost of money to the Bank and help lengthen
the maturities of its issues. The Bank's financial position
could be strengthened by some modifications in various ADB
financial policies. This is important because bond purchasers
will look not only at the degree of governmental support
for the Bank, whether through paid-in or callable capital,
but also at the financial operations and management of the
Bank itself. In this regard I note with concern that the
Bank's income in 1975 did not increase from the level in
1974, even though the scale of the Bank's operations increased
substantially. The Bank's financial statements for 1975
indicate that this was due to sharply increased borrowing
and administrative costs, changes in currency values, and
increased funding of grant technical assistance.
Specific policies which we believe are necessary to
improve the financial strength of the Bank include: (1) that
the Bank's lending rate more fully cover the costs of its
borrowings and operations, (2) that the effective commitment
fee charged on undisbursed loans more closely parallel the
practices in the other international development banks,
(3) that the Bank make efforts to find ways other than use of
Bank income to fund grant technical assistance, and (4) that the
Bank restain the growth of administrative expenses.
6 7<Z
- 8 Our goal, and the goal of all friends of the Bank is a
financially viable and strong regional institution that is
secure in international capital markets, requiring decreasing
amounts of paid-in capital, and building reserves sufficient
to set aside portions to help finance ADF operations. It is
our hope these can be achieved over the course of the next
few years.
Before I close I want to express our great appreciation
to the Government of Indonesia for hosting this Ninth Annual
Meeting of the Asian Development Bank. We have looked forward
to visiting this dynamic and growing city of Jakarta and to
this opportunity to discuss the challenges and opportunities
facing Asia and the ADB.
In closing, I think it is worth remembering that the
fundamental purpose of the ADB, and of all the development
lending institutions, is to helo the people in developing
countries improve their living conditions. The basic justification for U.S. support of the ADB and of the other development banks has to be that they do a good job in using money
to help the developing countries help themselves and that
this development reaches the people in these countries in
a way that justifies U.S. taxpayer support. The practical
effects of our contribution will be spread to the poorest
villages, slums, and isolated areas in Asia where little
is known of the United States or the ADB, but where improved
seed, a well, a visiting health team, availability of credit,
or a road to the market can make — at small cost — an immense
difference in the quality of life.
oOo
mpartmemvfMREASURY ||^
6HINGT0N, D.C. 20220
TELEPHONE 964-2041
J"73
FOR RELEASE UPON DELIVERY
STATEMENT BY THE HONORABLE GERALD L. PARSKY
ASSISTANT SECRETARY OF THE TREASURY
BEFORE THE
SUBCOMMITTEES ON
INTERNATIONAL RESOURCES, FOOD AND ENERGY;
INTERNATIONAL ECONOMIC POLICY;
INTERNATIONAL ORGANIZATIONS;
AND INTERNATIONAL TRADE AND COMMERCE
OF THE HOUSE COMMITTEE ON INTERNATIONAL RELATIONS
WASHINGTON, D.C.
MONDAY, APRIL 26, 1976, AT 3:30 P.M.
UNCTAD IV: THE U.S. APPROACH TO CURRENT ECONOMIC ISSUES
Mr. Chairman, members of the Committee, I welcome this
opportunity to discuss the range of international economic
issues that will be the subject of intense debate and
negotiations during the fourth session of the United Nations
Conference on Trade and Development (UNCTAD IV).
We approach this meeting sympathetic with the aspirations
of the developing countries. We want to work with them in
seeking practical, realistic solutions to their problems.
Although each country is different, presenting unique
problems which require individual solutions, there are certain
WS-807
- 2-
needs that are shared and in turn there are certain priciples
which should apply to all.
All of the developing countries want to improve the
economic conditions of their peoples, and they want the
help of the developed countries in undertaking this effort.
We wish to see the growth and stability of the economies
of these countries.
It is clear to us all that this
world cannot indefinitely endure half rich and half poor.
The United States has played, and must continue to play
a leadership role.
We have given significantly of our
resources, both financial and human, to help in this process,
and we will continue to do so.
I believe the basic question
is not one of commitment to help, but rather one of process.
How can we best get the job done?
As such, I believe there
are several basic principles that we should bear in mind:
A country's economic growth rate will be
determined by the skill with which it utilizes
its own resources, not its status as an
industrial or less developed country.
Foreign
aid can make an important contribution to
development, but what developing countries
do for themselves will determine how they will
grow.
- 3-
Investment is the central propellant behind
economic development. While we must be sensitive
to the need to provide direct aid to those who
face drastic immediate problems, over the long
run the best way to assist developing countries
significantly is by helping them to create a
better climate for increased investment in their
country.
We must keep this goal in mind when
initiating new programs of bilateral and
multilateral assistance.
The development of a strong private sector
is essential.
In the United States and other
industrial countries, the private sector has
the technology and management expertise to
help developing countries.
We must not adopt
policies that will undermine maximum use of
this sector.
The free market may not be perfect but no
other system has been devised which will increase
production, improve efficiency and stimulate
growth in a better way.
Our efforts should be aimed
at helping other countries improve conditions for
- 4the better operation of the market system by
removing government controls.
We must resist
the erection of additional impediments to
market forces.
With these principles in mind, I believe the United
States must continue to lead others away from political
rhetoric to practical solutions.
Simplistic analysis
and overstatement, no matter how well intended, will
simply not help move us forward.
I do not believe that
calls for controlled commodity markets, massive transfers
of resources, and wholesale debt rescheduling or moratoria
are either realistic, or indeed necessary.
As we approach the problems of the developing countries,
we must not let the emotions of the international political
arena distort the economic realities.
For example, some
have expressed the view that "all of the developing countries"
are facing disastrous
balance of payments difficulties
requiring blanket solutions by the developed countries. The
recent world-wide recession has certainly
impacted the
developing countries severely, but they are not all teetering
on the brink of economic disaster, nor do they all share
the same problems.
In fact, although a large number of
3~v7
- 5developing countries have been experiencing abnormally large
current account deficits as the result of the increased prices
of their oil imports and weakened export markets, the deficits
have been financed without disrupting existing institutional
arrangements.
A number of developing countries have proven
creditworthy for substantial borrowings of private capital,
while other countries have benefitted from increased aid
flows.
There is reason to be optimistic that financing
will again be adequate in 1976, particularly in view of
lower requirements as a result of increased exports and
the new resources provided for by the Jamaica meetings.
Some individual developing countries will encounter
particularly difficult problems meeting their balance of
payments financing requirements, and we must find ways
to properly assist them, but we do not believe that this
will be a general problem
requiring blanket solutions.
This brief discussion of the realities of the LDC
balance of payments situation is only meant to illustrate
the dangers of oversimplification, and I will more thoroughly
discuss this issue later.
But I want to make clear that
we have attempted to shape our policies and proposals on
3 7S
- 6an objective analysis of the realities of the economic
situations of the individual developing countries, not
on the basis of misleading generalities that could result
in inappropriate, even harmful solutions.
UNCTAD IV in Perspective
Before turning to the specific issues which will arise
at UNCTAD IV, let me briefly review the events leading up
to this Conference.
The past two years have seen a
considerable change in the relations between the developed
and developing world.
In 1974, elements of confrontation
dominated the scene and certain relations became strained,
as the LDCs put forward their initial proposals for a
"New International Economic Order,"
which was elaborated
in the Charter of Economic Rights and Duties of States
adopted in December 1974, over the strong opposition, and
negative votes, of the U.S. and several other industrial
countries.
Such an atmosphere was truly counterproductive for
all, and in 1975
there was a major change in our relations
with the developing world.
At the Seventh Special Session
of the United Nations last September, Secretary Kissinger
put forth a broad range of positive proposals and consensus
- 7was reached on an approach to a number of major economic
issues that will be dealt with at UNCTAD IV.
Agreement
was also reached last fall to begin a serious dialogue
between the Western industrial nations, the oil-producing
developing countries, and the oil-importing developing
countries at the Conference on International Economic
Cooperation (CIEC).
The CIEC has resulted in an unparalleled, intense
dialogue between the developed and developing world.
Representatives from eight industrialized and nineteen
OPEC and non-oil developing nations are meeting each month
in Paris in the four commissions on energy, raw materials,
development, and financial affairs which form the CIEC.
UNCTAD IV will be another important part of this
dialogue.
This meeting, which brings together almost all
countries, including socialist states, will help determine
whether or not the North and South can continue a serious
joint effort to identify and solve problems relating to
our economic relations and avoid the nonproductive confrontation of the past.
A broad range of vitally important issues will be
discussed at UNCTAD IV, including commodities, trade, debt,
official development assistance, transfer of technology,
- 8and the future role of UNCTAD. A primary focus, will
certainly be on commodities, where UNCTAD advocates an
"Integrated Program" that includes many features we find
«
unacceptable, and on the financing problems of the
developing countries, where UNCTAD seeks generalized
relief measures.
I would now like to describe our approach to these
two important areas, as well as the other important
issues with which UNCTAD IV will be concerned.
Commodities
We expect that the commodities issue will be one of
the most important issues at UNCTAD IV.
It's difficult to predict precisely what the
developing countries really want, but if we look at the
Manila Declaration formulated last February and the UNCTAD
Secretariat's documentation for UNCTAD IV, I think we can
get a pretty good idea.
It would appear that they are
seeking endorsement of a so-called "Integrated Program" -a series of simultaneously negotiated commodity agreements
which would use buffer stocks as a price regulating
mechanism.
The buffer stocks would be financed by a
Common Fund, which would at the outset command about $3
billion in resources, with $1 billion from governments,
£*/
- 9 of which UNCTAD suggests roughly ten percent be contributed
by the U.S.
In addition, the LDCs want prices of their
raw materials to be indexed to the prices of manufactured
goods, they want the availability and concessionality of
compensatory finance improved, and they are anxious to
improve their access to developed country markets for raw
materials and processed and semi-processed goods.
The most controversial aspect of the UNCTAD commodity
program is the Integrated Program and its central mechanism,
the Common Fund.
The UNCTAD Secretariat
and many
developing countries appear to be seeking at UNCTAD IV an
agreement with the developed countries to:
hold a series of individual commodity negotiations
between producers and consumers which would lead
to commodity agreements for those commodities.
At a minimum UNCTAD would hope to get such
negotiations underway for a "core" of ten products, including cocoa, copper, cotton, hard
fibers, iron ore, jute, rubber, sugar, tea, tin.
agree in principle to the creation of a Common
Fund and establish a negotiating conference to
determine the precise structure and modalities
of such a fund.
- 10The Common Fund is the glue which holds the Integrated
Program together. It is, intended to be more th^n a buffer
stock financing mechanism. UNCTAD hopes.that such^an
institution would actively perform,the role of a catalytic
agent to prod producers and consumers to agree;pn specific
commodity agreements., UNCTAD envisages that^producers
in particular,would be stimulated by the availability
of funding for buffer stocks to overcome their own differences
and push hard for an agreement.
The United States has made.clear in the past that
we cannot endorse this aspect of the UNCTAD approach to
commodity problems, and we will do so again, at UNCTAD IV.
We do not believe that a generalized commitment can be
made to form commodity agreements, particularly agreements
based on a specific market intervention mechanism such as
a buffer stock. We believe that each commodity has its own
unique characteristics of production, transport,_storability,
marketing, and consumption, and thus thati commodity problems
can only be dealt with on a case by case basis.
We will also not support the concept of a Common Fund
for buffer stocks, particularly as a new independent
international institution which would play an activist role
in attempting to form agreements for individual commodities.
While we generally believe buffer stocks to be a price stabilization technique that is preferable to alternative market
intervention devices such as export controls, which may
build rigidities into the market, the applicability of
buffer stocks must be determined only on a case by case
basis. We have carefully reviewed the ten commodities which
UNCTAD has proposed as the core of its Integrated Program
and we are skeptical of the viability or utility of buffer
stocks as a stabilizing tool for most of those products.
We also believe that the appropriate method and sources
of financing to support the mechanisms of a commodity agreement must vary with the circumstances of each commodity.
These methods might include such techniques as commercial
borrowing, direct contributions by participants, export
taxes, or loans from existing international institutions.
If there is sufficient consensus among major producers and
consumers of a given commodity that an agreement is necessary,
and agreement is also reached that a buffer stock is the
appropriate technique to stabilize prices for that commodity,
we are willing to support a variety of different avenues
of financing the stock, but although we cannot support
aspects of the "Integrated Program" nor the Common Fund,
we do believe that a positive approach to commodity
problems is needed. It's for this reason that over the past
year and a half we have conducted an intense review of
£79
- 12 U.S. commodity policy. We created an interagency Commodity
Policy Coordinating Committee, reporting directly to the
Economic Policy Board and the National Security Council,
to undertake this task.
Through this mechanism, the U.S.
has reviewed the UNCTAD proposals and formulated our own
comprehensive approach.
In this review, we have found that we could support
a number of the objectives the UNCTAD program is intended
to achieve.
These would include a reduction in excessive
fluctuations in prices and supplies; the expansion of
efficient processing of primary commodities and diversification of productive capacity in developing countries; increased stability in developing countries1 export earnings;
and a lowering of trade barriers against processed and
semiprocessed forms of raw materials.
We believe the best means to accomplish these goals,
however, are different from the UNCTAD approach.
It is
our firm conviction that the market mechanism is on the
whole the most, efficient method of assuring that supply and
demand of commodities are kept in balance in a dynamic
world.
Although markets do not always operate efficiently,
the appropriate remedy is to strengthen their functioning,
not intervene or further impede market operations.
^P3~
- 13 At UNCTAD IV the U.S. will stress its own proposals in
the commodity field:
We believe that the most fundamental solution
to problems of wide swings in export earnings
as a result of changes in prices and demand
for commodities is to be found in compensatory
finance.
The recent reform of the IMF compensatory
finance facility, in line with U.S. recommendations at the Seventh Special Session, provides
very substantial additional balance of payments
support to those developing countries that
experience fluctuations in their export earnings,
while avoiding direct intervention in commodity
markets.
We have also proposed to broaden the
proposed Trust Fund to include additional compensatory financing to developing countries
that are particularly dependent on commodity
exports, where there is a balance of payments
need.
A decision on this proposal depends on the
creation of the Trust Fund and some experience
with its operations.
Commodity problems should be analyzed on a case
by case basis in forums composed of interested
producers and .consumers.
Where specific problems
- 14 arf identified, we will examine proposed solutions
and make suggestions of our own. Those proposed
solutions may range from research- and development
i
measures to promote consumption and improve market
)
^
it
}
distribution"systems and production efficiency,
to' the creation of buffer stocks to stabilize
prices and enhance supply security. In most
cases, we believe that coiriiiiddity problems will
best be solved through strengthening the market
mechanism, not by circumventing or thwarting it.
We support the creation of producer-consumer groups
for all major traded commodities where these do
not now exist. We will seriously study specific
commodity problems in such forums in order to
improve the operation of markets in those
commodities. We are moving toward such a forum
for copper and we are willing to look at others
such as bauxite or iron ore.
We continue to be concerned that the investment
climate in many developing countries may rePsult
in discouraging needed investment altbgether or in
forcing, investment in less productive, but safer
locations; in developed countries. We have urged
that the. World Bank Group increase its role in raw
£77
- 15 materials investment by combining its resources
and technical expertise with those of the private
sector.
We are also discussing the possibility
of proposing the creation of a new investment
institution which could be associated with
the World Bank to promote such investment.
In this way, we believe the U.S. has a positive,
comprehensive, and workable program to deal with commodity
issues.
We believe the solutions we propose meet the real
needs of the developing countries.
We hope that all
participants in UNCTAD IV will maintain a constructive
and realistic attitude in the commodity discussions, and
that agreement will be reached on a realistic, viable
program for further action in this field.
Development Issues:
Aside from commodity issues, the other major concern
at UNCTAD IV will involve problems of developing country
finance, particularly debt.
Before discussing this issue
in depth, however, I would like to make some observations
on development issues in general, as debt is only one aspect
of the larger question of how developing countries obtain
the external resources they need for development purposes.
£Tf
- 16 Development is a process requiring the infusion of capital,
technology, and management skills on a sustained and
substantial scale. While we believe that the developing
country itself is the main source for most of these resources
and must therefore make the effort necessary to hold down
present consumption in the interest of higher living standards
in the future, international support is also indispensable.
At UNCTAD IV, the most sensitive issue related to the
general question of aid flows is expected to be the demand
by developing countries that the industrial countries
increase their concessionary aid flows in order to achieve
the so called UN Second Development Decade target of 0.7%
of GNP.
This compares with actual aid flows from industrial
countries of 0.33% of GNP in 1974, the latest year for
which such data are available.
The U.S. supports a substantial increase in such flows
to the developing countries and has been increasing its
own development assistance.
We do not however, support
the .7% target -- which is clearly unrealistic for the U.S.,
since it would require over $11 billion annually in bilateral
aid, as compared with the $3.4 billion (0.251 of GNP)
provided in 1974. A number of DAC countries have accepted
the target in principle but only seven have committed themselves
£f?
- 17 to achieve the target by 1980. Sweden actually achieved
0.7% in 1974 -- the first DAC country to do so.
Concessionary aid flows are important for development
of poorer countries, but not as important for the other
developing countries as export promotion and other types
of capital flows.
For this reason, the U.S. made a number
of initiatives at the UN Seventh Special Session last fall
in the areas of capital market access, transfer of technology,
and direct investment.
Private capital markets are already a major source of
development funds, either directly or through intermediaries.
The World Bank and regional development banks borrow
extensively to lend to developing countries.
We have requests
before Congress or will soon be making requests to expand
the callable capital of several of these institutions.
As you know, such capital serves to guarantee IFI borrowings
in the private markets.
The more successful developing countries are the ones
that rely heavily on borrowing in private capital markets.
It is estimated that the developing countries borrowed
roughly $10 billion from private sector sources in 1975,
mainly in the form of commercial bank lending.
has, therefore:
The U.S.
^9d
- 18 Contributed actively to the work of the IMF/IBRD
Development Committee to explore ways to improve
access for developing countries.
Supported a major expansion of the resources
of the IFC -- the World Bank affiliated investment broker with the widest experience in
supporting private enterprise in developing
countries.
Proposed creation of an International Investment
Trust to mobilize portfolio capital for investment
in local enterprises.
Reviewed our own conditions for LDC access to
our capital markets and developed a technical
assistance program within AID to facilitate LDC
knowledge of and access to the U.S. capital
market.
The other two areas of concern -- transfer of technology
and private investment -- are closely related.
Technology
is vital to development, and international transfer of technology to the developing countries is necessary in view of
the cost and skills required to develop it.
Private invest-
ment is an important source of technology, as well as a
source of managerial talent and capital.
59/
- 19 Among the initiatives we have supported in these areas
are:
An International Industrialization Institute,
to sponsor and conduct research on industrial
technology.
An International Center for the Exchange of
Technological Information.
Voluntary and non-binding guidelines for
technology transfer to guide governments and
enterprises in this area, including the element
of restrictive business practices.
A voluntary and non-binding code of conduct for
multinational corporations to improve the understanding of all parties regarding their mutual
obligations.
We believe that the U.S. is in a position to play a
very forthcoming and constructive role at UNCTAD IV in
these three areas vital to the development of developing
countries -- capital market access, technology, and investment.
The Financing Difficulties of Developing Countries
Having briefly covered general development issues,
including the various proposals the U.S. has made to deal
with the development needs of the developing countries,
- 20 let me turn to the finance question in greater detail,
with particular attention to debt.
UNCTAD IV comes at a
period after the non-oil exporting developing countries
have experienced two years of abnormally large balance of
payments deficits as the result of increased oil prices,
the accompanying recession in the industrial countries,
and world wide inflation.
Deficits on current account,
which had averaged $9 billion annually in the early 1970's,
jumped to $28 billion in 1974 and an estimated $35-37
billion in 1975.
These increased deficits have been
largely financed by borrowings which of course will increase
debt service payments in future years.
Because of these circumstances, many of the developing
countries have focused all their attention on debt; whereas
we believe that the primary issue is really the balance
of payments.
In this regard, we believe that the balance
of payments situation for the developing countries as a
whole is beginning to improve.
We project that the
aggregate deficit of the non-oil developing countries will
decline by perhaps $5 billion in 1976, and that as a result
new external borrowing will also decline.
Projections of debt servicing prospects are difficult,
particularly in view of the wide diversity of debt situations
£73
- 21 and the fact that the capacity of individual countries to
respond to debt problems varies widely.
It should be
noted that a relatively small number of countries account
for the bulk of the debt and, in particular, of the borrowings
on commercial terms.
Furthermore, the poorer developing
countries most affected by recent economic events cannot
resort to private market borrowings to offset the higher
prices of oil and other imports and have to depend upon
concessional capital.
In view of low interest rates and
grace periods, such capital has a limited impact on debt
servicing, particularly in the short run.
Debt servicing is only one of the elements of the
balance of payments problems, but of course any sustained
deterioration in a country's
balance of payments position
makes debt service more difficult.
It is encouraging,
therefore, that improvement in the current account
positions of developing countries is anticipated as the
pace of recovery quickens in the industrial world and
commodity exports and prices increase.
Despite this,
many countries see no way to finance their desired development
programs without substantial further borrowings over the
next several years.
- 22 This situation has led the developing countries, with
the strong backing of the UNCTAD Secretariat, to set
forth a number of sweeping proposals to alleviate their
internal debt situation.
These proposals are based on
the premise that debt rescheduling would provide fastacting relief for their balance of payments situation and
supplement what they consider to be inadequate flows of
development assistance.
The proposals include:
For public development credits:
Waiving debt service payments by the mostseriously-affected countries for the remainder
of the decade; and
Converting such credits to grants for the least
developed countries.
For private credits:
An international fund to refinance service
payments over a period of 15-25 years at
commercial rates of interest.
In addition:
A conference of major developed creditors and
interested debtor countries to be convened in
1976 under UNCTAD auspices.
--
A shift in the forum and chairmanship for debt
rescheduling from the traditional creditor club
- 23 -
J~9£~
arrangements to the IMF.
The United States is deeply sympathetic with the
balance of payments position of the non-oil developing
countries and, together with other creditor countries, has
taken a number of steps to make available funds supplemental
to normal aid flows to meet the financial strain of the
developing countries erected by the oil price increase and
the onset of world-wide recession.
The United States
will continue its efforts in cooperation with other creditor
nations
to increase and direct aid flows to those countries
in greatest need
and to improve the access of developing
countries to private capital markets.
However, we cannot
agree to proposals for generalized debt relief, debt
moratorium, and new institutions for refinancing commercial
debt and the like for a number of reasons:
The proposals assume there is a debt problem
per se for all non-oil developing countries;
we believe that focusing on debt alone obscures
the overall balance of payments situation,
which for many countries is improving.
The proposals assume that all non-oil developing
countries or groups of non-oil developing countries
are encountering extreme problems in meeting their
debt service payments; we believe that debt service
- 24 problems are limited to very few countries.
--
The proposals assume that financing through debt
rescheduling should be based on the amount of
past debt or debt service payments incurred.
We believe finance needs must be evaluated
on a case by case basis, taking into account
a country's present circumstances and future
prospects.
The proposals assume that commercial credit can
be rolled over for extended,periods of time; wc
believe that commercial institutions cannot be
relied uponr to provide increasing amounts of
private capital if the ultimate timing of repayment is continually subject to question.
They assume that proposals for debt relief can
be undertaken without any adverse effects on
developing country creditworthiness and new
capital flows; we believe rescheduling adversely
affects developing countries creditworthiness and
new capital flows.
In short, we believe that adoption of these proposals
could lead to a severe deterioration in international
credit relationships. We strongly believe that these proposals are not in the best interest of the debtor countries
- 25 because they will destroy their creditworthiness and the
ability to borrow from public and private sources in the
future.
With regard to institutional arrangements for debt
rescheduling, the United States is willing to recommend
that the IMF play a greater role analyzing technical
issues related to rescheduling exercises than it has in
the past.
That would be in addition to its traditional
task of negotiating standby agreements that give the
creditors some assurance that the country requesting
debt rescheduling will follow policies that will turn
its economic situation around.
However, we firmly believe that actual negotiations to
reschedule a country's external debts should remain in the
creditor club context.
process.
A debt rescheduling is a very delicate
Debtors want a lenient rescheduling; creditors
wish to be repaid as soon as possible.
To shift the forum
and chair from the creditor club arrangement --
which has
served both debtor and creditor countries well over the years
through a series of extremely difficult debt rescheduling
exercises --
to the IMF, would expose the IMF to the
conflicting views of debtor and creditor countries and thereby
threaten to undermine the basis of its neutrality which is
of paramount importance to the continued success of the Fund.
ft'
It could also lead to pressures to reschedule IMF drawings,
thereby undermining the monetary character of the Fund.
We have recently appraised the nature and extent of
the external debt situation of the developing countries,
and have found the external debt situation of the great
majority of non-oil developing countries to be manageable.
The details of these findings were contained in our "Report
on Developing Countries External Debt Relief Provided by the
United States", submitted by Secretary Simon to this committee
on January 30, 1976.
Since the report was prepared, the
economic situation in several of the countries has improved.
Thus, for example, some countries, such as Bolivia, Peru
and Uruguay, now appear in a more favorable light, du6 to
the rise in economic activity of OECD countries and higher
commodity and metal prices.
Countries such as Chile and
Zambia, which rely heavily on copper exports for foreign
exchange earnings, now face a somewhat more manageable
situation, as the price of copper has risen from 55 cents
a pound in early January of this year to close to 70 cents.
As for countries such as Brazil and Mexico, which the report
noted have large private sector debts but also have productive
and diversified economies, the anticipated strong pick-up
in their exports to developed countries reinforces our earlier
conclusion that
they will be able to finance their projected
deficits and avoid debt servicing difficulties in 1976.
^77
- 27 As for the most seriously affected (MSA) countries,
it is significant to note that two MSAs, India and Pakistan,
account for over one-half of the debt service of all MSAs.
It is our perception that the economies of both India and
Pakistan are performing much better than most people realize.
For example, India is expected to attain a real growth
rate on the order of 5 - 6 percent this year and next, and
its trade deficit should narrow somewhat next year.
India's
international reserves have increased from $1.4 billion in
December 1975 to over $2 billion in March.
This amount
is sufficient to cover about 5 months1 imports which is quite
good for a developing country.
Pakistan's growth rate is also
projected at about 5 percent, its reserves are sufficient
to cover almost three months' imports, and Pakistan will
continue to benefit through at least 1978 from the debt
rescheduling arrangement of 1974.
As for the other MSAs, the picture is mixed.
Some
countries, such as Bangladesh, have contracted large amounts
of external debt mainly from multilateral and bilateral
institutions.
Since most of these credits carry extremely
low interest rates, the actual debt service payments falling
due this year and next are relatively small.
To conclude, U.S. policy has been, and will continue
to be, to extend credit on the explicit understanding
that it will be repaid according to the schedule agreed upon
6
- 28 by the borrower at the time the credit is authorized and signed.
The U.S. does not consider general debt relief to be
appropriate for providing official economic assistance to
the developing countries.
Our policy on debt rescheduling is to evaluate the merits
of each debt reorganization proposal on a case-by-case basis,
predicated on the principle of basic adherence to scheduled
terms of credit payment.
Within this framework, our objective
is to encourage countries to undertake appropriate corrective
policies in order to minimize the incidence of debt rescheduling
and relief operations.
Monetary Issues
In view of the comprehensive monetary reform package
that was agreed at Jamaica, I would not anticipate extended
debate on longstanding proposals by developing countries
to restructure the monetary system or an effort to re-open
a settled agreement.
While some may feel that the reforms
do not go far enough, I believe that most recognize that the
package as a whole -- involving important amendments to
the IMF Articles of Agreement, quota increases, and expansion
of access to IMF resources --
achieves the desired balance
and provides substantial benefits for all countries.
Without attempting to comment in depth on all the complex
- 29 provisions of the agreement, I would like to note the
most significant elements.
The new more flexible exchange arrangements focus
on achieving the underlying economic stability that is a
prerequisite for true exchange rate stability. Countries
are given wide latitude in choosing those particular exchange
rate practices best suited to their own needs so long as
they fulfill certain obligations calling for, among other
things, the promotion of stable underlying economic conditions
and non-manipulation of exchange rates to gain unfair
competitive advantage. Past efforts to mandate stability
by requiring maintenance of fixed rates provided only
the appearance of stability and often required extensive
controls and restrictions to sustain them. Such measures
disrupted development efforts by impeding trade, limiting
investment flows and forcing cut-backs in aid.
Concrete steps have been initiated to phase gold
out of a central role in the monetary system. The IMF
Articles will be amended to eliminate any important monetary
role for gold in the Fund and to provide for the future
disposition of IMF gold holdings. In addition, the IMF
will begin disposal, under existing authority, of 50 million
ounces of gold owned by the Fund (about one-third of its
total holdings), 25 million ounces to be sold for the
benefit of developing countries -- I already mentioned the
- 30 Trust Fund
--
and 25 million ounces to be sold to IMF
members in proportion to quotas.
The developing countries
will clearly obtain substantial benefits from these steps,
including the major share of the benefits from the agreed
Fund gold sales.
I am aware of some concerns of developing
countries that abolition of the official price might result
in a strengthened role for gold and in increases in liquidity
primarily for developed countries.
concerns are warranted.
I do not believe these
The comprehensive actions being
taken genuinely place gold on a one-way street out of the
monetary system.
The SDR will be made a more usable asset under the
amendments, thereby increasing its potential to become the
principal reserve asset in the system, a long-sought
objective of the developing countries.
Proposals for an
SDR-aid link were dropped from the monetary negotiations
at an early stage of the Interim Committee discussions,
and the U.S. will continue to oppose an SDR-aid link should
the proposals resurface in UNCTAD.
The link would be an
inappropriate means of providing aid and is inconsistent
with the monetary functions of the SDR.
In addition to amendments, IMF quotas will be
increased by about one-third, thus ensuring that the Fund
is in a position to meet members' future financing needs.
6a3
- 31 The quota share, and thus the voting share, of developing
countries has also been increased, thereby enhancing their
voice in IMF decision-making.
Monetary issues raised at UNCTAD IV may be introduced
in the context of the effort to find international financing
to meet the balance of payments problems of developing
countries.
Thus there may be efforts to use the IMF for this
purpose.
The Fund is the sole international institution with
responsibility for promoting the needed economic adjustments
that represent the only lasting solution to a country's
payments difficulties. The importance of IMF financing
therefore transcends the actual amounts involved, crucial
as they may often be, because it is closely linked to adoption
of economic policies designed to correct the underlying
cause of countries' problems.
The IMF has greatly expanded access to its resources
to help meet the enlarged balance of payments financing
needs of its members in the present period.
In the past
year, developing countries have borrowed nearly $2-1/2
billion from the IMF, nearly four times the peak annual
drawings prior to the oil price rise.
And, with agreement
on a comprehensive monetary package in Jamaica in January
the Fund's capacity to deal with members' payments problems
has been strengthened importantly.
- 32 --
A Trust Fund managed
by the IMF as trustee will
be established and begin operations in the very near
future to provide balance of payments support on concessional
terms for the poorest countries.
Resources will be obtained
by utilizing part of the gold owned by the IMF, through
market sales over a four year period.
Thus an asset which
has not been used in recent years will be mobilized to assist
needy countries in meeting their current balance of payments
difficulties.
Other financial contributions to the Trust
Fund will be welcomed.
-- A major liberalization of the IMF Compensatory
Financing Facility has been implemented that will be
expecially useful in dealing with payments problems in this
period of recession-induced fall-off in export earnings.
It is noteworthy that in the first quarter of this year,
the liberalized facility has already provided nearly
$500 million in loans, an amount that is more than 40
percent above the previous peak annual level of loans.
--
Access to the IMF's regular credit facilities
has been temporarily expanded by 4 5 percent, pending
implementation of the agreed increase in quotas.
-.
The IMF Buffer Stock Facility has also been
liberalized.
These measures represent a vigorous effort by the
6,
- 33 IMF to help its members, developed and developing, to deal
with their immediate financing problems.
They also
represent a reasoned response, and we do not feel it is
desirable, indeed possible, for the IMF to attempt to do more.
It is clear that the IMF cannot meet all the financing
needs of the developing countries and that its design, as
a monetary institution, is inappropriate to meeting development
financing requirements.
The resources available to the
IMF are finite, and steps to increase access further could
seriously impair the Fund's liquidity, to the detriment
of developed and developing countries alike.
A major strength of the IMF, and the basis of its
international prestige and support, is its unique monetary
character.
The private markets frequently rely on the
Fund's "discipline" to ensure that countries experiencing
balance of payments problems adopt the sound domestic
policies that are the essential prerequisites for maintenance
of credit-worthiness.
The policy conditions applied by the
IMF thus provide an important safeguard for private lenders,
in that they know IMF involvement will entail the adoption
of policies by borrowers that will strengthen their external
positions and enable them to repay their loans.
Should
the market's perception,of this role for the IMF be weakened
by an erosion of IMF conditionality, it is quite possible
that a resulting reduction in private credit
availability
- 34 would more than offset any potential increase in IMF financing.
This is one of the basic reasons why we cannot support a
further allocation of SDR's according to the principle
of an aid-SDR link.
A further weakening of conditionality
would seriously disrupt the flow of private credit to the
developing countries, and make achievement of their development
objectives even more difficult.
Trade
Although noncommodity trade issues will not be a central
theme at UNCTAD IV, some developing countries may seek
greater commitments from the developed countries on special
and differential treatment in the Multilateral Trade
Negotiations and for improvements on the various systems
of tariff preferences now in existence.
The developing countries are impatient over progress
in the MTN, and have argued that little progress has been
made toward granting them the kind of special trade treatment
suggested in the Tokyo Declaration of 1973, which launched
the current negotiations in Geneva.
They are particularly
interested in being exempted from limitations on the use of
export subsidies and in receiving special treatment or
exemptions in safeguard actions, such as the recent U.S.
escape clause actions on specialty steel and footwear.
- 35 They are interested in rapid action on the tropical products
negotiations in Geneva.
We are sympathetic with interests of developing countries
in securing additional benefits for their international
trade, in increasing their foreign exchange earnings,
diversifying their exports, and accelerating the growth
of their trade. The MTN will provide great benefits to the
developing countries. The tariff cutting formula we have
introduced will help the LDCs by increasing their general
access to the U.S. market, and by reducing the degree of
tariff escalation on semi-processed and processed products.
The U.S. has made a sound proposal in the tropical products
negotiations, and we too hope for rapid progress. We do
believe that some kind of special and differential treatment
for developing countries will prove feasible in certain
areas of the MTN, such as negotiation of general rules on
subsidies and countervailing. However, we believe that
the issue of special and differential treatment for developing
countries can only be dealt with in the context of particular
codes on other specific areas being negotiated, and cannot be
moved at a faster pace than the discussions on these issues.
We will also stress at UNCTAD IV, as we have in the MTN,
that the developing countries themselves can and must make
6t>7
Co?
- 36 contributions to the MTN, consistent with their levels of
development. This issue of supply access is a case in point.
Furthermore, we believe that special treatment for developing
countries must be linked with a phase-out mechanism, so that
as a developing country becomes more advanced and competitive
on the world market, its special treatment will be phased
out and it will begin to assume the same responsibilities
as other developed members of the world trade community.
As for generalized systems of preferences, the developing
countries would like to see these systems made a permanent part
of the world trading system and considerably liberalized.
We believe that as preferences are unilateral voluntary
actions by the developed countries, they are not subject to
negotiations, either in UNCTAD or at the MTN. We believe
the new U.S. system is a good one, and as we gain experience
with it we will examine possibilites of improving it.
While we will certainly listen to the suggestions of others
as to what improvements might be useful, actual decisions
are strictly an internal U.S. government affair.
Conclusion
I hope that my testimony has made clear that the
U.S. government has expended a great deal of effort in
carefully analyzing the problems identified by UNCTAD
and the solutions proposed by the Secretariat and by developing
countries. It should be clear that we believe that today's
6*?
- 37 world calls for cooperation among countries.
In that regard
we feel that we can agree with much of the articulation of the
problems and long-range goals identified by UNCTAD and the
developing countries.
There are differences of opinion with
respect to the solutions to these problems.
We will not
reject any proposed solutions out of hand, but explain why
we do not believe certain approaches would be in the interest
of the world.
Further we have developed proposals of our
own which we believe will accomplish the same objectives
more effectively. It will be our task at Nairobi to lay
these various proposals on the table and begin the process
of arriving at a consensus on where to go next.
If 1976
can be characterized as a year of dialogue, perhaps the work
accomplished over the next months will make 1977 the year
of consensus.
FOR RELEASE UPON DELIVERY
April 27, 1976
STATEMENT OF GERALD L. PARSKY
ASSISTANT SECRETARY OF THE TREASURY
FOR INTERNATIONAL AFFAIRS
BEFORE THE SENATE FOREIGN RELATIONS COMMITTEE
APRIL 27f 1976 at 10:00 A.M.
I welcome this opportunity to appear before your
Committee this morning in support of S. 3103, which would
authorize a U.S. contribution of $50 million to the Asian
Development Fund (ADF), the concessionary lending facility
of the Asian Development Bank (ADB). It is contemplated
that this amount, which has been included in the 1977
budget, would be the first installment of a three-year U.S.
contribution to the ADF to be spread over fiscal years
1977-1979.
Before discussing the details of this legislation and
the total replenishment proposal, I would like to address
briefly the importance of U.S. participation in the international development banks and then provi
@FedFRASER